John Talley, Missouri Department of Insurance
Bill Hodson of Gulfstream Risk Advisors and John Talley of the Missouri Department of Insurance give their views on recent developments, including regulatory changes and the IRS’s position on micro captives
How has the US captive industry been affected by recent economic and legislative developments?
Bill Hodson: In the past three years or so, the US economy has been very robust. The stock market and jobs market have been on a very positive trend. Federal banking policy has been stable, with only slight increases in interest rates and knock-on inflation. In this environment, the effect on the captive insurance marketplace has been positive, with the most popular and well-regulated US domiciles enjoying a steady number of new formations and net active captive numbers. Whether the root causes of challenges are political or ignorance of industry needs, the better regulated domiciles with a strong and active captive insurance association, and solid service provider infrastructure will continue to weather those challenges well.
John Talley: With the soft commercial insurance market, the Internal Revenue Service (IRS)’s position on micro captives and the corporate merger/acquisition activity, the formation of new captives has slowed but not stopped. Evidence of that is Missouri adding ten new captives in 2018, with only four companies closing or redomesticating.
With recent issues like the IRS crackdown on micro captives and the ruling in the Microsoft case, would you say captives are currently under fire in the US?
Hodson: Five or six years ago, the IRS woke up to the fact that the captive insurance industry was the new ‘soft target’ du jour. I believe that the targeting was/is mostly due to abuses of certain sections of the IRS code by captives that were formed for what I consider the wrong reasons. As a reinsurance and risk management professional, it just doesn’t make sense to me for a corporation, group or individual to form an insurance company for reasons other than risk management. Our industry is one of the most highly regulated in the US, so I never really understood the mindset of those who followed the advice and templates constructed by financial advisors, tax advisors and certain captive managers for making tax efficiency and/or tax avoidance the main driver of a captive insurance company, rather than risk management and risk financing. Once those captives that skirted or crossed the line popped up on the IRS’s radar, it was only natural that the IRS declared their version of ‘Whac-A-Mole’ on our industry.
The Microsoft case, is, in my opinion, nothing more than regulatory overreach. The Washington Office of the Insurance Commissioner employs some pretty intelligent people. I’m certain that they have one or two lawyers on staff who know how to read and interpret their own insurance law, as well as other states’ laws.
In the Microsoft case, I believe that, again, a soft target was found and the Washington Department of Insurance’s prime motivation was to hold Microsoft up for whatever ransom they could collect and it worked. So, given these two examples, I do believe that our industry in the US is under fire.
However, I also believe that in Microsoft’s case their domiciliary regulators and captive association dropped the ball when it came to defending Microsoft’s captive against the attack.
In those US domiciles where the captive insurance industry is working closely with their state governments—both legislature and Governor’s office—and that are competently and consistently regulated by captive experts at the DOI, I believe that attacks of this kind will be fewer and better defended.
I also believe that as a natural consequence of state captive associations growing and becoming more powerful in their lobbying efforts, and other state DOI’s and captive regulators emulating their peers in Vermont, South Carolina, Tennessee, etc, the targeting will ease.
Talley: If ‘under fire’ means enhanced IRS scrutiny, the short answer is yes. The IRS sees small captives, many of whom have elected section 831 (b) treatment, as problematic for several reasons (for example, non-risk bearing entities, no transfer of risk, circular reinsurance financing). The IRS believes that owners of these companies are ‘scamming the system’.
The concern with the Microsoft case is that other non-captive domicile states may begin to use their laws to levy taxes or fees on captives insuring owner facilities or employees within borders.
Whether this will happen remains to be seen.
What is the future of US-based captive insurance companies? Are there any new opportunities cropping up?
Hodson: I think the future of the US captive insurance industry is very bright. The captive industry began as a response to a lack of proper coverage, not to cover risks that were new, but to cover risks that were volatile. As the industry has evolved, it has responded to covering risks that are new and cutting edge. Cyber, blockchain, autonomous vehicles/mobility, the Internet of Things and the pervasive integration of artificial intelligence into our everyday lives will keep the challenges to our industry fresh. Being inherently forward-thinking and responsive, the US captive industry will meet any future challenges and opportunities.
Talley: I believe the future remains bright for new captive formations in the US, especially in Missouri. Missouri’s captive laws and regulatory processes are designed to work with the captive owner to further their company’s development. We have already had several recent inquiries this year regarding the formation of new captives. I see this trend continuing in all US domiciles as businesses evaluate their insurance needs and how to best meet them. If the recent rise in commercial insurance rates is any indication, the onset of a hardening market will spur more businesses to investigate the captive alternative
