Carlton Fields

TEXAS PASSES REDUCED COLLATERAL CREDIT FOR REINSURANCE LAW PERTAINING TO FOREIGN REINSURERS

November 8, 2017 by Carlton Fields

This past summer, the Texas legislature passed and the Governor signed a law that allows Texas insurers to negotiate reinsurance contracts with foreign reinsurers that do not require 100% collateral before the insurer can receive a “credit” for reinsurance on their financial statements. Prior to the passage of Senate Bill 1070 (“SB 1070”), Texas insurance law required reinsurers domiciled in other countries to post 100% collateral before the Texas insurer could receive the credit, regardless of the foreign reinsurer’s financial strength. The law evens the playing field between domestic reinsurers—who did not have to post 100% collateral before Texas insurers could claim the credit—and foreign reinsurers, paving the way for more access by Texas insurers to the world’s strongest reinsurers located abroad.

SB 1070 enacted a number of substantive changes to the Texas Insurance Code to effectuate that broad mandate, including:

authorizing insurers authorized to engage in business in Texas to provide reinsurance on any line of insurance in which the insurer is authorized to engage in the state (previously, the authorization to provide reinsurance was limited to only those insurers authorized to write property and casualty insurance);
authorizing credit for reinsurance ceded as an asset or a deduction from liability for assuming insurers certified as reinsurers in Texas that maintain adequate collateral as determined by the commissioner;
requiring the assuming insurers meet certain criteria, before the credit will be allowed, such as:
- certification by the commissioner;
- domicile and license to transact insurance or reinsurance in a qualified jurisdiction;
- minimum capital and surplus;
- sufficient financial strength ratings; and others
authorizing associations of incorporated and individual unincorporated underwriters to act as certified reinsurers;
requiring the commissioner to develop a list of qualified jurisdictions in which an assuming insurer must be licensed and domiciled in order to be certified for the credit-for-reinsurance provisions above;
requiring the commissioner to assign a rating to certified reinsurers based on financial strength rating and to publish a list of those ratings; and
amending the Insurance Code’s trust requirements.

The law’s effective date was September 1, 2017; but the changes are only applicable to reinsurance contracts entered into or renewed after January 1, 2018. A legislative analysis also has been published.

This post written by Thaddeus Ewald .
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TAX COURT DISALLOWS DEDUCTIONS FOR PAYMENTS TO CAPTIVE INSURANCE COMPANY

November 7, 2017 by Carlton Fields

A husband and wife who paid $1.54 million in premiums to their captive insurance company and $720,000 in premiums to another insurer over two years, almost all of which ended up back in their bank accounts, have had their tax deductions for those payments disallowed in a lengthy opinion by the United States Tax Court.

The couple, Benyamin and Orna Avrahami, own a set of businesses and commercial properties in the Phoenix, Arizona area. In 2007, they set up a captive insurance company called Feedback, incorporated in St. Kitts and for which they elected treatment as a small insurance company under Internal Revenue Code section 831(b). While their total insurance expense in the year before they set up Feedback was $150,000, the Avrahamis’ businesses paid Feedback insurance premiums of $730,000 in 2009 and $810,00 in 2010. One of those businesses also paid Pan American Reinsurance Company $360,000 in both years for terrorism risk insurance, while Feedback participated in a “risk distribution program,” under which Pan American paid Feedback $360,000 in both years. The Avrahamis then deducted all of these premiums—$1.09 million in 2019 and $1.17 million in 2010—as business expenses.

The IRS began an audit of the Avrahamis in 2012, ultimately disallowing their deductions for insurance expenses paid to Feedback and Pan American. The IRS took the position that the payments to Feedback and Pan American were not actually insurance premiums, and the Tax Court agreed. The court found that Feedback did not meet the essential insurance characteristic of distributing risk because it only issued 7 policies insuring 3 stores, had 2 key employees, 35 other employees, and 3 commercial properties, all in the Phoenix area, in the relevant years. Feedback’s purported reinsurance relationship with Pan American did not help to distribute that risk, the court found, because Pan American was not a bona fide insurance company. The Court based this on its findings that: (1) the premiums Pan American charged were “grossly excessive” when compared with what was available on the market—particularly when the Avrahamis’ own witness could not identify a single event in history to which its terrorism insurance would provide coverage; (2) Pan American distributed virtually all of the premiums it received back to its policyholders or related entities; and (3) it was unlikely that it could actually pay claims if they arose. The court also found that Feedback did not operate like an insurance company—it issued policies with unclear and contradictory terms, paid no claims until the IRS began its audit, unreasonably invested the premiums in unsecured loans to related parties, and charged “utterly unreasonable” premiums—and thus the premiums paid to it were not actually for insurance.

As a result, the court sustained the IRS’s finding that the Avrahami’s could not deduct the premiums they paid to Feedback and Pan American. However, the court found that these disallowed deductions did not justify imposing penalties on the Avrahamis, despite the fact that much of the advice they received was from an attorney who qualified as a promoter of these transactions, because, in setting up Feedback and taking those deductions, they also reasonably relied on the advice of another attorney who was not a promoter. The court also found that, because it was not actually an insurer, Feedback did not qualify for treatment as a small insurer under section 831(b), but this also meant that, as a St. Kitts entity, it did not owe any U.S. taxes.

Avrahami et al. v. Commissioner of Internal Revenue, Docket Nos. 17594-13 and 18274-13 (U.S. Tax Ct. Aug. 21, 2017).

This post written by Jason Brost.
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DESPITE HEAVY CRITICISM OF THE RATIONALE, BRITISH COURT REFUSES TO ENFORCE ARBITRAL AWARD SET ASIDE BY RUSSIAN COURT

November 6, 2017 by Carlton Fields

The British High Court of Justice recently decided not to enforce an arbitral award in a dispute over the calculation of the purchase price of a Russian metallurgical company where a Russian court set aside that award and Russian appellate courts affirmed the decision. The plaintiff had argued the British court should not recognize the Russian judgments setting aside the award because it was the result of bias, while the defendant argued under the doctrine of ex nihilo nihil fit that because the award had already been set aside there was nothing for the British court to enforce.

The court started its analysis by observing the heavy burden borne by the party challenging the foreign court decision. Not only must the party show the decision is wrong or manifestly wrong, they must also show the decision is “so wrong as to be evidence of bias, or be such that no court acting in good faith could have arrived at it.”

The original Russian judge decided to set the award aside on three grounds: (1) the non-disclosure of potential bias because of the arbitrator’s relationships with expert witnesses was non-waivable; (2) the arbitrators’ method of calculating the purchase price violated public policy because it did not follow the purchase agreement’s terms; and (3) the dispute involved a “corporate claim” which is non-arbitratable under Russian law. It is noteworthy that the latter two grounds were not ones raised by the parties and were only raised by the judge in her written opinion.

In a lengthy opinion, the British High Court criticized the Russian court’s decision on all three grounds. On the non-disclosure issue, the British court took issue with the Russian court’s failure to address the appropriate test for waiver (actual or constructive notice), and failure to reach any factual conclusions. The court also took issue with the sua sponte nature of the latter two grounds. On the public policy issue in particular, the court found it difficult to see how the arbitrators acted in contravention of the agreement terms in arriving at a price calculation. Moreover, even if it were in contravention, that would amount to an error of law at most, not an act against public policy. On the non-arbitrability issue, the court determined that the Russian judge might have been a pioneer in concluding that corporate disputes are not arbitrable, because it could not find any record of cases holding applying that rule. However, a number of Russian courts since have followed her ruling.

Despite taking issue with the “shaky” grounds upon which the Russian court decided to set aside the award, and with the Russian appellate courts’ decisions affirming, the High Court nevertheless refused to enforce the award. It held that the decisions were not “so extreme and perverse that they can only be ascribed to bias” against the Plaintiff. For that reason, the court dismissed the application to enforce the award and did not reach the ex nihilo nihil fit argument.

Maximov v. Open Joint Stock Co., [2017] EWHC 1911 (Comm) July 27, 2017.

This post written by Thaddeus Ewald .
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CONGRESS DISAPPROVES THE CFPB’S ANTI-CLASS ACTION ARBITRATION WAIVER RULE

October 29, 2017 by Carlton Fields

Congress has adopted a joint resolution of disapproval of the CFPB’s arbitration rule under the Congressional Review Act, 5 U.S.C. Section 801 et seq. President Trump’s approval of the joint resolution will prevent the implementation of the rule. With the disapproval of the rule, the CFPB’s rule “may not be reissued in substantially the same form, and a new rule that is substantially the same as such a rule may not be issued, unless the reissued or new rule is specifically authorized by a law enacted after the date of the joint resolution disapproving the original rule.” 5 U.S.C. Section 801(b)(2). While it seems highly unlikely that the present Congress would approve the same or similar rule, it is not known whether the CFPB will attempt to find another way to implement a prohibition of class action arbitration waivers.

This post written by Rollie Goss.
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COURT DISMISSES SUIT BY REHABILITATOR FOR PMI INSURER AGAINST CAPTIVE REINSURER AND AFFILIATED BANK

September 29, 2017 by Carlton Fields

A district judge in the Northern District of Illinois has dismissed all claims brought by the Illinois Director of Insurance, acting as rehabilitator for Triad Guaranty Insurance Corporation and Triad Guaranty Assurance Corporation (collectively “Triad”), after it was placed in rehabilitation, against AAMBG Reinsurance, Inc. and Bank of America (“BOA”).

The dispute arose out of an arrangement under which AAMBG provided reinsurance to Triad for private mortgage insurance (PMI) provided by Triad to borrowers with mortgages from a set of lenders that were affiliates of AAMBG. The complaint alleged that AAMBG and BOA breached a contractual duty to disclose to borrowers any benefits the loan originators received from PMI premiums, breached the duty of good faith and fair dealing by only referring borrowers with the highest default risk to Triad, violated RESPA by accepting excessive reinsurance premiums, and were unjustly enriched by these practices. AAMBG and BOA moved to dismiss, and the court dismissed the complaint in its entirety.

In dismissing the breach of contract claim, the court found that the plaintiff had not pointed to anything creating a duty on the part of AAMBG to make any disclosures to borrowers. The court also found that the complaint failed to “allege who the affected borrower was, the specific regulation violated, how it was violated, and, most important, how Triad was damaged.” The court found that the good faith and fair dealing claim was “totally implausible,” as it did “not make economic sense” for AAMBG to send poor risks to Triad when, under a hypothetical offered by the plaintiff, AAMBG would actually be responsible for a larger portion of the loss than would Triad. Fourth, the court found that the plaintiff had made no attempt to show that the safe harbor provision of RESPA Section 8(c) did not apply to AAMBG’s reinsurance contract with Triad, as the complaint did not allege that the agreement to provide reinsurance was illusory. The court also found that the RESPA claim was barred by the statute of limitations, rejecting a “continuing violation” theory put forth by the plaintiff and finding that the limitations period began to run when Triad last purchased reinsurance from AAMBG. Finally, the court rejected the unjust enrichment claim because the parties’ relationship was governed by a contract.

People ex rel. Dowling v. AAMBG Reinsurance, Inc., 16 C 7477 (N.D. Ill. June 1, 2017)

This post written by Jason Brost.
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