A copy of the "Dodd Frank & Captives" presentation given at the Delaware Captive Insurance Association.

1. DODD FRANK AND CAPTIVES
Delaware Captive Insurance Association
2013 DCIA Spring Forum
Hotel du Pont
Wilmington, DE
May 14, 2013
Charles J. (“Chaz”) Lavelle
Bingham Greenebaum Doll LLP
101 S. Fifth Street, Suite 3500
Louisville, KY 40202
502/587.3557
Fax 502/540.2155
clavelle@bgdlegal.com
Stuart H. Anolik
CBIZ MHM, LLC | Managing Director
3 Bethesda Metro Center, Suite 600
Bethesda, MD 20814
301.951.3636
Fax 301.951.0425
sanolik@cbiz.com

2. 2
Dodd Frank and the Wizard of Oz
• Dodd Frank is like the Wizard of Oz
– When the movie Wizard of Oz is mentioned, all think of the wizard
– Wizard drew all the attention during the movie
– The wizard was all the fury and commotion
– The wizard had nothing to do with the outcome – he was on
screen for 10 minutes and didn’t get Dorothy home
– Dodd Frank has little to do with the obligation to pay tax – it does
not impose a new tax, it only tells where the tax is paid (maybe)
– Dodd Frank did, however, focus attention on self procurement tax
• The self procurement taxes are the ruby slippers – they are
the main event

3. 3
Types of Taxes Based on Premium
• Premium Tax – imposed on insurance companies
licensed in state
• Surplus Lines Tax – imposed on broker licensed in state
with respect to insurance from insurance company not
licensed in state for hard to place coverage
• Self Procurement Tax – imposed on insured that
purchases insurance from an insurance company that is
not licensed in state

4. 4
Rates of Taxes Measured By Premium
• The commercial insurance premium tax is generally
in the range of 2% to 3%
• The captive insurance premium tax rate is often .4%
or .38% of premium (sometimes on the first $x of
premiums, then lower); some states impose a fee
(say $5,000) rather than, or a cap on, premium tax
• The surplus lines tax is typically greater than the
commercial insurance premium tax, often 2% to 5%
• The self procurement tax rate is usually comparable
to the surplus lines tax rate

5. 5
Nexus
• The premium tax is imposed on an insurance company
licensed in the state
• Normally, an insurance company must have some
“nexus” to the state in order for the state to have the
authority to tax that company
• “Nexus” generally means that the company has
sufficient contacts with the state (physical presence
property or employees in the state vs economic nexus)

6. 6
Nexus (cont’d)
• Allgeyer v Louisiana, 165 U.S. 578 (1897) – misdemeanor
and $1,000 fine prohibited where the risk was in Louisiana,
but it was insured in New York, although there was a letter
sent by the insured, from Louisiana
• St. Louis Cotton Compress Co. v Arkansas, 260 U.S. 346
(1922)
– Arkansas could not collect premium tax where the risk was
located in Arkansas, but the insurance company was in Missouri
– The insurance company did not have any office in Arkansas
– The insurance company did not have any agents in Arkansas

7. 7
Nexus (cont’d)
• Connecticut General Life Insurance v. Johnson,
303 U.S. 77
– California could not tax two insurance companies
authorized to do business in California, where
one reinsured life insurance on California
residents to the other in Connecticut

8. 8
Surplus Lines
Surplus Lines Broker
•Have to demonstrate inability to obtain coverage
•Must have made robust search
•Although the insurance company may be outside the
reach of the state to tax, the broker is subject to tax
•There is nexus because the broker does business in the
state

9. 9
Rates of Taxes Measured by Premium
(cont’d)
• The self procurement tax is imposed by about 40
states; Delaware does not appear to have a statute; see
Atlas Mutual Insurance Co. v Fisheries Co., 22 Del. 256
(1907)
• The self procurement tax is also referred to as direct
placement
• A state cannot impose a premium tax on a company not
licensed or doing business in that state and a self
procured policy is not subject to a surplus lines tax on
the broker (there is no broker on the transaction and no
company listed on the surplus lines list

10. 10
Self Procurement Tax
• The question is whether a state can levy a
tax on the self-procurement of insurance on
one of its citizens, when the acquisition of
the insurance takes place wholly outside
the state?

11. 11
Todd Shipyards, 370 U.S. 451 (1962)
• In State Board of Insurance v. Todd Shipyards Corp., the U.S.
Supreme Court held that Texas could not tax the purchase of
insurance by a New York company from a New York insurance
company, even though the risk insured (ship yard) was in Texas
– The policy was issued outside Texas
– All the negotiations for the policy took place outside Texas
– The payment of the premium was outside Texas
– The claims adjustment and payment would be outside
Texas
– The insurers are not licensed in Texas, nor have agents, an
office or place of business, nor solicit business or
investigate risks or claims in Texas

12. 12
Todd Shipyards (cont’d)
• Todd Shipyards reaffirmed the earlier cases such as
– Allgeyer v. Louisiana
– St. Louis Cotton Compress Co. v. Arkansas
– Connecticut General Life Insurance v. Johnson
• Todd Shipyards said that nothing in the McCarran
Ferguson Act changed the earlier cases
– McCarran Ferguson Act generally gives states the right
to tax and regulate insurance

13. 13
Dow Chemical Co. v. Rylander
• The Texas state court found that Texas could not
impose the self procurement tax in Dow Chemical Co. v.
Rylander, 38 S.W. 3d 741 (Texas 2001)
• The court followed Todd Shipyards because in Dow the
insurance company was outside Texas, the property
was owned by a non-Texas company, the policies were
negotiated, executed, delivered and paid for outside of
Texas, claims would be investigated outside Texas,
there would be no communications inside Texas, etc.

14. 14
Further Texas Action
• In January 2007, the Texas State Comptroller
stated that it will impose the self procurement tax,
when one of a number of activities take place in
Texas, in addition to the risk being located in
Texas: payment, policies issued or delivered,
underwriting or loss adjustment, investigation or
payment

15. 15
Other State Procurement Tax
Cases
• Despite Todd Shipyards and Dow Chemical, other state
courts have often imposed a self procurement or other
tax on purchase of insurance by an insured directly from
a non-licensed insurance company. For instance:
– Associated Electric & Gas Insurance Services, Ltd v.
Clark, 676 A. 2d 1357 (R.I. 1996), AEGIS is a leading
case

16. 16
AEGIS (R.I. 1996)
• Associated Electric & Gas Insurance Services, Ltd v.
Clark (R.I. 1996) -- AEGIS is a foreign (Bermuda)
insurance company that insured four electric utilities in
New Hampshire
• Neither AEGIS or its affiliate, AEGIS Services, and
MGA, entered the state of Rhode Island
• This case is really a premium tax case, because Rhode
Island did not have a self-procurement tax
• AEGIS said that it did not conduct business in Rhode
Island and Todd Shipyards forbade the imposition of tax

17. 17
AEGIS (cont’d)
• The Rhode Island court looked to a U.S. Supreme
Court case that occurred after Todd Shipyards, but had
nothing to do with insurance
• Quill Corp. v. North Dakota, 504 U.S. 298 (1992)
involved a company that saturated North Dakota with
mail order catalogues, although Quill did not have any
property or employees in North Dakota
• North Dakota imposed a sales tax on the mail orders
made by North Dakota residents

18. 18
AEGIS (cont’d)
• In Quill, the U.S. Supreme Court noted that, even
though Quill did not have a “physical presence” in North
Dakota, Quill “availed itself of an economic market” in
North Dakota
• The Rhode Island court concluded that (1) Quill
represented the current view of the U.S. Supreme Court
(and, essentially, Todd Shipyards had been passed by)
and that (2) the U.S. Supreme Court would impose a
tax under its current view
• Thus, the Rhode Island court imposed the tax

19. 19
Dodd Frank / NRRA
• Dodd-Frank Wall Street Reform and Consumer
Protection Act – PL 111-203 (July 21, 2010), effective
July 21, 2011
• The Nonadmitted and Reinsurance Reform Act of 2010
(NRRA)
– Tax on premiums of non-admitted insurance companies will
be paid to the home state, not to the various states in which
there is insured property
– Clearly applies to surplus lines, but many argue that it does
not apply to captive insurance companies

20. 20
Dodd Frank/NRRA – Cure to Perceived
Problem
• Prior to Dodd Frank, the perceived problem was that a
surplus lines broker who procured surplus lines for a
business with an office or other property in every state had to
divide the premiums among 40 states and process the
paperwork
• The surplus lines brokers wanted to streamline the process
and pay only to one state (and only file in one state)
• Those involved in the legislation say that captives were never
mentioned in the negotiations, and, if asked, those involved
would have said that Dodd Frank does not apply to captives

21. 21
Dodd Frank/NRRA - Framework
• Only the insured’s home state can impose a tax for
“non-admitted insurance” (section 521)
• Section 527(9) defines non-admitted insurance as
p&c insurance that is permitted to be placed directly
or through surplus lines broker with an eligible “non-
admitted insurer”
• A non-admitted insurer is one that is not licensed to
engage in insurance in a state
– Includes surplus lines company
– Does it literally include a captive?

22. 22
Home State for NRRA
• “There’s no place like home”
– Glenda, the Good Witch
– Dorothy
– Dodd Frank

23. 23
Home State for NRRA (cont’d)
• Home state is:
– State where the insured has principal place of business
– If 100% of the risk is outside the state with principal place
of business, then the home state is the one with the
greatest percentage of premium
– If affiliates are named insureds, then the home state is
the home state of the affiliate with the largest percentage
premium
• It is generally viewed that the home state is determined on a
policy be policy basis

24. 24
Compacts Among the States
• The NRRA authorizes (and “everyone” assumed that)
the states would enter into compacts (section 521(b)(1))
– The home state would collect 100% of the tax
– The home state could require that the surplus lines brokers
and insureds to file reports each year in which the
premiums would be allocated among the states in which the
risk resided
– The home state would then divvy up the tax among the
states in which the risk resided

25. 25
Compacts Among the States (cont’d)
• Two different compacts have arisen, but neither is in force
– NIMA (Non-Admitted Insurance Multi-State Agreement)
• This has the support of the NAIC
• 12 states have adopted, but 6 have pulled out
– SLIMPACT (Surplus Lines Insurance Multi-State Compact)
• Supported by the NCOIL – National Council of Insurance
Legislators
• 9 states have adopted
– Many larger states have determined to keep the 100% that they
collect, and forego the ability to share in other states’ receipts

26. 26
NRRA – Approaches?
• Some approaches?
– Domicile captive in the headquarters state of the operating
company
• Either use the domicile captive as the only captive or as a front
which reinsures to the historic captive
• Will this result in jurisdictions with substantial captive expertise,
but few headquarters, to lose captive to states with many
headquarters ?
– Issue policy to one or more, but not all, insureds in an
affiliated group; perhaps have more than one captive

27. 27
Coalition for Captive Insurance Clarity
• McIntyre & Lemon PLLC “white paper” concludes that
there was no intent for the NRRA to apply to captives --
10/6/11
• Coalition for Captive Insurance Clarity -- November
2012
– http://www.vermontcaptive.com/DoddFrank
• VCIA organized the coalition
• CICA wrote a supportive letter

28. 28
Coalition for Captive Insurance
Clarity (cont’d)
• Rep Judy Biggert 12/16/12 statement that Dodd Frank
was never intended to apply to captives
– Rep. Biggert was Chair, Subcommittee on Insurance,
Housing and Community Opportunity, Committee on
Financial Services
• Rep Scott Garrett (R-NJ) 2/6/13 statement that Dodd
Frank was never intended to apply to captives
– Co-author of NRRA
• Anderson Kill & Olick paper 2/27/13

29. 29
What if the Coalition is Successful?
• If the Coalition is successful, it will make it clear that the
home state cannot collect 100% of the tax
• The insureds will still be subject to self-procurement tax
to the extent that they were previously subject
• States may be more sensitized to the ability to impose
self procurement tax
• Presumably Todd Shipyards will apply to the extent that
it applied before Dodd Frank