The Nonadmitted and Reinsurance Reform Act, enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, has heightened awareness of state self-procurement premium taxes. Michael Byrne of Drinker Biddle & Reath L.L.P. discusses issues for captive owners and managers to consider with regards to the NRRA.
Those in the captive industry by now are probably aware of the various discussion threads about whether the Nonadmitted and Reinsurance Reform Act, enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, applies to nonadmitted insurance procured from a captive.
A number of commentators have expressed the view that the NRRA creates uncertainty regarding the application of state self-procurement premium taxes to nonadmitted insurance procured from a captive insurer and that clarification from Congress that the NRRA does not apply to captives would remove this uncertainty.
In fact, the outgoing chair of the Subcommittee on Insurance in the U.S. House of Representatives, former Rep. Judy Biggert, R-Ill., sought to provide such a clarification in a recent letter to the new chairman of the House Committee on Financial Services.
This article offers a different view.
The issue of applying state self-procurement tax statutes to captive insurance does not originate with the NRRA — these taxes long preceded the NRRA. However, the NRRA has triggered some heightened awareness of self-procurement taxes due to legislation enacted by the states in response to the NRRA as well as the efforts of some states to persuade companies based in the state to “come home with your captive.” These events raise various issues and options for captive owners and managers to consider, as discussed below. However, none of these involves clarifying or amending the NRRA.
By way of background, all U.S. jurisdictions generally prohibit a nonadmitted insurer, i.e. an insurer that is not licensed, from transacting insurance in the state — the “doing business” laws. A captive insurer typically will be licensed to transact insurance in a single U.S. jurisdiction (its “domiciliary” state), and that state typically imposes on the captive itself a low, low gross receipts tax rate, often capped at, say, $250,000.
In other jurisdictions where the captive insurer is not licensed, the insurer is considered “nonadmitted” and therefore is generally not permitted “by mail or otherwise” to transact the business of insurance, absent an applicable exemption.
Most states have one or more exemptions from their “doing business” law that permit a qualified insured to procure insurance from any nonadmitted insurer, and these exemptions are used by captive owners to access their captive insurers domiciled in other jurisdictions. These exemptions typically require the insured to report the transaction and pay premium tax to the insured's home state … and, prior to the NRRA, states other than the insured's home state could — and did — assert jurisdiction to tax based on insured locations and/or exposures.
It is important to understand the state insurance regulatory framework for the taxation of nonadmitted insurance. Following are some points to keep in mind in assessing the connection between the NRRA and captive insurance.
1. The NRRA itself does not impose premium tax on nonadmitted insurance or insurance with captives. Nor does the NRRA require the states to impose such a tax or to regulate nonadmitted insurance in a certain manner (or even to recognize nonadmitted or surplus lines insurance in the first place). The NRRA simply provides that only the insured's home state can impose premium tax on nonadmitted insurance. “Premium tax” is generally defined as any compensation given in consideration for a contract of “surplus lines or independently procured insurance.” “Independently procured insurance” under the NRRA means insurance procured directly by an insured from a nonadmitted insurer.
2. State laws govern self-procurement tax on nonadmitted insurance. Roughly two-thirds of U.S. states impose a self-procurement tax. The laws typically require an insured to pay tax on premium paid for any insurance procured directly from a nonadmitted insurer and report the transaction to the state. We are aware of only a couple of states that exempt captive insurance from this tax; otherwise, the self-procurement tax laws do not distinguish between insurance procured from captives and noncaptives.
Prior to the NRRA, with a few exceptions, all states that imposed self-procurement tax applied the tax based on the premium allocated to that particular state. States had not typically required payment of the tax based on 100% of the premium when the nonadmitted insurance was placed under their laws. (Some states coupled this allocation rule with a provision allocating any premium not actually reported to and taxed by another state to the state, which was the equivalent of requiring tax on 100% of the premium in some fact patterns.) It was possible, and indeed common, for more than one state to assert the right to collect premium tax on its allocated share of the premium for a placement covering a multistate risk. Now, post-NRRA, nearly all states impose their self-procurement tax on 100% of the premium paid by a home state insured.
3. The NRRA applies to nonadmitted insurance. The most important NRRA reform is the exclusive authority provided to the insured's home state to tax and regulate nonadmitted insurance and pre-empting inconsistent state laws. The home-state rule was intended to simplify and streamline the payment of premium taxes on nonadmitted insurance covering multistate risks. Now, captive owners need only consult the laws of their home state regarding applicable exemptions and premium tax obligations.
It is true that the legislative history of the NRRA focuses on surplus lines insurance, and neither that history nor the NRRA itself addresses captives or self-procurement tax specifically. Still, the NRRA by its plain language applies broadly to all nonadmitted insurance placements and thus applies to nonadmitted insurance procured directly from any insurer, U.S. or non-U.S., that is not admitted in the insured's home state, including a captive insurer.
4. Excluding captive insurance from the NRRA reforms may have negative unintended consequences for captives. If the NRRA did not apply to captive insurance, the NRRA's home-state rule would not apply to such insurance. This would potentially result in claims by multiple states to impose self-procurement tax on and regulate placements with captives. For example, an insured's home state could impose a tax on 100% of the premium paid to the captive, and the NRRA would not prevent another state or states from also imposing a premium tax — for example, if that state's self-procurement tax were not limited to insurance procured by home-state insureds, or if that state's definition of “home state” yielded a different home state than under the NRRA definition.
In summary, self-procurement taxes are governed by state law and do not emanate from the NRRA, and therefore a clarification or an amendment to the NRRA would not resolve the issues regarding the application of self-procurement taxes to captive insurance. The NRRA streamlines the regulation and taxation of all nonadmitted insurance placements. Excluding captives from the NRRA would therefore deprive captive owners of the NRRA reforms and potentially increase their premium tax obligations. However, the NRRA has heightened awareness of self-procurement taxes and the related opportunities for alternatives to the traditional captive domiciles and other options.
Captives and captive managers may wish to consider the following options:
• Pay the self-procurement tax by applying the home state's rate to 100% of the premium, as may be required by state law and as applicable;
• Pursue state legislation to exempt captive insurance from self-procurement tax;
• Pursue federal legislation providing exclusive authority to the captive insurer's domicile to regulate and impose premium tax on captive insurance;
• Explore re-domestication of the captive, or formation of a new or branch captive, in the insured's home state or other state where the insured maintains a substantial physical presence;
• Move the insured's headquarters to, or establish a substantial physical presence in, the captive domicile.
Michael Byrne is a partner in the insurance practice group of Drinker Biddle & Reath L.L.P. Elda Feldman and Taylor Romigh assisted with this article. Mr. Byrne can be reached at firstname.lastname@example.org.