Regulation
Controversy and captives
Washington has long sought to find a way to tax captives that operate in the state but are not domiciled there. Earlier this year, it passed a law to do precisely that. Captive International reports.
“This law provides a framework for captive insurers to do business in Washington.”
Kara Klotz, Washington OIC
In May 2021, State Governor Jay Inslee signed in legislation providing a framework for captive insurers doing business in the State of Washington. The bill, which was requested by Mike Kreidler, the Washington Commissioner of Insurance, has proved controversial and the journey to its signing in has not been without its hiccups.
“Prior to this, Washington state law didn’t specifically authorise or disallow captive insurers to operate here. This law provides a framework for captive insurers to do business in Washington,” says Kara Klotz, communications manager, public affairs at Washington State Office of the Insurance Commission (OIC).
Rather than making Washington a captive insurance domicile (Washington is not one of the 35-plus states that authorise the formation of captive insurers), the law requires captives that are domiciled elsewhere—but doing business in Washington—to pay a 2 percent premium tax on insurance premiums annually, starting in 2022. It doesn’t just look forward: the 2 percent tax is retrospective.
An independent study commissioned by the OIC estimated that the law will generate $2.5 million in revenue per year for the state’s general fund and that captives will owe more than $29 million in past premium taxes. “That’s a positive long-term outcome for state revenue,” says Klotz. Captives looking to do business in Washington will also need to register with the OIC and pay a registration fee of $2,500.
Registered eligible captive insurers will be able only to provide property and casualty insurance to a captive owner or the captive owner’s affiliates. However, they will be able to “obtain or provide reinsurance for ceded or assumed risks insured in this state or elsewhere”, according to the law. It adds: “They may assume or cede risks to other insurers through reinsurance without regard to those limitations.”
Bills and budgets
When the bill became law, Kreidler called it an important step to “allow companies to continue utilising this prudent risk management tool”. He added that captives could do this while paying their fair share of premium tax to the state’s general fund “like other insurance companies have done for decades”.
David Fisher, spokesperson for the Responsible Employer Coalition (the lobby group of employers that supported the legislation), adds that the win-win objectives of the legislation were achieved. “It was a victory for employers and for the people of the state,” he claims.
Fisher believes that the bill was introduced to address a gap in insurance law in the state. “Before this legislation, Washington law did not clearly distinguish between captive insurers and commercial insurance companies, which play very different roles.
“That ambiguity resulted in the OIC having no clear legislative direction for its regulatory and taxation treatment of captives,” he says. Responsible Employer Coalition members included Alaska Airlines, Amazon, Fortive, Microsoft, Starbucks, SSA, and True Blue.
The coalition—and Kreidler—jointly supported the legislation, adds Klotz. “The new framework provides regulatory authority, consumer protection and the opportunity to improve the business climate for Washington employers, while simultaneously generating additional revenue for the state budget.”
Washington collects more than $1.2 billion in premium tax every two years from more than 2,400 insurance companies—these funds are the state’s second largest source of revenue.
Others take a dimmer view of the reasoning behind the law. In March 2021, Richard Smith, president of the Vermont Captive Insurance Association, claimed that the captive insurance industry is “facing a new slippery slope”.
Smith told Captive International that Washington’s OIC completely misunderstands the nature of captive insurance. “Perhaps they were seeking ways they could collect more tax revenue for the state, which all states are hungry to do. In doing so, they created the context that Washington enterprises were undertaking ‘illegal’ insurance activities with captives domiciled in other states.
“Nothing could be further from the truth,” he says.
A look back in time
Legislation to set up a framework of taxation and regulation was considered in 2020 but did not pass. By legislative request, in March 2020, the OIC began to study and identify the number and type of captives that exist, the types of insurance being procured, and the volume of premiums being held.
Fisher says that the Commissioner’s staff worked with the coalition on the legislative-mandated study of the captive insurance market in Washington. It also “negotiated the final bill language that dealt with the authority of Washington-based employers to utilise captive insurance subsidiaries domiciled in other states, as well as the basis for taxation of those subsidiaries’ activities”.
The study and passing of the law is not the whole history, however. Back in 2019, the OIC began investigating Washington state-based companies that had formed their own captives and pursued unpaid premium taxes, interest, and penalties. As part of the OIC investigation, 16 captives self-reported and two of the 16 settled before the 2020 legislative session.
Washington-based Microsoft ended up settling with the OIC, with its Cypress Insurance Co. of Phoenix, Arizona, agreeing to pay $573,905 in unpaid premium taxes and $302,915 in interest and penalties in August 2018. Months before, Kreidler had ordered Cypress to stop transacting insurance without a licence and to pay tax on its written premiums.
In March 2019, Costco’s captive agreed to pay $3.6 million in unpaid premium taxes, penalties, interest and a fine after self-reporting. Later in the year, Kreidler ordered Olympic Casualty Insurance Co. and ASA Assurance to stop insuring risk in Washington for their parent companies, Starbucks and Alaska Air Group. The litigation was suspended in March 2020, when the OIC began its captive insurance study.
A seat at the table
While some across the industry have voiced their concerns and watched the developments in Washington with apprehension, the captive owners coalition did come to the table to work with the OIC on the law and the study. Fisher says he’s not aware that the law enacted by the legislature was controversial for captives owners.
On the other hand, Smith—who stresses that he was not privy to the discussions behind the scenes on how the agreement came together—observes that the “threatening manner from the OIC to fine companies with legitimate captives drove many captives owners to the table to avoid a political fight or potential litigation”.
He believes that the law has been controversial with captives owners because it “ignores the basic principle around state regulation and the how captives work”.
Smith adds: “Registering captives and taxing them with fees and premium taxes throws into question the reasons captive insurance has been so successful for organisations around the country in controlling their risks and costs.
“No Washington citizens are at risk with captive insurance procured from businesses and non-profits in the State of Washington—the only potential downside is to the captive owners themselves.”
Chilling effect?
There have been murmurs across the captives industry that Washington’s new legislation may be a path for other non-domicile states to follow. Fisher and Klotz both note that it is difficult to predict what other states will do, with Fisher explaining that “many already authorise captive insurance operations within their own borders, so their situations are very different”.
Klotz adds: “This legislation puts Washington on the leading edge of establishing a fair and equitable framework for lawful captive insurance activity.”
Smith is hopeful that the law is an isolated incident, specific to the politics of the state. He concludes: “With over 35 states already adopting captive insurance laws or with self-procurement taxes, I think the impact of the Washington law is small. However, it stands out as an example of how overzealous insurance regulators, either knowingly or unknowingly, can damage this important risk management industry."
The long-term impact of Washington’s much-discussed new law—for both the state and its companies—has yet to be seen, but any developments are sure to be scrutinised closely across the entire captive insurance industry.
