The Non-admitted and Reinsurance Reform Act (NRRA) was a piece of the historic Dodd-Frank financial industry oversight regulation that went into effect in July 2011.
The Non-admitted and Reinsurance Reform Act (NRRA) was a piece of the historic Dodd-Frank financial industry oversight regulation that went into effect in July 2011. The primary intent of the NRRA was to create a more simplified and efficient regulatory system by limiting regulatory authority of surplus lines transactions to the home state of the insured, as well as establishing federal standards for the collection of surplus lines premium taxes. Most captive industry observers interpreted the NRRA to specifically exclude captive insurance.
Unfortunately for the industry, a number of individual states interpreted the NRRA otherwise. A number of the largest states declined to participate in ‘compacts’ relating to the distribution of premium taxes and administration of surplus lines insurers. The two compacts have yet to secure sufficient membership to become formally operational. Some of these states continue to insist on their share of premium taxes and require non-admitted insurers (including some captives) to file financial and other regulatory reports.
On 7 January, the captive industry received some good news. Departing chairperson of the US House of Representatives’s Subcommittee on Insurance and Financial Services, Judy Biggert, stated in a letter that the NRRA was “unequivocally” not intended to include captives. With this announcement, the industry breathed a collective sigh of relief. Despite this positive statement, it does not appear the issue is completely settled. Later in her letter, Biggert suggested a technical amendment to the NRRA may be necessary in order to clarify the issue on captives. Given the current level of dysfunction in the US Congress, it is not clear how quickly and easily such an amendment might be passed.
Also, it remains unclear if some of the larger states will comply with the act. As noted above, several states declined to participate in compacts on premium tax or other information sharing agreements. It appears some states may be taking a similar position under the NRRA as they have taken with risk retention groups (RRGs). The Liability Risk Retention Act (LRRA) has clear language regarding the limitations on information that can be required of RRGs by non-domiciliary states. But several states continue to require RRGs to become ‘approved’ before they can write business in that state. Even with federal law on their side, most RRGs comply with the requirements of individual states. For most RRGs, the financial and administrative burden of challenging such requirements are prohibitive. Outside of efforts by industry groups and some sympathetic legislators, support at the federal level has been limited at best.
Despite this turmoil, there are steps that captive owners can take with regard to the NRRA to reduce the uncertainty. Some captive owners decided to re-domicile or form branches in their home states. Fledgling captive domiciles aggressively marketed to businesses in their states to ‘bring their captives home’ by making commitments to stand by the letter of the NRRA and protect those captives from other states seeking to collect additional premium tax. The increasing number of states passing captive laws made this option viable for numerous captive owners. As this option will add administrative burden and cost, it needs to be weighed against the overall potential expense of possibly having to comply with the ‘worst case’ interpretation of the NRRA. This option is obviously not available for captive owners with businesses based in non-captive states.
Even with the ‘home state’ option, there are steps all captive owners should be taking to mitigate their exposure to non-domicile regulatory scrutiny. Even if the NRRA is interpreted in favour of captives, certain activity could subject a captive to the jurisdiction of a non-domicile regulator.
One step is to ensure that no insurance business is conducted in the non-domicile state. All agreements and policies should, ideally, be executed in the domicile state. Board meetings and other decision making activity should also be conducted in the captive domicile. For an offshore captive, this may not always be possible, but business should be conducted in a non-US jurisdiction.
Another step is to make sure the captive is current with all domicile requirements relating to filing of reports and the payment of fees/taxes. Also, all captive policies should be issued directly to affiliated insureds on an indemnification basis. This means that any claim payments will be made directly to that insured, even if the loss involves a third party. The use of ‘pay on behalf of’ language that is common in most commercial insurance policies could put the captive in the position of conducting business with third parties. Doing so would not only violate the regulations of the captive domicile, but also subject the captive to fair claim practices and other guidelines of the non-domicile state. Both transgressions could lead to significant regulatory actions in their domicile and non-domicile states.
A final step is to understand if the parent company is subject to self-procurement tax or not. Some states levy a self-procurement tax as a way of generating some tax revenue from entities that use captives or similar vehicles. Other states have what is called an ‘industrial insured exemption’ in which an organisation meeting certain size and risk management expertise requirements can procure coverage directly from alien insurers. The current definition can vary from state to state. A similar exemption is included in the NRRA, so the individual state definitions may change if the NRRA is formally adopted. In the absence of an industrial insured exemption, a captive owner may be subject to self-procurement tax. This issue should be reviewed by captive owners with their tax/legal advisors.
While the NRRA may ultimately provide the captive industry with the non-domicile compliance standards that it has fought so hard to establish, it is not clear how or when this issue might be decided. Captive owners and their advisors need to keep up-to-date on developments with the NRRA and continue to press their elected officials to support the position proffered by Biggert. In the meantime, they also need to closely follow the rules of their captive domicile and those jurisdictions in which they have insurable risks. Even if the NRRA ends up supporting captives, it is not a panacea. Captive owners will need to remain vigilant and be sure that their captives remain in compliance with their domicile state while avoiding activity that could put their captive under the authority of a non-domiciliary and likely unfriendly state regulator. CIT
