In an attempt to enforce a summons against the Delaware Department of Insurance (DDOI), the Internal Revenue Service (IRS) has recently petitioned the US District Court for the District of Delaware. Their ultimate goal – to allow a federal agency to override a state agency’s laws – has serious implications as a precedent.
While the summons is for documents related to the IRS investigation of Artex Risk Solutions and Tribeca Strategic Advisors (as of 2010 fully owned by Artex), there are a few statements included by the IRS that I have not yet seen be directly addressed.
To understand how events have transpired to reach the point of the IRS requesting a court to enforce its summons, it is worth taking a minute to consider what exactly is the purpose of the DDOI’s captive bureau. As any authority granted to a regulatory body, we look to the statutes.
For Delaware this is 18 Del.C. § 6901 ‘Finding Purpose’, which states as follows:
It is determined and declared as a matter of legislative finding that captive insurance companies can serve a valuable risk management function and that their responsible utilisation and the growth of the captive insurance industry in the State of Delaware are in the best interests of this state.
It is further determined and declared that the purpose and policy of this chapter shall be:
To provide for the regulation of captive insurance companies consistent with their nature and purpose;
To provide flexibility and opportunity to captive insurance companies and to persons utilising them; and
To foster economic development in this state through the growth of the captive insurance industry.
The ‘Finding Purpose’ statute is comparable to the mission statements of many other large US domiciles but is far more explicit in its goals. The Delaware General Assembly instructs the DDOI to create an environment that facilitates the growth and flexible regulation of captive insurers so that it fosters economic development. Based on these criteria, the DDOI is extremely successful. Today Delaware ranks as the world’s fifth-largest captive domicile and the third-largest in the US. A 2016 study prepared by the University of Delaware shows the captive programme contributing nearly $360 million annually to the state’s gross domestic product. In 2019, the DDOI’s captive insurance programme contributed $4 million of surplus revenue to the state and its largest city, Wilmington.
Some domiciles, but not all, have associations to support the industry, but these associations are in no way tied to the departments and act independently. The associations participate in the industry in various ways. Because the attraction of captive insurers to a state is very competitive, captive insurance regulators must attend industry events to network and attract captive insurers. To provide an example of the different activities of captive domiciles and associations and this industry’s competitive nature, for the 2020 Captive Insurance Companies Association conference, captive regulators from 13 domiciles registered to set up and run booths, while two state associations also registered.
On a detailed examination, there are two sections in the declaration of IRS revenue agent Bradley Keltner that I find interesting. The first is on page 2, paragraph 5(a), which states: “In email correspondence that occurred on 25 February 2013, the DDOI agreed to issue certificates of authority to an Artex client with a certificate date of 31 December 2012”.
Factually, the captive application approval process in place in 2013 (and through 2018) allowed for a completed application to be submitted up to 11:59 pm on the 31 December. If a full application was submitted and all requirements had been reviewed and met, the applicant was given legal authority to issue policies as of the date of the application’s submission, or at a later date if requested. If the application was not approved the company did not receive its license. The process is comparable to file-and-use law and is a common practice among domestic and international domiciles.
Over time it led to the formalisation of the DDOI conditional license process which has been emulated in North Carolina, Vermont, and several other states. As states compete for the quality insurance business, an overburdensome or confusing application process is a good reason for a captive call somewhere else "home".
The ease of availability and communication with a regulator is also a key part of the decision-making process for determination of a domicile and it leads to the second section I find interesting.
In paragraph 5(b) on page two of the declaration states in part: that in another email, the director of the Bureau of Captive and Financial Insurance Products declines a dinner invitation from Artex. As the director explains, "[it’s] not that we don’t want to, but we’ve already accepted the invitation of another captive manager for dinner” that evening. The Artex employee and the director then schedule a breakfast at the green room in the Hotel Du Pont with six DDOI employees the following morning.
To place it in context, the breakfast was during the Delaware Captive Insurance Association’s Spring 2013 Forum. Conference schedules are tight with board meetings, speaking engagements, and sessions to attend. When everyone is in the same place for a limited period you take meetings whenever there is availability for all parties, including at breakfast.
The registration cost for most conferences includes the cost of food and beverages for attendees. If you’re going to talk about captives for more than a few minutes you absolutely need sustenance and preferably gallons of caffeine. All attendees, including the DDOI staff, pay a fee for attendance.
Regarding the breakfast itself, the DDOI is subject to financial disclosure in 20 Del.C. § 5813(e) which requires the reporting of ‘gifts’ of more than $250, and the Delaware Public Integrity Commission which allows gifts up to $250. I confirmed independently the breakfasts were not reported in any financial disclosure(s). Based on the average cost of breakfast in 2013, unless gold caviar was served it’s safe to assume each meal was under $250.
Captive managers, like Artex, are the liaison with captive owners and regulators. There are numerous reasons one would want to meet with the regulators in person. On a most basic level, regulators can answer questions with authority, give sound advice relating to their laws and expectations, and are people you will be working with on an ongoing basis.
One of the first things I did when I joined the industry was attend a conference to meet people. For a person just breaking into the captive industry or new to a company like Artex, the variety of positions and service providers is immense, confusing, and takes years to understand. Getting to know the regulators is crucial and it takes years to develop these relationships. Knowing the regulators on a personal level means you learn who to call for a specific question, how to submit a request correctly, can more easily keep up with changes and better understand expectations, among many other benefits. Efficiency benefits all parties. If the regulators are accessible, and they are in Delaware, then a captive manager becomes comfortable with recommending that domicile to their clients. Captive managers, like any other professionals, do not want to be embarrassed before their clients. That is why they seek out domiciles where they have access to and get straight answers from the regulators.
Clients and industry professionals want to work with a domicile who has a credible reputation and are reliable in their communication. They certainly want to create their insurance company in a state where they and their confidentiality will be respected and defended.
While the above topics were interesting to me based on what Keltner may be implying, the email messages about having breakfast are an easily dismissed distraction. At the core of the summons, the IRS is asking the DDOI to ignore its confidentiality law and provide documents that the captive insurer has not expressly given permission to share.
In part, 18 Del.C. § 6920 requires: All portions of license applications reasonably designated confidential by or on behalf of an applicant captive insurance company, all information and documents, and any copies of the foregoing, produced or obtained by or submitted or disclosed to the commissioner and all examination reports, preliminary examination reports, working papers, recorded information, other documents, and any copies of any of the foregoing, produced or obtained by or submitted or disclosed to the commissioner…must, unless the prior written consent (which may be given on a case-by-case basis) of the captive insurance company to which it pertains has been obtained, be given confidential treatment, are not subject to subpoena, may not be made public by the commissioner, and may not be provided or disclosed to any other person at any time.
To the extent of the applicable law, the DDOI has complied with the IRS. It provided 18,331 pages of documents on behalf of 16 captives because they were given permission by those captives. The IRS is not stating the DDOI has not cooperated and required enforcement, it is requesting the DDOI be forced to breach its own laws. In this case, the DDOI would be violating not only the law it is required to enforce, but the trust of all captive managers, their clients, and future clients. Captive managers and their clients want the documents submitted to the DDOI to be confidential and there are many reasons why.
The majority of small captive insurers, which are the IRS targets, are owned by privately held companies. Privately held companies are not subject to the financial disclosure laws applicable to publicly traded companies.
When a privately held company forms a small captive insurer in Delaware, it may have many reasons to seek the confidentiality offered by Delaware’s captive insurance laws. An obvious reason is that they do not want their competitors to know. Perhaps the captive is insuring the product liability for the research and development of a new product, a joint venture with a new business partner, or providing cyber insurance for software and hardware systems the captive owner does not want to be publicly known.
One of the reasons § 6920 exists is to protect trade secrets when a captive insurer is insuring trade secrets.
What is important to note is that § 6920 allows the DDOI to share confidential information with other state and federal government agencies.
However, the DDOI may only do so if the other agency “agrees in writing to hold it confidential and in a manner consistent with this section”. Nowhere within the IRS’ petition does it claim to have offered such an agreement.
That raises the possibility of the confidential information sought by the IRS being publicly disclosed in a tax court case.
This case is currently to be determined, so hopefully, the next steps in the situation will be for the judge to ask the DDOI to lay out its case.
The judge must weigh the argument of the IRS which is that the IRS believes the DDOI must provide what they ask for.
On the other hand, there are multiple interests to weigh. First, those of the State of Delaware and the City of Wilmington in protecting a captive insurance programme that generates revenue and economic development; second, the interests of the DDOI in not being forced to violate the same law it is charged with enforcing; and finally, the interests of captive insurers who submitted their information to the DDOI with the expectation of confidentiality.
There is a lot at stake. If Delaware is forced to disclose the confidential information, it means that any other domicile holding confidential information sought by the IRS may be forced to do the same.
