Reinsurance Regulation

D.C. CIRCUIT HOLDS THAT WHOLLY FOREIGN RETROCESSIONS NOT SUBJECT TO U.S. EXCISE TAX

June 9, 2015 by Carlton Fields

In late May, the United States Court of Appeals for the District of Columbia Circuit affirmed a grant of summary judgment to a reinsurer in a dispute with the IRS regarding the imposition of U.S. excise taxes on a wholly foreign retrocession arrangement. The case involved Validus Reinsurance, Ltd., which is organized under the laws of and with a principal place of business in Bermuda. The court found that the relevant provision of the Internal Revenue Code did not apply extraterritorially and ordered the return of the taxes paid by Validus. Validus is a foreign reinsurance company with no operations in the United States. However, Validus does sell reinsurance to insurance companies selling policies covering risks, liabilities, and hazards within the United States. Validus also purchases retrocessions for its own reinsurance, often from other non-U.S.-based retrocessionaires. The transactions at bar involved a U.S.-based risk with reinsurance issued by Validus and a retrocession issued by a foreign retrocessionaire.

Congress had expanded the excise tax applicable to foreign insurance in order to “eliminate an unwarranted competitive advantage now favoring foreign insurers,” which were not subject to U.S. income tax laws. After another amendment, the particular provision of the Code section at issue, § 4371, requires an excise tax of one cent per dollar of premium paid on foreign-issued “reinsurance covering any of contracts taxable” as casualty insurance or life insurance. Because the retrocession is covering reinsurance that covers the taxable underlying contract, the court had to resolve an ambiguity in the statute. Looking to the fact that the government’s proposed reading would lead to a “cascading tax theory” with no limit as to the number of times that the government could collect tax on retrocessions with some underlying U.S.-based risks, the court determined that Congress had not shown an intent for the law to apply this extraterritorially. Under the canon of statutory interpretation against implying a reading of extraterritoriality absent a showing of intent by Congress, this transaction was an overbroad reading of the statute. Validus Reinsurance, Ltd. v. United States, No. 13-109 (D.C. Cir. May 26, 2015).

This post written by Zach Ludens.

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MONTANA LAW REVISED TO ALLOW CAPTIVES TO ORGANIZE AS LIMITED LIABILITY COMPANIES

May 21, 2015 by John Pitblado

On April 28, 2015, Montana Governor Steve Bullock signed into law amendments to Montana’s law regarding captive insurers. Significantly, the amendments make it possible for public entities in Montana to set up captives. Additionally, the amendments allow captives in Montana to be organized as limited liability companies. Such LLCs must be established with a minimum of five members. John Jones, President of the Montana Captive Insurance Association (“MCIA”), called these amendments “meaningful improvements to what is already one of the country’s premier captive domiciles.” The amendments, spearheaded by the MCIA and the Montana Commissioner of Securities and Insurance, aim to make Montana a more attractive destination for companies looking to establish or re-domesticate captives.

This post written by Zach Ludens.

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FIO DIRECTOR TESTIFIES ON THE IMPACT OF INTERNATIONAL REGULATORY STANDARDS ON THE COMPETITIVENESS OF U.S. INSURERS

May 20, 2015 by John Pitblado

The Director of the Federal Insurance Office (FIO), Michael McRaith, recently testified before the House Financial Services Subcommittee on Housing and Insurance regarding the impact international regulatory standards have on the competitiveness of United States insurers. Citing to the FIO’s 2014 Annual Report, McRaith noted that, in the aggregate, insurers operating in the U.S. continue to show resilience in the aftermath of the 2008 financial crisis. At year-end 2013, the life and health sector reported $335 billion in capital and surplus, and the property and casualty sector reported approximately $665 billion in capital and surplus. McRaith testified that the pace of globalization in insurance markets has “increased exponentially and is expected to continue to grow in the coming years.” Due to this global economic growth, many jurisdictions, both developing and well-established, are modernizing insurance supervisory regimes. These jurisdictions include Mexico, Canada, Australia, China, and South Africa.

McRaith cited to a recent agreement among members of the International Association of Insurance Supervisors (IAIS), as publicly described in March 2015, where members agreed on the “ultimate goal” of a single insurance capital standard (ICS) that will include a common methodology by which ICS achieves comparable, i.e., substantially the same, outcomes across jurisdictions. That agreement followed the IAIS October 2014 annual meeting where IAIS adopted an approach to the Basic Capital Requirement (BCR) for globally systemically important insurers. McRaith also noted that the European Commission was recently given the mandate to pursue an agreement with the U.S. to “facilitate trade in reinsurance and related activities” and to “recognize each other’s prudential rules and help supervisors exchange information.” McRaith concluded his testimony by stating that “U.S. insurance authorities are positioned to provide U.S. leadership that complements the shared interest in a well-regulated insurance market that fosters competition, promotes financial stability, and protects consumers.” McRaith’s April 29, 2015, testimony can be found here.

This post written by Renee Schimkat.

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IRS PROPOSES REGULATIONS DIRECTED TO “PASSIVE” HEDGE FUND FOREIGN INSURANCE ENTITIES

May 12, 2015 by Carlton Fields

On April 24, 2015, the Internal Revenue Service proposed regulations directed to “situations in which a hedge fund establishes a purported foreign reinsurance company in order to defer and reduce the tax that otherwise would be due with respect to investment income.” The IRS proposed regulations designed to clarify its applicable tax rules, by attempting to define exceptions to “passive income” from foreign insurance companies. Such income (earned from investments) is taxed at higher rates than income from insurance business, which is taxed only when it is realized, and at lower capital gains rates. The proposed regulations seek to clarify when investment income earned by a foreign insurance company is derived in the “active conduct” of an “insurance business,” and thus whether it qualifies for the passive income exception.

The proposal provides that “insurance business” means “the business activity of issuing insurance and annuity contracts and the reinsuring of risks underwritten by insurance companies, together with those investment activities and administrative services that are required to support or are substantially related to insurance and annuity contracts issued or reinsured by the foreign insurance company.” The proposed regulations “do not set forth a method to determine the portion of assets held to meet obligations under insurance and annuity contracts.” The IRS requests comments by July 23, 2015, “on appropriate methodologies for determining the extent to which assets are held to meet obligations under insurance and annuity contracts.”

This post written by Michael Wolgin.

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OHIO PROPOSED RULE REGARDING ALTERNATIVE RESERVE METHODOLOGY FOR SPECIAL PURPOSE CAPTIVES

May 7, 2015 by John Pitblado

The Ohio Department of Insurance has proposed a new rule, Rule 3901-11-05 (the “Proposed Rule”), to establish a process and method that allow a special purpose financial insurance company captive (a “SPFIC Captive”) to request the use of an alternative reserve methodology other than that found in the National Association of Insurance Commissioner’s (“NAIC”) Accounting Practices and Procedures Manual.

The Proposed Rule requires a request to use an alternative principle-based valuation method to be accompanied by a written actuarial opinion that is signed by the appointed actuary for the SPFIC Captive and the ceding insurer. The Proposed Rule prescribes certain criteria for the alternative reserve methodology being requested:

Must be a principle-based valuation method that uses one or more methods or one or more assumptions proposed by the SPFIC Captive.
Must address all material risks associated with the contracts being valued and their supporting assets and determined capable of materially affecting the valuation of its obligations with respect to the risks assumed. Examples of risks to be included in the principle-based valuation method include but are not limited to risks associated with policyholder behavior, such as lapse and utilization risk, mortality risk, interest rate risk, asset default risk, separate account fund performance, and the risk related to the performance of indices for contractual guarantees.
Must be consistent with current actuarial standards of practice.
Must consider the risk factors, risk analysis methods, and models that are incorporated in the SPFIC Captive’s overall risk assessment process. The overall risk assessment process may include, but is not limited to, asset adequacy testing, GAAP analysis, internal capital evaluation process and internal risk management and solvency assessments.
Must incorporate appropriate margins for uncertainty and/or adverse deviation for any assumptions not stochastically modeled.

The SPFIC Captive is required to provide any information the superintendent may require to assess the proposed alternative methodology. If an alternative methodology is approved by the superintendent, then the SPFIC Captive must use the alternative methodology until, and unless, the superintendent approves an another alternative method. Finally, upon the superintendent’s request, the SPFIC Captive is required to secure the affirmation of an independent qualified actuary that the alternative methodology complies with the criteria set forth in the Proposed Rule. The independent qualified actuary must be approved by the department and provide a written actuarial opinion detailing their affirmation and a report supporting that opinion to the superintendent. The independent qualified actuary report must comply with division (E)(3) of section 3964.03 of the Ohio Revised Code.

This post written by Kelly A. Cruz-Brown.
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