A regulatory enforcement action has raised the spectre of how and
whether captives may be subject to unexpected premium tax liabilities in
states outside their domicile. Joseph Holahan of law fi rm Morris, Manning
& Martin explores the issue.
US Captive 2018 37
In May, Washington State Insurance Commissioner Mike Kreidler
issued an order alleging that Cypress Insurance Company, a
single-parent captive owned by Redmond, Washington-based
Microsoft and domiciled in Arizona, was unlawfully doing business
in Washington State.
The Commissioner ordered Cypress to cease and desist conducting
any further insurance business in the state and, in a related order,
announced his intent to collect approximately $2 million in back
premium taxes, penalties and interest.
Kreidler’s actions against Microsoft have become the object of
much concern in the captive insurance community and raise anew
the question: what can the owners of captives insuring risks in the US
do to mitigate the risk of being exposed to regulation or unexpected
premium tax liabilities in states outside the captive’s domicile?
Subject to certain common exceptions, the law of every state prohibits
any person from transacting the business of insurance without being
“authorised”—ie, licensed—in the state. The definition of “transacting
the business of insurance” generally includes selling, soliciting,
negotiating or effecting contracts of insurance. “Effecting” a contract
of insurance typically includes the activities required to execute and
service the insurance coverage such as conducting risk assessments,
delivering contracts of insurance in the state, taking receipt of premium
payments originating from the state and adjusting claims.
Captive insurance, of course, is premised on the concept that the
captive does business only in its state of domicile and therefore
need not be licensed elsewhere. Yet every captive insurer has some
contact with the states in which it insures risks, even if the contact is
limited to the fact that the insured risk is located there.
The mere fact that a captive insures risks located in a state, or
that an insured does business there, alone, most likely does not
Morris, Manning & Martin
constitute sufficient contacts to allow the state to regulate the captive
or subject the insurance it writes to premium taxes. This principle
was established by the US Supreme Court in its 1962 decision State
Board of Insurance v Todd Shipyards, 370 US 451 (1962).
In Todd Shipyards, the court held that under federal limitations
on state authority to regulate the business of insurance, the state of
Texas could not assess a premium tax on an insurance transaction
where the only contacts with the state were the fact that the insured
did business in the state and the insured property was located there.
In reaching this conclusion, the court noted that the insurance
transactions involved took place entirely outside Texas. The insurance
was negotiated and paid for outside the state. The policies were issued
outside Texas. All losses under the policies were adjusted and paid
outside Texas, and the insurers had no office or place of business in
Texas. In addition, the insurers did not solicit business in Texas, had no
agents in Texas and did not investigate risks or claims in Texas.
Todd Shipyards remains good precedent, but lower courts deciding
similar cases in more recent years generally have adopted a narrow
reading of the decision and sought to limit the ruling to the facts of the
case. Under these rulings, almost any contact between a captive and
state that goes beyond the fact that an insured does business in the
state and an insured risk is located there may be sufficient to allow
the state to regulate and tax the captive’s insurance transactions.
Practical constraints make it difficult to limit the activity of a captive
this way, especially in the state in which the captive owner has its
principal place of business, where risk managers and officers with
responsibility for the captive may be located.
Nevertheless, captives owners can and should limit the activities of
their captives outside their domiciles to help reduce the risk that a state
will obtain jurisdiction to regulate and tax the captive’s transactions.