Extras on Excise: What’s the Big Idea With … Captive Insurance and Taxes?

Bloomberg BNA state tax coverage often burrows deep into industry matters, so sometimes it’s helpful to take a few steps back and give a general overview of a tax concern. This week, we’re telling SALT Talk blog readers what the “big idea” with captive insurers is—what they are, why they’ve been in the news, and some SALT takeaways.

For most people, insurance is a byzantine labyrinth of horrors, and classifications like “captive” only make the general concept more difficult to understand, especially since there are multiple types of subgroups within the “captives” category. In layman’s terms, a captive insurer is an insurance company that an organization creates to insure its own risks in lieu of purchasing a policy from a traditional insurer. The exact definitions vary by state.

Captives are formed according to state law and applicable laws and regulations are regularly tweaked to increase competition among captive domiciles. Some states like California and Alaska do not recognize captive insurers. States that authorize captive formation typically impose premiums taxes on them; tax rates vary by state.

Vermont, the largest captive domicile in the United States, recently established statutory provisions for agency captive insurance companies to operate in-state via H. 85, effective May 1. Agency captives can only insure risks for commercial policies placed by insurance organizations that own or control the agency captives, and they must have at least $500,000 in paid-in capital and surplus to receive a license.

Texas enacted changes to its captive laws on June 15 that went into effect immediately. H.B. 1944 adds an entire section to create the framework for captive exchanges, which the state defines as “reciprocal or interinsurance exchange[s].” Accordingly, the statute updates the definition of captive insurance and permits captives to issue life insurance to insure ERISA employee benefits.

The bill also amends Texas’ captive formation requirements. Now, a captive can submit “other documentation demonstrating [its] valid formation” when applying for a certificate of authority, in lieu of submitting a certificate of formation. The state can also waive the requirement for a captive to file annual actuarial reports if the captive has less than $1 million of net written premiums or reinsurance, or has been operating less than six months as of the end of the previous calendar year.

Earlier this year, Georgia revised its captive formation requirements, effective July 1. Prior to that date, captive formation was governed by the formation requirement statutes for domestic stock and mutual insurers. S.B. 173 revises the law to codify these requirements in the Georgia Captive Insurance Company Act instead of captives being subject to potential future changes to requirements applicable to traditional insurers; these requirements include a $100 formation fee and submission of documents that the state will review “to determine whether such documents will enable the captive insurance company to comply with the applicable insurance laws of th[e] state.”

Georgia also made some changes to its tax statutes; risk retention group captive insurers are now only subject to direct premiums taxes for in-state coverage. 

Tennessee’s Department of Commerce and Insurance is contemplating changes to its regulations that clarify eligibility requirements for captives wishing to be subject a five-year audit period. Additionally, under the proposed regulations, captives in operation less than 90 days before their fiscal year’s close would be able to defer their comprehensive annual audit; also, protected cell captives  would be able to elect to omit individual cells from their audited annual financial report that 1) did not collect premiums or write policies for their calendar or fiscal year and 2) were under no liability or potential liability for policies issued in previous years. This follows legislation enacted earlier this year, S.B. 1190, that revised the penalties for failure to pay captive premiums taxes and established statutory definitions and classification requirements for dormant captive insurance companies.

Aside from changes in state law, captives have been in the federal spotlight in recent years due to concerns about tax avoidance or evasion. Small captives meeting the criteria of I.R.C. § 831(b) can elect to be taxed on their investment income instead of premium income, leading to concerns that captives are being created for tax purposes instead of for insurance purposes. Micro-captives have been on the IRS “Dirty Dozen” list for three years, and recent IRS guidance indicates that the agency is taking note of “transactions of interest.” Time will tell what, if any, course of action the IRS takes on the issue. In the meantime, it appears that states are looking forward to continuing business with captives.

Watch this space and other Bloomberg BNA products for captives news and other explanations of industries’ tax concerns!

Continue the discussion on BBNA State Tax Group on LinkedIn: Does your state permit captive insurance companies to be formed in-state?

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*This post has been corrected to explain that the proposed Tennessee regulations elaborate on the requirements for extending the audit period to five years from three, not that the proposed regulations would change the audit period to three.