Captive Insurance Study Washington State Department of Revenue and Office of Insurance Commissioner
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MILLIMAN REPORT Captive Insurance Study Washington State Department of Revenue and Office of Insurance Commissioner January 18, 2021 Joel S. Chansky, FCAS, MAAA Craig R. Brophy, FCAS, MAAA David R. Kennerud, FCAS, MAAA Joseph T. Holahan, JD 1301 5th Avenue, Suite 3800 Seattle, WA 98101 USA Tel +1 206 624-7940 Fax +1 206 749 6227 Milliman milliman.com Milliman MILLIMAN REPORT Table of Contents I. Background, Scope, and Intended Purpose ..........................................................3 A. Background.....................................................................................................................3 B. Scope and Purpose.........................................................................................................4 C. Limitations on Distribution ...............................................................................................5 II. Executive Summary...............................................................................................6 A. Overview .........................................................................................................................6 B. Captive Insurance Is Both Simple and Complicated ........................................................8 C. Captive Insurers Are Different Than Other Insurers.......................................................10 D. Why Do Companies Use Captive Insurance Companies?.............................................11 E. Captive Insurance Activity in Washington......................................................................13 F. Projected Captive Insurance Premium and Premium Tax Revenues.............................15 III. Insurance Regulation and Taxation .....................................................................19 A. Background...................................................................................................................19 B. Regulation and Taxation of Insurance ...........................................................................19 C. Regulation and Taxation of Insurance in Washington....................................................21 IV. Captive Insurance: What, Why, How Much In Washington..................................26 A. The Different Types of Captive Insurers ........................................................................26 B. Why Captive Insurance Is Used: Benefits of Captive Insurers and Discussion of “Reimbursement Policies” for “Retained Risk” ..........................................................................32 C. How Much: The Survey – What is the Extent of Captive Insurance in Washington........35 V. How Current Washington Law Treats Captive Insurance Premiums ...................40 VI. Relevant Federal Law..........................................................................................41 A. Nonadmitted and Reinsurance Reform Act of 2010.......................................................41 B. How the IRS Defines Insurance / IRS Litigation of Captive Insurers ..............................41 C. Federal Excise Taxes on Foreign Insurance and Reinsurance......................................43 D. Department of Labor Rules on Captives Insuring Employee Benefits............................43 VII. How Do Other States Regulate and Tax Captive Insurance................................44 A. Regulation of Captive Insurance....................................................................................44 B. Taxation of Captive Insurance.......................................................................................47 VIII. Policy Considerations and Revenue Forecasts ...................................................53 A. Policy Considerations....................................................................................................53 B. Projected Captive Insurance Premium and Premium Tax Revenues.............................63 C. Estimated Unpaid Taxes ...............................................................................................63 IX. Disclosures and Limitations .................................................................................65 1 Washington State Department of Revenue and Office of the Insurance Commissioner January 18, 2021 Captive Insurance Study Milliman MILLIMAN REPORT A. Acknowledgement of Qualifications...............................................................................65 B. Data and Information.....................................................................................................65 C. Uncertainty....................................................................................................................65 Appendix A Excerpts from Contract and RFQQ.........................................................69 Appendix B Technical Appendix ................................................................................74 Appendix B1 An Overview of How the Insurance Industry Functions ....................................75 Appendix B2 How OIC Collects Premium Taxes and How DOR Collects B&O Taxes...........78 Appendix B3 Captive Insurance Regulation in Non-Domiciliary States..................................82 Appendix B4 Federal Law – Nonadmitted and Reinsurance Reform Act...............................86 Appendix B5 Federal Law – How IRS Defines Insurance/IRS Litigation of Captive Insurers .93 Appendix B6 Federal Law – Limitations on State Authority to Tax Captive Insurance ...........98 Appendix B7 Costs of Owning and Operating a Captive Insurer .........................................102 Appendix B8 Benefits of Captive Insurers ...........................................................................107 Appendix B9 Federal Tax Benefits – Single Parent Captive Insurers ..................................130 Appendix B10 Federal Tax Benefits – 831(b) Captive Insurance Companies ....................134 Appendix B 11 Captive Insurance in Washington – Survey Results....................................137 Appendix B 12 Estimates of Premium and Tax Revenue....................................................146 Appendix C Insurance Premium Tax Statistics by State ..........................................150 Appendix D Forecasts of Captive Insurance Company Numbers, Premiums, and Tax Revenues 151 Appendix E Results of Tax Savings Model ..............................................................152 Appendix F Captive Insurance Survey Questions....................................................153 Appendix G Captive Insurance Study Report Excerpts ............................................154 2 Washington State Department of Revenue and Office of the Insurance Commissioner January 18, 2021 Captive Insurance Study Milliman MILLIMAN REPORT I. Background, Scope, and Intended Purpose A. Background The state of Washington provided us with the following background information: “The Washington state (“Washington” or “the State”) insurance market is the 35th largest in the world, and insurance is the 8th largest industry in the State, with $47 billion in annual premiums. Insurance Commissioner Mike Kreidler protects consumers through fair and effective regulation of the insurance industry and collected over $1.2 billion in insurance premium taxes over the past 2 fiscal years for the general fund. State law requires Commissioner Kreidler to collect premium taxes on most insurance transactions. In 2018, Commissioner Kreidler discovered some Washington companies had created captive insurance companies in other states to cover Washington insurance risk without paying premium taxes on these risks. Captive insurance activity is legally designated as unauthorized insurance activity and a violation of State insurance code. In 2018, Commissioner Kreidler found that Microsoft’s captive, Cypress Insurance Co., engaged in the unauthorized business of insurance from 2009 through 2018, owing $573,403 in unpaid premium taxes. Cypress Insurance Co. acknowledged its unauthorized activity and in September 2018 paid all unpaid premium taxes and $302,915 in interest and penalties. All $876,318 collected for this unauthorized activity went to the State’s general fund. In 2019, Commissioner Kreidler found Costco’s captive, NW RE Limited, engaged in the unauthorized business of insurance from 2008 through 2019, owing $2,392,907 in unpaid premium taxes. NW Re Limited acknowledged its unauthorized activity and in April 2019 paid all unpaid premium taxes and $1,241,188 in interest and penalties. All $3,634,095 collected for this unauthorized activity went to the general fund. During the 2020 legislative session, at the request of legislative leadership, Commissioner Kreidler discontinued enforcement action against Alaska Airlines’ and Starbucks’ captive insurers, pending completion of a study on captive insurance to understand, among other things, the extent of the use of captive 3 Washington State Department of Revenue and Office of the Insurance Commissioner January 18, 2021 Captive Insurance Study Milliman MILLIMAN REPORT insurance in Washington and options for regulating and taxing captive insurance in Washington.”1 Specifically, together with the Washington Department of Revenue (“DOR”), the Office of Insurance Commissioner (“OIC”) was asked to study the taxation and regulation of captive insurance more closely with the help of outside, independent captive insurance experts. In April of 2020, the State issued Request for Quotes and Qualifications (“RFQQ”) #S202107 seeking proposals to conduct a study on captive insurance on behalf of the OIC and DOR (collectively