Slippery Slope or Stable and Sustainable? The Washington State captive law

The years-long fight between captives operating in Washington State and the state’s Insurance Commissioner Mike Kreidler may be coming to an end (in part).

In April the much-contested new Washington State captive bill passed the state’s legislature, and after being signed by the Washington State Governor in May and is now law.

The bill will not make Washington State a captive domicile, but will introduce a 2% premium tax on a captive’s ‘Washington-based’ risks. The 2% premium tax is also retrospective, and will net Washington State $34.2m in the first year.

It will also require captives operating in the state to register with the Washington State Office of the Insurance Commissioner, paying a $2,500 fee. An annual fee may also be payable, with the bill report stating “a renewal fee may be set by the [Office of the Insurance Commissioner] OIC not to exceed $2,500 a year”, however it has not been confirmed when or if this renewal fee will be in place.

Registered and approved captives will also only be allowed to provide property and casualty insurance, however they will be able to “obtain or provide reinsurance for ceded or assumed risks insured in this state or elsewhere”. Captives for higher education institutions still need to register with the state but are exempt from the premium tax.

This bill comes out of Kreidler’s belief that captives operating in Washington State should be approved by the OIC and critically, paying premium tax on their Washington based risks—even though all captives are domiciled elsewhere.

For many reasons, this bill has been controversial. The concept of taxing an insurance entity not domiciled in your state is not new, and in 2010 the US passed the Nonadmitted Reinsurance Reform Act (NRRA) to try regulate the practice. Since then, many states have enacted self-procurement taxes that may apply to captives.

However the new bill does not operate as those self-procurement taxes do. It applies to captives insuring any risk in Washington State, and also requires them to register, be approved, and pay fees to Washing State OIC.

Background

The Washington State bill, Senate Bill 5315, is a project of Insurance Commissioner Mike Kreidler, who has been on a long-running campaign to tax captives in Washington State. Kreidler, who was re-elected as Commissioner in the 2020 elections, spent his prior term battling with captive insurers.

While Kreidler was first elected Insurance Commissioner in 2000—after serving in the state legislature for 16 years and being elected to US Federal Congress for one term—but his policies regarding captives only started to get attention in the last few years.

In 2018 Microsoft’s Arizona-domiciled captive Cypress was issued with a cease and desist order by the Washington State Office of the Insurance Commissioner (OIC), for allegedly writing insurance in the state without a certificate of authority or a surplus lines licence. The OIC alleged that Microsoft owed the state $1.42 million in unpaid premium taxes, and $611,540 in penalties and interest.

Microsoft initially fought the cease and desist order, with much support from the captive industry, but ended up settling with Washington State in mid-2018, paying $573,905 in unpaid premium tax and $302,915 in fines.

After this success, Kreidler offered reduced penalties to captives that self-reported to the OIC. In 2019 Costco captive NW Re self-reported to OIC and settled with the state for $3.6 million—$2.4 million in unpaid premium tax and $1.2 million in fines and penalties.

While some captives self-reported and paid tax and penalties, others decided to fight Washington State. At the time the bill was proposed the OIC was engaged in legal battles with both Alaska Air—whose captive ASA Assurance is domiciled in Hawaii—and Starbucks—whose captive Olympic Casualty Insurance is domiciled in Vermont.

Then, a breakthrough: in late 2020 a captive coalition was formed by some of captive insurers in Washington State, and they were able to work with the OIC on the bill.

Criticism

Despite the controversy, some captive insurers in Washington State—namely those in the captive coalition—have spoken in support of the bill.

Denny Eliason, a partner at government relations firm Alliance Northwest, spoke earlier in the year to a public hearing for the bill on behalf of Amazon, Starbucks, and the other members of the captive coalition.

Eliason contended in the hearing that the 2% premium tax was an “appropriate level of taxation”.

“[Captive insurance] is a tool that companies in Washington prudently use when commercial and or surplus lines coverage is either unavailable or unaffordable at the scale with which we need to protect against our future losses,” Eliason said.

“This bill does indeed call for an appropriate level of taxation, a 2% premium tax in Washington-only risk exposures. Please understand that this tax is in addition to the premium taxes we pay and the states where our captives are domiciled.

“That said, we believe that this is an equitable level of taxation under which it will still be prudent for Washington headquartered companies to use this important financial tool on behalf of our coalition.”

The wider captive industry had been watching the Washington State situation closely for the last few years, and there is trepidation about what this could mean not just for captives in the state, but across the US.

Last month president of the Vermont Captive Insurance Association (VCIA), Rich Smith, wrote that the bill was “poorly drafted”.

“Besides being poorly drafted, the bill sets a terrible precedent whereby acquiescing some regulatory oversight by the Washington State insurance commissioner on captives domiciled in other states,” Smith wrote on the VCIA blog.

“This is the culmination of a battle over the past few years between Washington’s Office of Insurance (OIC) and reality. For whatever reason, the OIC has not liked that companies in Washington can set up captives to better manage the risks of their organisations.”

Kreidler has consistently stated that he, and Washington State, are not anti-captive. Yet there is still deep trepidation in the captive industry about the impact of the new law.

After this, the next question to consider is: what does the Washington State captive bill mean for the larger captive industry?

Slippery Slope

Despite the criticism of the bill, it has now passed and the premium tax is law. Exactly how this will impact the larger captive industry is unknown, although as Rich Smith suggests, it may lead to a slippery slope of non-domicile US states looking to implement a premium tax in the current less than ideal economic conditions.

Sources tell Captive Review that California—which is not a captive domicile, but is home to the headquarters of many parents of captives—has been taking an interest in captives, stepping up enquires into California captives.

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