Captive Insurance Regulation: Is State Authority under Attack?

In an open letter to state insurance commissioners posted on his company's website, Sean G. King, CIC Services, LLC, principal and in-house counsel, warns that, in his view, states must actively resist Internal Revenue Service (IRS) attempts at becoming the "de facto regulator of insurance" unless they are prepared to relinquish regulatory authority.

"Unless states unite to defend their legal authority to regulate insurance, the IRS will become the de facto regulator for some types of insurance in the United States," says Mr. King in his June 13, 2016, "Captivating Thinking" commentary.

Mr. King’s "An Open Letter to State Insurance Commissioners: States of America, Unite!" is important to read for those involved with or interested in captive insurance companies, particularly the small captives electing federal tax treatment afforded under Internal Revenue Code § 831(b).

The author of the opinion piece argues that "… state insurance departments have largely remained silent as the IRS indiscriminately attacked the legitimacy of many of the insurance companies they regulate." Like Mr. King, Captive.com's coeditor has heard some captive regulators say it is the job of the states to only regulate insurance and not be concerned about the federal taxation of the captives they regulate.

Recent IRS captive audits have focused on whether the risks being insured by captives are "insurance risks" versus business or investment risks. This focus begs the question of whether state insurance departments are licensing captive insurers that are not providing insurance. To date, the commonly held view is that state insurance departments inherently have the exclusive authority to define "insurance." What do you think?

Mr. King concludes his open letter by stating, "Unless states are prepared to give up regulatory authority, they must actively resist IRS attempts to become the de facto regulator of insurance." Is it time for captives and their associations to encourage captive domiciles and the National Association of Insurance Commissioners (NAIC) to develop a proactive strategy that takes steps to assure that states, not the IRS, have the sole authority to define "what is insurance"?