Morris, Manning, and Martin
Washington DC has been the scene of some big moments for captive insurance in the last year, but Skip Myers of Morris, Manning, and Martin says that 2015 could follow a similar pattern
Given its timeliness, what is your reaction to the reauthorisation of TRIA?
The initial reaction from my point of view would be that it is great that Congress finally got its act together and the President signed the bill. It was all done pretty quickly, which was nice, and I don’t think there was any real surprises—it was a re-endorsement of the Terrorism Risk Insurance Act (TRIA), with somewhat less federal government involvement.
What I mean by this is there was a push by some in Congress, particularly those on the right, to lessen the government’s role, while those on the left preferred a bigger government role. The new trigger point limits the amount that the federal government would be on the hook for in the event of a designated terrorist attack, though this doesn’t apply to nuclear, biological, chemical and radiological risks. It is an endorsement of the principle that the federal government should provide liquidity to the reinsurance market and reinsurance where there would be very little available if there was no TRIA. This is a good thing for the industry, particularly captives.
Was there any uncertainty from within the industry that this would go through?
There was definitely some real apprehension that it would not get done. That was in part because of the philosophical debate, but more because of the general dysfunction of Congress. As late as right after Christmas, people knew that the new speaker and majority leader had this high on the agenda—but these are just promises. We never really knew. We were fortunate to get it done so quickly in the new Congress.
I think people still assumed that act was going to be reauthorised and never really got to the stage where they were putting substitute programmes in place or not getting the appropriate coverage. It happened quickly enough that it didn’t create a great deal of wasted effort.
Are there any similarly concerning regulatory hurdles to clear in 2015?
TRIA was a big item for dealing with Congress, as it lapsed, but there is nothing as pressing on the horizon.
Something like the clarification of the Non-Admitted and Reinsurance Reform Act related to captives would be really great to get done this year, but that will take time.
There are other things that need to be done on more of a defensive basis to prevent federal involvement in insurance business where some people do not like it. An issue such as the federal government placing additional taxation on reinsurance with offshore companies has been a threat for five or six years and that needs to be prevented.
There is talk of the IRS conducting investigations into ‘abuses’ of captive arrangements. What will be the implications of this?
I think it is pretty common knowledge in the industry that this is going on. From what I understand, the Internal Revenue Service (IRS) is looking at pools that are allegedly being improperly used to provide third party risk to micro, or 831(b), captives.
The IRS thinks that these captives are being ‘abused’ because there may not be any arm’s length pricing or real transfer of risk. Basically, it is a way to postpone taxes and only get taxed on the income from investments, rather than the insurance income as well.
For estate planning purposes, that can be valuable (transferring assets from one generation to another), but there are clearly instances of this not being done correctly. The IRS is trying to get to them by hitting the pooling mechanisms that, in some cases, underwrite risks that are not real insurance risks. Ironically, in these arrangements, the reinsured pays a lot more for this coverage than it is really worth, because it is the insured’s insurance company and there is little incentive to pay any claims, anyway. The theory is that the chances of a valid claim are so minimal that they are just going to accumulate cash.
CICA says that you should do captives right or not at all, and I agree with that. In other words, you have got to adhere to the rules on underwriting, third party risk and arm’s length arrangements, and it is an abuse of the system if you don’t do that. The IRS examination was predictable and we don’t know how it will turn out, other than the faulty arrangements will go out of business. It will be a message to micro captives that these types of arrangements had better be done right, or they are going to have problems in the audit.
Aside from regulations, do you see any potential shifts in the US captive industry in 2015?
I don’t see anything right now that is going to alter the captive industry itself. There have been a number of significant new domiciles emerging in recent times, such as Texas and Connecticut, which has created more competition for the same business.
We have also still not seen the end of the soft market, though if we had, then I believe that would have had a major effect on business. I think that this market, and the concurrent lack of demand, means that we will not see as many risk retention groups being formed in 2015. However, I think it is important to remember that both the soft market and the proliferation of new domiciles were both trends in 2014, so are nothing new.
