Author Archives: Robert Myers

About Robert Myers

Robert “Skip” Myers is the managing partner of the Washington, D.C. office of Morris, Manning & Martin, LLP. His practice focuses on insurance regulation and corporate matters with an emphasis on captive insurance and alternative risk transfer.
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D.C. Improves its Captive Law

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Since the passage of the first captive law in the District of Columbia in 2000, D.C. has become one of the premier captive domiciles in the United States. In 2006, the captive law was significantly enhanced by the enactment of protected cell legislation. D.C. was the first domicile in the nation to have an incorporated cell capability, which has proven to be very popular. The D.C. Council recently passed the Captive Insurance Company Amendment Act of 2014 (2014 Amendments), which was designed to streamline the chartering, licensing and operation of D.C. captives.

One of the most attractive aspects of the D.C. law is its protected cell regime. However, the minimum capitalization requirements have proven to be an unnecessary burden. The 2014 Amendments grant the commissioner the authority to reduce or eliminate the minimum capital requirement for both the cells and the “core” (the cell representing the protected cell company), as long as the capital is adequate for the “type, volume and nature of insurance that is transacted.…” This decision is placed entirely within the discretion of the commissioner and means that, going forward, no cell will be required to have excess capital.

A second problem addressed by the 2014 Amendments is the concern about the accessibility of captive information to the public under the D.C. Freedom of Information Act (D.C. FOIA).  The new law provides an express exception from D.C. FOIA for business information, financial pro formas, contracts and other captive documents. This information will not be subject to discovery or subpoena in a civil suit. However, it can be shared with other regulators and the National Association of Insurance Commissioners (NAIC) as long as those authorities are willing to maintain the confidentiality of the information.

The third significant improvement to the law is that the commissioner will have the discretionary authority to waive the requirement that a captive be examined at least once every five years under the following conditions:

• The captive has filed unqualified audited financial statements since its last examination.

• The commissioner finds that the audited statements demonstrate that the captive has sufficient surplus to satisfy all obligations to its policyholders and creditors.

• The captive is in compliance with all applicable D.C. laws and regulations.

• The captive is not a risk retention group (RRG). This latter requirement is due to the multi-state nature of RRGs.

The value of an examination for a single parent captive, or really any captive that only covers first party risk, has long been subject to question when qualified auditors have already examined the captive each year and signed off on the bona fides of its financial activity. The cost of the examination of a single parent captive seemed unreasonable in this context.

The 2014 Amendments made a few other changes to improve efficiency, as well. The Unfair Claims Practices and Claims Settlements Act were made applicable to D.C. for domiciled RRGs. These RRGs will also be required to file quarterly statements (which had previously been required by the Department of Insurance Securities and Banking), and all references to “segregated accounts” were removed from the law to avoid confusion.

In sum, the D.C. captive law has been improved by addressing three problematic areas: minimum capitalization for cells, the protection of confidential information, and the burden of unnecessary and sometimes excessively expensive financial examinations. These are significant changes and should help D.C. maintain its position as one of the most efficient and responsive captive domiciles in the United States.

This article previously ran on the Morris, Manning & Martin, LLP website.

Captives under Scrutiny

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A mere decade ago, captive insurers were viewed by most regulators as a small, even exotic part of the insurance industry. Most were assumed to be offshore and aroused little attention. Now, captives have gone mainstream. A sizable, but undetermined, portion of the property casualty coverage is placed through, or issued by, captives. A good guess is 30% to 40%, but no one has been able to establish an accurate number. Thirty-nine states have some form of captive or self-insurance law. Captives are now part of everyday life for regulators and the result is more scrutiny.

The issues now on the agenda for captives are significant:

• XXX and AXXX Reinsurance Captives

According to Superintendent Joseph Torti (Rhode Island), 80% to 85% of life and annuity insurance is ceded to reinsurers. Much of the so-called “excess reserves” required by Rules XXX and AXXX are ceded to captive reinsurers or special purpose vehicles owned by the same licensed life and annuity companies which cede the risk. Because the amount of this risk is so large, any trouble collecting this reinsurance could have a major effect on the industry. Some regulators, even a few who approved these cessions, have criticized these arrangements. In some cases, the collateral for the reserves has been subject to parental guarantees, which tends to undermine the confidence which can be placed in the transaction. The NAIC is continuing its examination and has met some stiff resistance from the industry.

• Multistate Insurers 

The proposal to amend the preamble to the NAIC Accreditation Standards to treat captive reinsurers as “multistate insurers” (with some limited exceptions) was withdrawn at the last NAIC meeting in Louisville. A new proposal should be forthcoming (and may have already been issued by the date of publication of this Newsletter). The premise of this proposed change is that non-domiciliary regulators need to know how insurance issued in another state may affect the citizens of their state. The opposite point of view is that the regulators of the domicile have done their job and should be trusted by their regulator colleagues and that the transaction should not affect third parties, anyway. Some say the risk to the domestic captive industry is existential. If enacted and enforced, the proposed change could, ironically, drive much of the industry offshore and therefore beyond the authority of the regulators promoting it.

• Nonadmitted Risk and Reinsurance Act

Captives have been inadvertently drawn into the regulatory structure imposed by this federal legislation intended to streamline the reporting and payment of surplus lines taxes. It has shined a spotlight on the payment (or non-payment) of state self-procurement taxes, but, ironically, does not in any way alter either the application of them or their payment. While risk retention groups (RRGs) were able to get an exemption from the law during its formative phase, captives, because they are (generally) single state entities and therefore not doing business as a “non-admitted” insurer, did not even attempt to get an exemption. Now there is a group, the Coalition for Captive Insurance Clarity, which is seeking a legislative exemption on Capitol Hill.

• Insurance Company Income Taxation

The Internal Revenue Service is investigating several insurance pooling mechanisms and, in some cases, the captives that have utilized them to establish third party risk—which is essential for an insurer to get the benefit of insurance tax treatment. This investigation is presumably a response to the rapid growth of “micro-captives” as mechanisms to assist with avoidance of taxation in estate planning and wealth transfer. This process is in its early stages, but is likely to produce some dramatic results.

• Federal Home Loan Bank (FHLB)

Who would have thought that the FHLB would have anything to do with captives?  It appears that some captives, and at least one risk retention group, are members of the FHLB, which allows them to obtain federal funds at advantageous rates. The Federal Housing Finance Agency (FHFA), which regulates the twelve FHLBs, has proposed a rule that would exclude all captives from membership by defining “insurance company” to mean an entity which “has as its primary business the underwriting of risk for nonaffiliated persons.”

Why is this happening now? While there are numerous reasons for these kinds of actions, there are two primary motivators. First, regulation is always subject to the problem of “what’s worth doing is worth overdoing.” Reasonable minds can differ on the interpretation of statutes and regulations. Each of the above includes an element of “pushing the envelope,” which can be significant or insignificant issues depending on your point of view. Second, captives have been caught in the vortex of regulatory competition. As we have discussed before in this column, the National Association of Insurance Commissioners (NAIC), the Federal Insurance Office (FIO), and the International Association of Insurance Supervisors (IAIS) are jockeying for position and power. Add to the mix the position of the Organization for Economic Cooperation and Development (OECD) that captives may be used as a device to avoid taxation (“base erosion” in OECD parlance), and you have a tumult of regulatory action which at the same time can be challenging and conflicting in its goals and implementation.

What does this bode for the future of captives? Once you have been seen on the radar, it is hard to drop off. Captives can expect more of the same for the foreseeable future.

This blog was previously published on the Morris, Manning & Martin, LLP website.