On June 5, Texas Governor Rick Perry signed into a law that allows the Texas Department of Insurance to license and regulate captive insurance companies in the Lone Star State.
A captive insurance company is as it sounds: An insurance company formed by a parent company to underwrite the insurance needs of the parent company's various subsidiaries, with the insurance company being restricted (the "captive" part) to underwriting no other business than that of the operating subsidiaries. This is what the new Texas law will allow when it goes into effect on September 1.
Texas joins the majority of states, around 30 depending on how you count them, that authorize the formation of captive insurance companies. Vermont is by far the largest, being in fact the second largest captive insurance domicile in the world, and not far behind the leader, Bermuda.
Since the IRS finally gave their blessing to captive insurance companies in 2002 (after losing years of court challenges against captive arrangements), captives have substantially changed the business insurance landscape. Now, relatively few large companies do not have captives, and captives have proven to be extremely popular with middle-market companies. Captives allow companies to underwrite substantial pieces of their own risks, and now even allow companies to take on certain of the risks inherent in employee benefit plans and the like.
Although a majority of states have passed captive legislation, not all of these states actively support captives. Some states passed legislation but never funded it, for whatever good that accomplished, while other states' insurance commissions or departments never got on board with the concept and so it was stillborn in those states.
A significant reason that states have passed captive legislation is to try to keep the captive business at home, and not lose it to Vermont, Utah, or other of the several other states that are aggressively seeking that business. There is also the matter of revenues: Captives are Vermont's second largest industry, and the captive insurance business employs literally thousands of folks in those states with aggressive captive sectors.
Many of these revenues come in the form of either licensing fees or premium taxes. But states that do not offer captive insurance companies to their businesses also risk losing substantial revenue in the form of fees and taxes normally paid by the larger insurance companies in their states on the business that the captives have stolen away from them. To such "outside insurers", most states have imposed taxes on business which satisfy their insurance needs from insurance carriers that are not admitted in the state.
These taxes most commonly appear in the form of "independently procured taxes", and many states -- most notably Texas -- have been very aggressive in attempting to collect these taxes from their states' businesses. Unfortunately for the states, but fortunately for their businesses, these taxes have run afoul of federal law as first announced by the U.S. Supreme Court in State Bd. of Ins. v. Todd Shipyards Corp., 370 U.S. 451, 82 S.Ct. 1380, 8 L.Ed.2d 620 (1962). The Texas insurance regulators were slapped down in this case, and then 20 years later by the Texas Court of Appeals in Dow Chemical Co. v. Rylander, 38 S.W.3d 741 (Tex.App. 2001).
Which brings us back to Texas. Despite its self-proclaimed "pro business" aura, one area where Texas has been much less than friendly to Texas businesses has been in the area of captive insurance. To the contrary, the Texas Department of Insurance has long been a royal pain to businesses in the state that have captive insurance companies, often asserting the position that captive insurance companies were an evil because they might not adequately protect the Texas businesses that were insured by captives.
This position was utterly absurd, of course, since the captive was owned by the parent company of the businesses that were buying insurance from the captive, and therefore if for whatever reason a captive didn't pay claims, the only one hurt was the parent company itself.
In the Department's defense, sometimes scam artists have offered what amounts to straight insurance to Texas insureds under the terminology of "captive insurance", and those insureds have suffered. But for the most part, the Department's longtime rampage against captives was throwing the baby out with the bath water, for what many captive practitioners considered to be little more than naked regulatory protectionism of its turf.
Nonetheless, with the tremendous and surprising growth of the U.S. captive industry following the IRS's 2002 guidance, even the Texas Department of Insurance bowed to the inevitable, and the Texas Insurance Commissioner, Eleanor Kitzman, quite sensibly noted in her 2012 Biennial Report (at page 10) that:
An opportunity exists to further enhance Texas’ pro-business climate. Allowing the formation of Texas domestic captive insurance companies could help attract new businesses and retain existing Texas companies. In addition to touting the current benefits that Texas has to offer, Texas-based Fortune 500 and other corporations could benefit from reduced costs and administrative burdens related to their captive operations.
Commissioner Kitzman then recommended the adoption of the laws which Governor Perry ultimately signed, allowing Texas businesses to form, license and operate captives within the state. Good for her!
But passing captive insurance laws is only the first step towards developing a market for captives in the Lone Star State. As mentioned, other states have adopted captive laws but did not follow up with the numerous other things necessary to give their states a robust captive sector.
So what we know is that Texas has passed captive legislation. Whether Texas captives will "work" depends on quite a few things, but most importantly whether the TDI will hire a deputy commissioner who is savvy to how captives operate, and also segregate the regulation of captives as much as possible away from the normal regulation of insurance companies that often makes little sense in the captive context. In other words, the TDI needs a captive-friendly office to both promote captives in Texas and defend captives against the historically captive-hostile attitudes within the rest of the department.
Otherwise, Texas will need to avoid the mistakes of other states that went into the regulation of captives badly, meaning that they approved unscrupulous or questionable captive managers (Texas already has some of these effectively operating in the state though forming their captives elsewhere), allowed demi-captive arrangements that were little more than fraudulent schemes to defraud insureds, or allowed businesses to obtain licenses for captives whose business owners simply didn't know what they were doing and were unwilling to learn. It is usually better for new captive regulators to slowly wade into the captive market, than to jump in whole-hog as some early captive states did and ended up a number of ill-advised captives requiring liquidation.
The point of all this is that just because Texas has adopted captive laws does not mean that Texas captive insurance sector will ipso facto be a success. To the contrary, Texas business owners should avoid the euphoria that the adoption of such new legislation usually brings, and instead take a skeptical, even cynical, attitude towards Texas captives until Texas has proven that it will take the necessary steps to be a friendly captive domicile.
I am hopeful that Texas will eventually turn out to be a good domicile for captives, but cannot understate the caution to wait and see how all of this shakes out. Stay tuned.
[By way of disclosure, I am the current Chair of the American Bar Association's Committee on Captive Insurance Companies in the Business Law section, the author of the book Adkisson's Captive Insurance Companies, and am a Texas-licensed attorney (though not any legal specialist in this or any other field).]
This article at http://onforb.es/13wy5ZY and http://goo.gl/Q3kVz
