DODD FRANK AND CAPTIVES

Delaware Captive Insurance Association2013 DCIA Spring Forum

Hotel du PontWilmington, DE

May 14, 2013

Charles J. (“Chaz”) LavelleBingham Greenebaum Doll LLP101 S. Fifth Street, Suite 3500Louisville, KY 40202502/587.3557Fax 502/540.2155clavelle@bgdlegal.com

Stuart H. Anolik CBIZ MHM, LLC | Managing Director 3 Bethesda Metro Center, Suite 600 Bethesda, MD 20814 301.951.3636Fax 301.951.0425sanolik@cbiz.com

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Dodd Frank and the Wizard of Oz

• Dodd Frank is like the Wizard of Oz– When the movie Wizard of Oz is mentioned, all think of the wizard– Wizard drew all the attention during the movie– The wizard was all the fury and commotion– The wizard had nothing to do with the outcome – he was on

screen for 10 minutes and didn’t get Dorothy home– Dodd Frank has little to do with the obligation to pay tax – it does

not impose a new tax, it only tells where the tax is paid (maybe)– Dodd Frank did, however, focus attention on self procurement tax

• The self procurement taxes are the ruby slippers – they are the main event

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Types of Taxes Based on Premium

• Premium Tax – imposed on insurance companies licensed in state

• Surplus Lines Tax – imposed on broker licensed in state with respect to insurance from insurance company not licensed in state for hard to place coverage

• Self Procurement Tax – imposed on insured that purchases insurance from an insurance company that is not licensed in state

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Rates of Taxes Measured By Premium

• The commercial insurance premium tax is generally in the range of 2% to 3%

• The captive insurance premium tax rate is often .4% or .38% of premium (sometimes on the first $x of premiums, then lower); some states impose a fee (say $5,000) rather than, or a cap on, premium tax

• The surplus lines tax is typically greater than the commercial insurance premium tax, often 2% to 5%

• The self procurement tax rate is usually comparable to the surplus lines tax rate

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Nexus

• The premium tax is imposed on an insurance company licensed in the state

• Normally, an insurance company must have some “nexus” to the state in order for the state to have the authority to tax that company

• “Nexus” generally means that the company has sufficient contacts with the state (physical presence property or employees in the state vs economic nexus)

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Nexus (cont’d)

• Allgeyer v Louisiana, 165 U.S. 578 (1897) – misdemeanor and $1,000 fine prohibited where the risk was in Louisiana, but it was insured in New York, although there was a letter sent by the insured, from Louisiana

• St. Louis Cotton Compress Co. v Arkansas, 260 U.S. 346 (1922)– Arkansas could not collect premium tax where the risk was

located in Arkansas, but the insurance company was in Missouri– The insurance company did not have any office in Arkansas– The insurance company did not have any agents in Arkansas

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Nexus (cont’d)

• Connecticut General Life Insurance v. Johnson, 303 U.S. 77

– California could not tax two insurance companies authorized to do business in California, where one reinsured life insurance on California residents to the other in Connecticut

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Surplus Lines

Surplus Lines Broker•Have to demonstrate inability to obtain coverage•Must have made robust search•Although the insurance company may be outside the reach of the state to tax, the broker is subject to tax•There is nexus because the broker does business in the state

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Rates of Taxes Measured by Premium (cont’d)

• The self procurement tax is imposed by about 40 states; Delaware does not appear to have a statute; see Atlas Mutual Insurance Co. v Fisheries Co., 22 Del. 256 (1907)

• The self procurement tax is also referred to as direct placement

• A state cannot impose a premium tax on a company not licensed or doing business in that state and a self procured policy is not subject to a surplus lines tax on the broker (there is no broker on the transaction and no company listed on the surplus lines list

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Self Procurement Tax

• The question is whether a state can levy a tax on the self-procurement of insurance on one of its citizens, when the acquisition of the insurance takes place wholly outside the state?

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Todd Shipyards, 370 U.S. 451 (1962)

• In State Board of Insurance v. Todd Shipyards Corp., the U.S. Supreme Court held that Texas could not tax the purchase of insurance by a New York company from a New York insurance company, even though the risk insured (ship yard) was in Texas– The policy was issued outside Texas– All the negotiations for the policy took place outside Texas– The payment of the premium was outside Texas– The claims adjustment and payment would be outside

Texas – The insurers are not licensed in Texas, nor have agents, an

office or place of business, nor solicit business or investigate risks or claims in Texas

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Todd Shipyards (cont’d)

• Todd Shipyards reaffirmed the earlier cases such as– Allgeyer v. Louisiana

– St. Louis Cotton Compress Co. v. Arkansas

– Connecticut General Life Insurance v. Johnson

• Todd Shipyards said that nothing in the McCarran Ferguson Act changed the earlier cases – McCarran Ferguson Act generally gives states the right

to tax and regulate insurance

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Dow Chemical Co. v. Rylander

• The Texas state court found that Texas could not impose the self procurement tax in Dow Chemical Co. v. Rylander, 38 S.W. 3d 741 (Texas 2001)

• The court followed Todd Shipyards because in Dow the insurance company was outside Texas, the property was owned by a non-Texas company, the policies were negotiated, executed, delivered and paid for outside of Texas, claims would be investigated outside Texas, there would be no communications inside Texas, etc.

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Further Texas Action

• In January 2007, the Texas State Comptroller stated that it will impose the self procurement tax, when one of a number of activities take place in Texas, in addition to the risk being located in Texas: payment, policies issued or delivered, underwriting or loss adjustment, investigation or payment

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Other State Procurement Tax Cases

• Despite Todd Shipyards and Dow Chemical, other state courts have often imposed a self procurement or other tax on purchase of insurance by an insured directly from a non-licensed insurance company. For instance:

– Associated Electric & Gas Insurance Services, Ltd v. Clark, 676 A. 2d 1357 (R.I. 1996), AEGIS is a leading case

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AEGIS (R.I. 1996)

• Associated Electric & Gas Insurance Services, Ltd v. Clark (R.I. 1996) -- AEGIS is a foreign (Bermuda) insurance company that insured four electric utilities in New Hampshire

• Neither AEGIS or its affiliate, AEGIS Services, and MGA, entered the state of Rhode Island

• This case is really a premium tax case, because Rhode Island did not have a self-procurement tax

• AEGIS said that it did not conduct business in Rhode Island and Todd Shipyards forbade the imposition of tax

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AEGIS (cont’d)

• The Rhode Island court looked to a U.S. Supreme Court case that occurred after Todd Shipyards, but had nothing to do with insurance

• Quill Corp. v. North Dakota, 504 U.S. 298 (1992) involved a company that saturated North Dakota with mail order catalogues, although Quill did not have any property or employees in North Dakota

• North Dakota imposed a sales tax on the mail orders made by North Dakota residents

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AEGIS (cont’d)

• In Quill, the U.S. Supreme Court noted that, even though Quill did not have a “physical presence” in North Dakota, Quill “availed itself of an economic market” in North Dakota

• The Rhode Island court concluded that (1) Quill represented the current view of the U.S. Supreme Court (and, essentially, Todd Shipyards had been passed by) and that (2) the U.S. Supreme Court would impose a tax under its current view

• Thus, the Rhode Island court imposed the tax

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Dodd Frank / NRRA

• Dodd-Frank Wall Street Reform and Consumer Protection Act – PL 111-203 (July 21, 2010), effective July 21, 2011

• The Nonadmitted and Reinsurance Reform Act of 2010 (NRRA) – Tax on premiums of non-admitted insurance companies will

be paid to the home state, not to the various states in which there is insured property

– Clearly applies to surplus lines, but many argue that it does not apply to captive insurance companies

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Dodd Frank/NRRA – Cure to Perceived Problem

• Prior to Dodd Frank, the perceived problem was that a surplus lines broker who procured surplus lines for a business with an office or other property in every state had to divide the premiums among 40 states and process the paperwork

• The surplus lines brokers wanted to streamline the process and pay only to one state (and only file in one state)

• Those involved in the legislation say that captives were never mentioned in the negotiations, and, if asked, those involved would have said that Dodd Frank does not apply to captives

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Dodd Frank/NRRA - Framework

• Only the insured’s home state can impose a tax for “non-admitted insurance” (section 521)

• Section 527(9) defines non-admitted insurance as p&c insurance that is permitted to be placed directly or through surplus lines broker with an eligible “non-admitted insurer”

• A non-admitted insurer is one that is not licensed to engage in insurance in a state– Includes surplus lines company– Does it literally include a captive?

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Home State for NRRA

• “There’s no place like home”

– Glenda, the Good Witch

– Dorothy

– Dodd Frank

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Home State for NRRA (cont’d)

• Home state is:

– State where the insured has principal place of business

– If 100% of the risk is outside the state with principal place of business, then the home state is the one with the greatest percentage of premium

– If affiliates are named insureds, then the home state is the home state of the affiliate with the largest percentage premium

• It is generally viewed that the home state is determined on a policy be policy basis

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Compacts Among the States

• The NRRA authorizes (and “everyone” assumed that) the states would enter into compacts (section 521(b)(1))– The home state would collect 100% of the tax

– The home state could require that the surplus lines brokers and insureds to file reports each year in which the premiums would be allocated among the states in which the risk resided

– The home state would then divvy up the tax among the states in which the risk resided

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Compacts Among the States (cont’d)

• Two different compacts have arisen, but neither is in force– NIMA (Non-Admitted Insurance Multi-State Agreement)

• This has the support of the NAIC• 12 states have adopted, but 6 have pulled out

– SLIMPACT (Surplus Lines Insurance Multi-State Compact)• Supported by the NCOIL – National Council of Insurance

Legislators• 9 states have adopted

– Many larger states have determined to keep the 100% that they collect, and forego the ability to share in other states’ receipts

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NRRA – Approaches?

• Some approaches?– Domicile captive in the headquarters state of the operating

company• Either use the domicile captive as the only captive or as a front

which reinsures to the historic captive• Will this result in jurisdictions with substantial captive expertise,

but few headquarters, to lose captive to states with many headquarters ?

– Issue policy to one or more, but not all, insureds in an affiliated group; perhaps have more than one captive

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Coalition for Captive Insurance Clarity

• McIntyre & Lemon PLLC “white paper” concludes that there was no intent for the NRRA to apply to captives -- 10/6/11

• Coalition for Captive Insurance Clarity -- November 2012

– http://www.vermontcaptive.com/DoddFrank

• VCIA organized the coalition• CICA wrote a supportive letter

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Coalition for Captive Insurance Clarity (cont’d)

• Rep Judy Biggert 12/16/12 statement that Dodd Frank was never intended to apply to captives– Rep. Biggert was Chair, Subcommittee on Insurance,

Housing and Community Opportunity, Committee on Financial Services

• Rep Scott Garrett (R-NJ) 2/6/13 statement that Dodd Frank was never intended to apply to captives– Co-author of NRRA

• Anderson Kill & Olick paper 2/27/13

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What if the Coalition is Successful?

• If the Coalition is successful, it will make it clear that the home state cannot collect 100% of the tax

• The insureds will still be subject to self-procurement tax to the extent that they were previously subject

• States may be more sensitized to the ability to impose self procurement tax

• Presumably Todd Shipyards will apply to the extent that it applied before Dodd Frank