Dodd-Frank Act – impact on captive domicile decisions

Read our article in the Cayman Financial Review Magazine, eversion 

Captive insurance is a prominent sector within the Cayman Islands financial services environment with its well developed infrastructure to promote, develop and maintain this business. Given our geographical proximity, a very substantial portion of this business originates from the US.  

The Cayman Islands historically have been a domicile of choice for US clients looking to establish captive insurance solutions. The article below considers the Nonadmitted and Reinsurance Reform Act of 2010 and its provisions that have recently come into effect as the local captive insurance industry must consider and understand the implications of this legislation and its impact on Cayman as a domicile of choice.  

Background

US and non-US insurers are greatly impacted by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The Act created the Federal Insurance Office (FIO), the first ever US federal agency specifically established to oversee the insurance industry, promote regulatory uniformity amongst the US states, and empower the FIO to usurp state authority on international insurance matters by entering into covered agreements with foreign jurisdictions.

The state based insurance reform provisions found in Subtitle B, section 511 to 542 took effect this July and are referred to as the “Nonadmitted and Reinsurance Reform Act of 2010”, or NRRA.

Expanding role of FIO over state based regulatory system in the US

The FIO’s power to enter into covered agreements with foreign jurisdictions that pre-empts state laws should be an area of interesting developments next year. The Senate summary on the Dodd-Frank Act states the FIO “… will serve as the uniform, national voice on insurance matters for the United States on the international insurance stage”.

Preservation of state based insurance regulation has been heavily debated since 1945 when the US Congress passed the McCarran-Ferguson Act ceding insurance regulation to the states. Every decade since 1945 Congress has conducted investigations to assess whether the states were regulating insurance adequately.

A 1958 report found “state regulation lacking, incapable of dealing with interstate and international issues, and unwilling or unable to ‘bring the blessings of competition’”. While the EU initiatives including Solvency II and ORCA may have paved the way for creation of the FIO in the US, it was inevitable that self-regulatory organisations like the National Association of Insurance Commissioners (NAIC) would prove insufficient to address the deficiencies of the state-based insurance regulatory system.

Nonadmitted and Reinsurance Reform Act implications

The NRRA advances “lead state” regulation efficiencies started in 1981 with passage of risk retention group enabling legislation. The NRRA provisions aim to eliminate overlapping reporting and taxes that have caused all manner of compliance difficulty and costs for businesses with multi-state operations.

Perhaps unintended, the NRRA creates a potential loophole which may encourage these large multi-state companies to re-domicile captives to “home based” states to reduce premium taxes associated with non-admitted and reinsurance premiums. Claim of exemption for restructured arrangements may also be attempted with respect to the Internal Revenue Code § 4371 foreign insurance excise tax.

Aspects of NRRA address the premium taxes charged by states on premiums paid non-admitted insurance companies. Prior to the NRRA taking effect in July, many large companies were required to file reports with every state they did business in, involving complicated forms and difficult allocation calculations aimed to share premium taxes amongst the states.

These large organisations were successful in lobbying the US Congress and get NRRA provisions enacted as part of the DFA that allows only a “home based” state to require reporting and taxation on the premiums paid non-admitted insurance companies.

NRRA intends to create one collection point for surplus lines premium taxes and encourage states to enter into an interstate compact or agreement to allocate shares of the premium taxes, based on the risks covered in a state.

The Act’s definitions of “nonadmitted insurer” and “nonadmitted insurance” are broad, and a cursory reading of them could lead one to conclude that they include captive insurers and captive insurance, respectively. Some attorneys believe however that a strong argument can be made that NRRA was intended to apply only to surplus lines insurance and that captive insurance is not covered. Separate provisions of NRRA apply to “independently procured insurance”, which likely encompasses captive insurance.

Top tax attorneys advising large single parent captives are already suggesting that if these companies domicile their captive in their “home state”, they may be able to avoid the 3 per cent to 5 per cent premium tax imposed by many states on non-admitted and reinsurance premiums.

Section 521 of the NRRA states that, “No state other than a home State of an insured may require any premium tax payment for non-admitted insurance.” The definition of home state may be debated amongst the states pending clarification by the FIO, but generally a company’s home state is wherever its “nerve centre” is – essentially where it is headquartered and executive decision making occurs.

With so many US states now authorising captives, many large corporations can domicile a captive within their home state to reduce and potentially avoid all taxes on non-admitted insurance premiums. Where a company’s home state is not the domicile of their captive, the state where they conduct the highest percentage of business will be deemed the home state that can then levy premium taxes on non-admitted insurance.

US states implementing NRRA

NRRA encourages the states to enter into tax sharing compacts. As of August 2011, 44 states have passed legislation conforming to the requirements of NRRA allowing the states to enter into non-admitted insurance premium tax sharing agreements. Three approaches have surfaced. The NAIC’s multi-state agreement known as NIMA has been agreed to by 12 states. A competing approach known as SLIMPACT has 9 states on board.

Ten states have elected to not join any tax sharing pact including many of the leading captive domiciles as these states intend to keep all non-admitted premium taxes rather than share them with other states.

Future related events to watch for

Section 526 of NRRA requires the US Controller General to issue a study and report to Congress on the non-admitted insurance market and impact of NRRA within 30 months of enacting DFA, or by the end of 2012.

Also, the Neal Bill (HR 3424) has not yet been reintroduced but likely will be as the US Congress looks for ways to address the US deficit issue. President Obama’s budget proposal contained aspects of this bill that would deny an insurance company deduction for reinsurance premiums paid to an affiliated foreign reinsurance company if the foreign reinsurer (or its parent) is not subject to US income tax.

The US Congress certainly did not intend to reduce government revenue streams with passage of NRRA. Tax advisers suggesting this potential loophole to save taxes by domiciling captives in a client home state is subject to interpretation. Affected states and foreign jurisdictions might consider lobbying the FIO to adopt regulations dispelling this construction of the NRRA.

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April Panton
With extensive experience in both onshore and offshore offices of the company, April brings to Advantage a thorough knowledge of international and captive insurance management, risk retention and wealth management structuring, including re-domiciliation processes. April is an Associate in Captive Insurance, which is the world’s the only recognized captive insurance designation, is a Member of the Institute of Chartered Secretaries and Administrators, and is currently studying the Society of Trust and Estate Practitioners (STEP) program.


April Panton
Senior Manager, Sales & Development
Advantage International Management (Cayman) Ltd.
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Tom Cifelli

Tom practiced business and estate planning in private law practice, served as General Counsel and Chief Financial Officer with private and publicly traded corporations, practiced public accounting as a financial auditor and tax consultant, served as a municipal treasurer, and served as Managing Director of Investment Banking for US regulated broker dealer firms.

Tom Cifelli
Managing Editor
CaptiveExperts.com
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CaptiveExperts

Our Managing Director and Editor was selected at the US Captive Awards ceremony for one of only two individual awards in 2012.  Read more about this prestigious award and our Managing Director's dynamic professional background by clicking here.

He has published articles in leading ART industry publications including Captive Review and Cayman Financial Review and speaks at industry conferences.

Our Managing Director's experience includes practicing business, tax, estate planning and securities law, serving as General Counsel and Chief Financial Officer with fully reporting publicly traded corporations, practicing public accounting (auditing of financial institutions and later tax planning with the largest global tax firm), serving as a municipal treasurer, and serving as Managing Director of Investment Banking for U.S. regulated broker dealer

CaptiveExperts.com
14362 North Frank Lloyd Wright Blvd
Scottsdale, AZ 85260
USA

T: +1 (602) 677 7578
E: tom.cifelli@captiveexperts.com
W: www.captiveexperts.com