A cease and desist order recently issued by the Office of the Commissioner of the State of Washington has revived attention around one of the least understood and most vexing of all U.S. insurance regulations and that is the topic of direct procurement. I would like to shed a bit of light and issue the usual and quite necessary cautions.
The situation appears to be that a Nevada licensed captive issued a surety bond for a Washington firm, and while the signature on the bond was deemed illegible, the officer of the captive was not licensed as a Washington agent. The Nevada captive was also not licensed or admitted in Washington.
Please note that my remarks are from an insurance person, who is licensed in most jurisdictions, including the State of Washington. I am not an attorney and am certainly not giving legal advice. That said, being licensed as an insurance producer is a legal responsibility which I take very seriously. Often in discussions of captives, the role and responsibilities of a licensed intermediary are given little consideration. This order may give you pause in that regard.
The Nonadmitted, Nonlicensed Insurer Exception
It is clear that the states regulate insurance transactions in their jurisdictions and have the clear legal right to do so. It is also clear that the laws, regulations, and manner in which they are enforced vary widely. In general, insurance companies cannot offer coverage to a particular state's citizens unless it has been admitted or licensed to do so, which entails applying for admission, completing voluminous forms, and submitting to highly intrusive regulation. Nonadmitted insurers can be licensed and usually are so required. Of course, a tax is levied on both transactions.
A transaction with a nonadmitted, nonlicensed insurer moves into murky waters. A captive is usually such a nonadmitted, nonlicensed insurer. The captive's domicile exempts and excepts it from the usual rules of admitted, licensed insurers. But what about writing business in other domiciles? What about, as in the case above, writing in a noncaptive domicile?
There is also the issue of surplus lines. Surplus lines placements are usually nonadmitted but licensed and regulated. They also are taxed transactions, and the rates vary by state. They are paid by the insured but usually are required to be handled by a licensed surplus lines broker. Captives are not surplus lines insurers per se, but I am aware of some captives that have paid surplus lines taxes just to avoid the discussion. It is highly unusual for a regulator to question a tax that has been paid.
The Case of Intermediaries
Then there is the question of an intermediary. In many states and circumstances, the state has laws defining an insurance transaction. This often includes the role and responsibilities of the person licensed to explain coverage and make the sale. Captives and their followers like to believe, and promote, that captives are outside of the normal insurance company statutes. This cease and desist order reminds us that that ain't necessarily so.
This is where murky water gets turbulent. First let's be clear that no two states handle these situations in the same manner. Some do not handle them at all. Let's also recognize that while the regulators are diligently protecting their fellow citizens, they are also seeking additional tax revenue.
To address these situations, various states have devised laws to clarify what is to be done by people doing business in their particular state. For instance, as a broker licensed in New York, I cannot help you with coverage in a nonadmitted, nonlicensed insurer while physically in New York. You and I must do it outside of New York. Think of a trip to London, as many Lloyd's transactions are neither admitted nor licensed by New York. Then it is a permitted transaction.
Direct Procurement Situations
Some states have passed laws that enabled insureds, not their agents or brokers, to approach nonadmitted, nonlicensed insurers directly to obtain coverage. These are generally called direct procurement laws. They are taxed and payable by the insured. A variation on this theme is the industrial insured exemption which essentially says that if an insured is of sufficient premium size, usually $25,000 annually, and has qualified, full-time risk management staff, said company can directly approach a nonadmitted, nonlicensed insurer. These transactions are also subject to tax.
How does this affect captives? Some captive parents are concerned enough about exposure to these statutes that they just pay the tax. Many others whistle past the regulators front door. It is unusual to read of an action against a captive based on admission and/or licensing. That is why the recent Washington case gives me pause. States are desperately seeking cash. Will taxing nonresident captives become a new stream? The Nevada captive was not taxed in this case, as it had no legal standing in Washington, which was the proximate cause of the order, I believe.
Facing the Challenge
What are recommended steps to mitigate or avoid these challenges? First of all, I would suggest that the captive owner/board become familiar with the direct procurement statutes of the states in which they will be conducting business and issuing evidence of coverage. That may not be the state of their domicile. Then I would review the formal relationships with brokers and agents. This should also drive the selection of the location in which to conduct the transaction. It is likely very well worth the investment in an airplane ticket or hotel room to show evidence that the entire transaction, or certainly the relevant parts, took place in an approved location, in or out of the state in question depending upon the law.
It must be noted that this discussion is by no means definitive on the subject and may not be current in regard to the latest law tweaks. But the message is that captives should study closely the laws of the states in which not only they are domiciled but also in which their paper will be shown.
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