Recent legislation around captives have kept us and many of our colleagues on our toes. Last year, we had the Avrahami case. This year we had the Reserve Mechanical case. Now, we’re looking at an interesting turn of events between Microsoft, its captive, and the state of Washington.
For some background, tech giant Microsoft is based in Redmond, Washington. Its pure captive, Cypress Insurance Company, was formed in 2008 and is domiciled in Arizona.
In May of 2018, the Insurance Commissioner of Washington state issued a cease-and-desist to Microsoft. This order, number 18-0220, required that Cypress stop selling insurance to its parent company and asked for about $1.4M in unpaid premium taxes.
The insurance Commissioner contends that:
- Microsoft/Cypress did not pay 2% premium tax for the business being underwritten by the captive. Within the ten years between the captive’s establishment and the cease-and-desist, Microsoft paid over $91 million in written premiums to Cypress. Washington state law mandates insurance companies to pay a 2% tax based on their written premiums.
- Cypress did not hold a certificate of authority to sell insurance in the state of Washington.
- The coverage provided to Microsoft through Cypress was not placed through a surplus line broker licensed in Washington.
Surplus lines typically come into play for lines of coverage not usually covered by other, commercial insurers.
The Commissioner argued that, because of the above points, Cypress was violating the following sections of the Revised Code of Washington (RCW):
- RCW 48.05.030(1) (certificate of authority required)
- RCW 48.15.020(1) (solicitation by unauthorized insurer prohibited)
- RCW 48.17.060(1) (license required)
- RCW 48.14.020(1) (failing to remit two percent premium tax)
- RCW 4S.14.060(l)-(2) (failing to timely remit two percent premium tax)
On July 1st, Microsoft announced that it had established new policies for Cypress through a surplus line broker, but that didn’t negate the issue. Further, they settled the case with the commissioner in mid-August. The settlement involved a $867,820 payment ($573,905 in unpaid premium taxes and $302,915 in interest and penalties) from Microsoft to the Washington State Insurance Commissioner. As a result, the cease-and-desist has been lifted, and Cypress can continue operations. The Insurance Commissioner of Washington did note that it has its eye on other Washington-based companies using captives.
The announcement of the settlement came around the same time that New Jersey made some of its own captive legislative moves on medical and consumer-goods conglomerate, Johnson & Johnson. The organization, headquartered in New Jersey, has long been utilizing an out-of-state captive and paying taxes on the premiums written to the captive for risks located in New Jersey. However recently, the state decided that, according to the Non-admitted and Reinsurance Reform Act (NRRA), Johnson & Johnson and like companies should be paying taxes on premiums written for all risks within the U.S. , not just those residing in the state. While the company tried to argue that the NRRA uses vague language that seems to only apply to surplus lines of business, they ultimately lost the battle, along with the $55 million refund they were looking for.
What can we learn from these instances?
Captive owners should review their structure based on recent developments and business changes. In light of the changes in the tax code, regulatory changes and the recent case laws, regardless of the state of domicile, it would be prudent to review your captive based on its unique situation and circumstances. Doing so on a regular basis is an advisable business practice.
These recent cases are a step towards a maturing industry and should give captive and insurance professionals the motivation to be as diligent and cautious as they should always have been.
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