Delaware expects its captive market to be solid throughout this year, but like other US domiciles, challenges could arise from the IRS and new tax proposals
Ranking third in the US and fifth in the world in terms of captive domiciles, Delaware is set for another year of strong growth within its captive market following a positive 2020. Last year, the state licensed 70 new captives in 2020, including 67 conditional licenses. The 2020 licensing figures showed an increase from the 2019’s stats, where the Delaware Department of Insurance (DDOI) licensed 56 captive insurance companies.
The Insurance Commissioner Trinidad Navarro recently provided members of the Joint Finance Committee the department’s budget presentation, informing the General Assembly on how captives benefit the state.
Navarro revealed that the work of the captive division has reduced taxpayer burden by contributing $1 million to the city of Wilmington and $2.9 million to the State of Delaware General Fund in the fiscal year 2020.
Jerry Messick, CEO of Elevate Risk Solutions, suggests that Delaware’s current captive market is “very strong”.
Messick says that the ongoing COVID-19 pandemic has forced a heightened state of awareness regarding enterprise risk management.
When combining the pandemic with the current state of dramatically rising premiums in the US property and casualty (P&C) market, Messick says that Delaware is positioned to demonstrate steady growth.
The state has seen property, directors and officers (D&O), and commercial auto all remain extremely tight in the current market conditions which continues to drive interest in captives. Messick suggests that this will continue until Q2 or Q3 of 2022 earliest.
Understanding and anticipating trends in the captive market requires the department of insurance to analyse the commercial market.
Based on the commercial market trends, Christina Haas, senior policy advisor at the DDOI, comments: “We see the cost of both property and liability insurance policies increasing in the commercial insurance market, and so we expect strong demand for captive insurers in these areas.”
What’s on offer?
With strong growth on the cards, what can Delaware offer to new potential captive owners?
Steve Kinion, director of the captive insurance programme at DDOI, suggests that a big part of Delaware’s strength is the consistent and stable regulation and team members with decades of industry experience.
“The DDOI boasts many multilingual team members, including speakers of French, German, Lithuanian, Russian, and Spanish, which allows the department to be able to communicate and compete on a global scale,” Kinion explains.
Another important factor is the relationship between the Delaware Captive Insurance Association (DCIA) and the state’s department of insurance.
Joanne Shaver, president of DCIA, says that the two teams meet regulatory throughout the year to ensure the captive insurance remains competitive.
Despite the challenges of the pandemic, the DCIA and the DDOI were able to meet three times during 2020 to discuss trends, to consider changes to the existing legislation, and to flag a few alternatives to keep Delaware competitive in the captive marketplace in 2021.
Shaver explains: “It helps that Delaware is a small state and that the DCIA board is made up of captive service providers who have their pulse on the industry at all times.”
Delaware is one of just four domiciles that holds an International Center for Captive Insurance Education (ICCIE) trained designation issued ICCIE.
ICCIE was developed in response to a need expressed by captive insurance professionals for in-depth educational offerings, information on current topics, and a professional designation.
Haas says: “It is important to note that the DDOI pairs this regulatory experience and international industry knowledge with a willingness to innovate.”
“This is something Insurance Commissioner Navarro is passionate about, and in taking this viewpoint, we can streamline processes and make our domicile more attractive,” she adds.
In the US November 2020 election, Navarro, a Democrat, won his second term as Delaware’s Insurance Commissioner.
A new bill
Delaware has also proposed to update its captive insurance legislation. In February, the Delaware State Senate passed Senate Bill 36, which is an act to amend title 18 of the Delaware Code relating to captive insurance companies.
In section one of the bill, one change includes adding definitions for ‘policy’ and ‘premium’. It also revises the definition of ‘pure captive insurance company’ to clarify that a pure captive insurer may insure its parent, its parent’s affiliates, or a controlled unaffiliated business.
Under section two of the bill, it expands the captive insurance licensing authority for a series as defined under chapter 69 of title 18 to allow a Delaware series to be licensed as an agency, branch, or reciprocal captive insurance company.
Section three of the bill allows certain captive insurers to select the Delaware series form of business organisation.
In section four of SB 36, it makes the insurable interest provisions of 2706 of title 18 applicable to captive insurance companies.
Additionally, this bill makes technical corrections to conform existing law to the standards of the Delaware Legislative drafting manuals.
The SB passed Delaware’s Senate with 21 votes and will take effect upon being signed into law.
Bumps in the road
Like many US domiciles, one of the biggest challenges is the increased scrutiny from the Internal Revenue Service (IRS), which has targeted micro captives for years. However, in more recent times they have ramped up their efforts to do so.
In 2016, the Department of Treasury and IRS issued Notice 2016-66, which formally labelled micro captives as ‘transactions of interest’. The IRS advised that these transactions have the potential for tax avoidance or evasion.
Under section 831(b) of the US tax code, captive insurers that qualify as small insurance companies can elect to exclude limited amounts of annual net premiums from income, so that the captive pays tax only on its investment income.
The IRS and domiciles continue to weed out the “bad captives electing 831b status”, according to Messick.
In June 2020, the IRS petitioned the US District Court for the District of Delaware against the DDOI to enforce a summons for documents related to its micro captive investigation.
Commenting on the lawsuit at the time of filing, Haas explains that the state has provided non-confidential information to the IRS, and has worked with the industry to provide a collection of confidential documents with the consent of those companies.
Haas notes that the only exceptions were “those cases where consent was given by the company, we must act within the confidentiality confines of Title 18, Chapter 69 of the Delaware Code”.
“Our office has cooperated with their requests to the extent that our statute allows,” she adds.
“The department continues to feel strongly that the confidentiality provisions of our state law are critical to both the state-regulated industry, and to public policy as a whole,” Haas noted.
New US administration
It was recently noted that US President Joe Biden’s major tax proposals are set to have a positive impact on the tax effects of proper risk financing utilising a captive strategy, but a larger exit tax if not properly planned, according to RH CPAs’ Teresa Jones, Diana Hardy and Daniel Milan.
It was suggested that the tax effect of the proposals “will likely result in larger upfront savings by utilising a captive as part of the risk financing strategy of a business who qualifies”.
However, Messick says: “Unfortunately, you will also see a rise in tax rates by the current administration, you’ll see a spike in more promoters pushing the tax aspects of capt
