Will Dodd-Frank Double-Tax Captive Insurers?

Confusion about a sub-section of the act has left an opening for a state to tax a corporate-owned insurance company if it's domiciled in another state.
Caroline McDonald

A sub-section of the Dodd-Frank Act, the Nonadmitted and Reinsurance Reform Act (NRRA),  has become a source of worry for the senior finance and tax executives of companies that self-insure their own risks via domestically domiciled captive insurance companies.

The source of anxiety is whether a captive domiciled in a state other than its parent company's home state may expose the parent company to double taxation: a self-procurement tax on the corporate policyholder collected by the home state (under the NRRA), and a premium tax on the captive charged by the state where the captive is domiciled.

Confusion arising from the NRRA, which took effect July 2011, has left an opening for states hungry for revenue to treat captive insurers as "non-admitted insurance companies," requiring their corporate owners to pay a premium tax if they're domiciled in a different state than their captives are. A rewording of the bill may be required to put the genie back in the bottle, experts say. (Nonadmitted insurance companies are those insurers that are not licensed in a given state. The NRRA changed the basis for the collection of self-procurement taxes from the state where the corporate policyholder has risk exposure to the policyholder's home state.)

Rep. Scott Garrett (R.-N.J.), co-author and a principal sponsor of the NRRA, has tried to clarify the matter, addressing the Speaker of the U.S. House of Representatives in February. “The NRRA was drafted with the specific intention of addressing burdensome and often conflicting regulatory and tax compliance issues facing only two industries—the surplus lines and reinsurance,” he said. “This legislation received bi-partisan support and was passed by the U.S. House of Representatives in multiple Congresses. At no point during the bill’s multi-year consideration was its application to the captive insurance industry ever discussed.”

He added, “Should regulators implement this faulty interpretation, captive insurance companies would be subject to additional taxation and regulation—the exact opposite intent of the underlying legislation.”

Rep. Garrett also said he has “pledged to work with his colleagues” on the Financial Services Committee to see that the bill is implemented as was intended by Congress. Maggie Seidel, a spokesperson for Garrett, told CFO, however, that whether a bill aimed at rewording the NRRA will be introduced is uncertain. “We’ll keep an eye out, but as far as moving anything, does this mean we are rewording the bill? To that effect and what the time frame is, I couldn’t tell you,” she said, adding, “There are no plans for that at this time. We are looking at it.”

Anderson Kill & Olick attorneys Phillip England, Marshall Gilinsky, Andrew Walsh and Patricio Suarez explained in a Bloomberg Bureau of National Affairs Daily Tax Report in December 2012 that the NRRA represented the culmination of efforts by surplus lines insurance companies and brokers to streamline the way taxes on surplus lines insurance are collected. But in “tacking the NRRA onto the Dodd-Frank Act, Congress unintentionally has pitted states against each other in the search for revenue and now often is viewed as having inserted itself into business judgments which are better left to corporate managers,” according to the report.

“The uncertainty that the NRRA has caused for captives could be resolved easily via clarifying federal legislation but, despite efforts by certain legislators, congressional action regarding Dodd-Frank’s implications for the captive insurance industry might well take second place to dealing with the well publicized concerns expressed by prominent financial institutions about other features of the Dodd-Frank reforms,” the authors noted.

Meanwhile, Brady Young, president and chief executive officer of Strategic Risk Solutions, a captive management firm, recalls that before Dodd-Frank “and all the recent attention, there was no procurement-tax issue, or the obligation. The issue was under the radar screen.”

Now, however, captive owners should pay close attention the issue. “It’s not going to just go back to the ‘good old days.’ If it’s an issue of potential risk for captive owners, then it’s something the captive industry needs to deal with,” he says.

David Provost, deputy commissioner in the captive insurance division of the Vermont Department of Financial Regulation, notes that Rep. Garrett’s statement “certainly didn’t hurt. It will help to get a positive resolution in some form or other.” He added, “It helps that he came right out and said, ‘We never even considered captives.’” (Vermont is the leading U.S. captive domicile.)

“This was all about surplus lines tax and not about captives. The way [some of the states] were reading it is that since a captive isn’t ‘admitted,’ you could call it non-admitted,” he says.

Taxing captives for locating outside a state domicile, however, is “not good for any domicile. Even those that might get a short-term advantage by pressing it, realize that in the long run, all this would do is limit states to domiciling their home businesses, which will automatically limit your audience,” he observes.

While confusion over the NRRA may have affected what domiciles some captives have chosen, he doesn’t believe the act has dampened formations overall.

Captive insurance is a regulated form of self-insurance that has been used by corporations since the 1960s to better manage their risks. Captives are generally used for such corporate lines of insurance as property, general liability, products liability, and professional liability.