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INDEPENDENTLY PROCURED INSURANCE--
TODD SHIPYARDS SAILS ON

Tom Jones and Holly Hemphill of McDermott, Will and Emery's Chicago and
Washington, D.C. offices, respectively, contributed the following:

Despite predictions of its demise, the United States Supreme Court's 1962 decision in State Board of Insurance v. Todd Shipyards Corp. shows continued vitality. Todd Shipyards invalidated the Texas tax on "independently procured" insurance. Nearly 40 years later, Texas attempted to apply basically the same tax statute to another out-of-state insurance transaction and was again rebuffed in the courts.

The Texas statute considered by the Supreme Court in Todd Shipyards was very broad and contained no limitations requiring activity in Texas by the insurer in order for the tax to apply. While the insured property (the shipyard) was located in Texas, all transactions regarding the insurance contract and claims processing took place in New York. The insurance company was located in London and had no office or agents in Texas. According to the Supreme Court, "the only connection between Texas and the insurance transactions is the fact that the property covered by the insurance is physically located in Texas."

The Supreme Court discussed the fact that the McCarran-Ferguson Act established that states are not barred by the Commerce Clause of the U.S. Constitution from regulating and taxing insurance transactions. But Congress intended certain Constitutional due process restrictions on state power should continue to apply. Specifically, a state may not tax an insurance transaction that has no connection with the state other than the location of the risk.

In 1996, the Rhode Island Supreme Court in the AEGIS case upheld a tax on an unlicensed, out-of-state captive insurer. The court found that the Todd Shipyards decision had been overtaken by intervening judicial due process developments and decided the case based on the fact that the taxpayer insurance company had "purposefully availed" itself of the Rhode Island insurance marketplace. The insurer's only contact with Rhode Island, other than the location of the insured properties, was through correspondence with the insureds.

Meanwhile, back in Texas, the independently procured insurance tax invalidated in Todd Shipyards was still on the books and still being asserted and enforced by the Texas Comptroller against out-of-state insurers. Dow Chemical Company finally managed to get the issue back before the courts in a case decided last year. The Texas Court of Appeals determined that the law and Dow's facts were essentially the same as in Todd Shipyards and that Todd Shipyards therefore controlled. The Court of Appeals declined to follow a due process analysis of more recent decisions, finding no room for further analysis under the Todd Shipyards precedent. The U.S. Supreme Court subsequently declined review of the Texas court's decision.

Bottom line: Todd Shipyards lives. The Todd Shipyards analysis remains the key to determining the validity of a state tax on independently procured insurance (also called directly procured or self procured insurance): So long as all insurance activities take place outside the state so that the only connection with a state is the location of the risk, the state tax may not be imposed. In the authors' view, recent decisions, such as AEGIS in Rhode Island, present the question: How much is enough? That is, how much contact with the state is enough to sustain a tax on an essentially out-of-state insurance transaction? In Rhode Island at least, very little in the way of in-state activity may subject an unlicensed, out-of-state insurer to tax. Other states may be expected to test these limits.