Expert Commentary

Federal Proposals for Captive Insurance Regulation

In an effort to provide timely comment and helpful observations on current captive matters, it behooves me to shed a bit of light on the recent proposal, known as the Blueprint for Financial Reform, proffered by Secretary of the Treasury Henry Paulson.

April 2008

This Blueprint is a sweeping 218-page document put together in the finest federal style. You can find it in full on the Web. It covers many areas of financial regulatory reform and has quickly drawn a lot of discussion. My purpose today is to draw your attention to the proposals on insurance, and share thoughts on what impact, if any, these may have on captives.

The basic proposal is quite simple and lacking in details as is so often the case with federal proposals. The proposal is to offer an optional federal charter (OFC) to insurance companies. This means that an insurer, instead of being domiciled in one of the states and governed by its rules and subject to the differing rules of any other state in which it wishes to do business, would be chartered by the federal government to operate in all 50 states, and in U.S.-governed territories I presume. No more is really said. In the insurance world, this has been known as the 50 monkeys versus 1 gorilla argument.

Nothing is mentioned about captives. At some point however they must be addressed as this proposed legislation slogs through the halls of Congress.

A Historical Perspective

A little history: insurance regulation for at least 135 years has been carried out at the individual state level. This structure has been affirmed judicially and while occasionally challenged, it has stayed in place. Treasury says that this system does not work because it does not serve the world of commerce and hurts us internationally.

We are country with a strong history of states' rights. As to regulating insurance there are at least 50 different approaches. Some legislatures are knowledgeable about insurance and involved in all of the important aspects of protecting the public and shareholders. The primary concern arises from insurers who are unable to pay claims or to stay in business to reward their shareholders. While this is true for every type of business, insurance has successfully shrouded itself in mystery and boredom sufficient to deter most people from understanding what is done. This shroud has allowed some greedy and/or stupid and/or incompetent people to inappropriately take money that should have gone to claimants or shareholders.

As regulation developed its many approaches, it was driven by the culture of the state in which it resided. Some insurance regulators are elected by popular vote for example, leading to blatant pandering for votes on the wrong issues and accepting bribes to look the other way. Other states appointed regulators in which the patrons of the regulator were seeking rewards from the insurance community for having made the appointment of a malleable soul. It is sometimes called negotiable virtue. Most regulators are upstanding, hard working, thoughtful, and virtuous.

Along the way, some folks determined that uniformity was necessary. That is reasonable. A trade group, the National Association of Insurance Commissioners (NAIC), was formed and began to design Model Acts to promote uniformity to a high degree. It was thought that this would speed the regulatory process and result in great efficiencies for all. That didn’t happen for many reasons.

Is the OFC the Answer?

Today, we have a system that sometimes works very well and other times not at all. Because of the power of the NAIC to withhold "certification" of a state which doesn’t follow their party line criticism is quite muted. But such criticism does exist, and it has been growing. This proposal, if it does nothing else, brings the insurance issue to the front if not the center because of the other reforms proposed of which insurance is but a small part. The chances of anything being done by Congress in an election year are rather near zero. But the gauntlet has been thrown, and the forces of good and evil are preparing to work with a new president and a new Congress on these issues.

The principal criticisms have been the lack of uniformity in process and speed to market. I will leave to others the many tales of regulatory futility involved in filing to do business in multiple states, but suffice it to say that there are legions of lawyers and accountants and regulators who spend uncountable unproductive hours and days and months on these minutiae. One could easily understand the desire to find a savior in this mess. Is that the federal government?

As we daily recognize the parameters of our global economy the inability of insurers to introduce new products, rates, coverages, or forms due to regulatory approval delays are considerably hampering the ability to compete with foreign-based insurers. Many knowledgeable insurance executives believe that without an offshore holding company in a domicile in which they can quickly and efficiently transact business they cannot compete or produce satisfactory results. Is an OFC the answer? I don’t know, but I do know that considerable improvement is needed in the present system.

How will an OFC affect captives? This is great material for debate. Will RRGs be included? What taxes will be paid and to whom for what? How much capital and surplus will be required? I am going to speculate that when Congressional committees and subcommittees begin writing and fleshing out details and listening to lobbyists that the requirements to receive an OFC will cause most captives to either remain in their comfortable stateside domicile or to stay or move offshore. There will be restrictions and fees and reporting requirements such that most captives will want none of it. If good regulators are in short supply in the states, how many will relocate to the District of Columbia? How many DC-based regulators understand captives? If a captive stays in its domicile, how will it be affected in its relations with companies licensed with an OFC?

All of these issues and more will likely arise over the next 12 months as Congress wrestles with financial regulatory reform. It is good to be a part of it and to move for real, substantive, positive regulatory change. It will be a good debate, but captive geeks must keep a sharp eye for their interests.

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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