|November 5, 2013|
Previously published on October 31, 2013
Hospitals and health systems often use captive insurance companies or risk-retention groups to fund primary layers of liability exposure, large deductibles or self-insured retentions. Providers also may use a captive to provide stop-loss or reinsurance protection in connection with a provider-sponsored health insurance plan. Hospitals and systems that have captive insurers (or that are considering forming a captive) should be aware of recent changes in federal and state laws regarding insurance premium taxes. Some hospital captives have already moved their captives back home from “offshore” as a result of these changes.
NRRA and captives
The Nonadmitted and Reinsurance Reform Act, or NRRA, which was enacted as part of the Dodd-Frank Act in 2010, has triggered heightened awareness of self-procurement taxes. This is due to legislation enacted by the states in response to the NRRA as well as efforts by some states to persuade companies based in those states to “come home with your captive.” The NRRA provides that only the insured’s “home state” can impose a premium tax on “nonadmitted insurance”.
By way of background, all U.S. jurisdictions generally prohibit a nonadmitted insurer—i.e., an insurer that is not licensed—from transacting insurance in the state: the so-called “doing business” laws. A captive insurer typically will be licensed to transact insurance in a single U.S. jurisdiction (its “domiciliary” state), and that state typically imposes on the captive itself a low, low gross receipts tax rate, often capped, at say $250,000. In other jurisdictions where the captive insurer is not licensed, the insurer is considered “nonadmitted” and therefore is generally not permitted to transact insurance, absent an applicable exemption. Most states have one or more exemptions from their “doing business” laws that permit a qualified insured to procure insurance from any nonadmitted insurer, and these exemptions are used by captive owners to access their nonadmitted captive insurers.
Roughly two-thirds of U.S. states impose a self-procurement tax. The laws typically require an insured to pay tax to the insured’s home state on the premium paid for any insurance procured directly from a nonadmitted insurer, and to report the transaction to the insured’s home state. Only a couple of states exempt captive insurers from this tax; otherwise, the self-procurement tax laws do not distinguish between insurance procured from captives and from non-captives. State laws may not provide an express exemption from the self-procurement tax for premiums paid by hospitals or other not-for-profit entities. Prior to the NRRA, with a few exceptions, all states that imposed self-procurement taxes applied them on the basis of the premium allocated to that particular state. States had typically not required payment of the tax based on 100% of the premium when the nonadmitted insurance was placed under their laws. (Some states coupled this allocation rule with a provision allocating any premium not actually reported to and taxed by another state to the state, the equivalent of requiring tax on 100% of the premium in some circumstances.) It was common for more than one state to assert the right to collect premium tax on its allocated share of premium for placements covering multistate risks. Today, post-NRRA, nearly all states impose their self-procurement tax on 100% of the premium paid by a home state insured, and only the insured’s home state can regulate or impose premium tax on a nonadmitted insurance transaction.
These developments raise various issues and options for captive owners and managers, including re-domestication of the captive or formation of a captive in the insured’s home state or in another state where the insured maintains a substantial physical presence.
“Bring your captive home”
A number of states are actively marketing themselves as a competitive domicile for captive insurers. For example, New Jersey imposes a 5% tax on all of the premium paid by a New Jersey-headquartered insured for insurance procured from an insurer that is not authorized in New Jersey, such as a captive insurer. This tax is imposed on and is paid directly to the state by the insured. Historically New Jersey (like other states) imposed this tax on only the portion of the premium attributable to the New Jersey risks, and therefore the unauthorized insurance premium tax exposure for New Jersey insureds has potentially increased significantly within the past couple years.
New Jersey’s premium tax rates associated with insurance purchases from a domestic captive compare favorably with other captive domiciles, and the New Jersey Department of Banking and Insurance has a unit dedicated to captive insurer regulation that is efficient and transparent. New Jersey’s premium tax on insurance written by New Jersey captives is less than 0.05% and is subject to an annual cap of $200,000.
There are similar initiatives in Arizona, Connecticut and Delaware, among other states, which complement the historically “best-in-class” captive jurisdictions such as Vermont and Bermuda.
As a result of the changes in the NRRA, it may make sense for some health systems to “bring home” their captives. In making this decision, health systems should consider the following:
- Potential self-procurement premium tax savings from moving the captive, or from forming a new captive, or, alternatively, from pursuing legislation that would exempt the health system from the premium tax;
- Whether the captive could operate effectively in the potential new domicile, including whether the potential new domicile has the necessary resources and expertise and appropriate economic and regulatory environment; and
- A cost-benefit analysis of the above.