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Reform Pending for Illinois Captive Insurance Framework

Summary

A captive insurance and self-procurement tax law is awaiting the governor’s signature in Illinois. This new business-friendly law may provide a substantially improved environment for Illinois-based companies looking for captive solutions.

In Depth

Illinois Governor Bruce Rauner has until August 28 to sign or veto Senate Bill 1737 (Bill), a proposed new law that would reform the Illinois Insurance Code’s regulatory framework for captive insurance companies and significantly drop the state’s current premium tax rate on self-procured insurance. The Illinois General Assembly passed the Bill on May 31, 2018 with bi-partisan support. The Illinois Department of Insurance, key industry groups and several large Illinois-based taxpayers also support the legislation.

Improved Regulation of Illinois-Licensed Captives

If it becomes law, the Bill would create a much more favorable regulatory framework for Illinois captives, following the lead of multiple jurisdictions, including Vermont, Hawaii, South Carolina and the District of Columbia. Highlights of the Bill include the following.

1. Revised minimum capital and surplus requirements 

The Bill would give broad authority to the Illinois Director of Insurance (Director) to set minimum capital and surplus requirements for Illinois licensed captives based on the amount of premium written, the type of assets held by the captive, the terms of reinsurance arrangements, the types of business covered in policies issued by the captive, the underwriting practices and procedures of the captive, and any other criteria that has an impact on the captive deemed significant by the Director. The Bill provides only that the capital and surplus requirements be not less than $250,000 for a “pure” captive insurance company (insuring only the risks of its parent/affiliated companies), $500,000 for an “industrial insured” captive insurance company (insuring the risks of larger insureds with aggregate annual premiums in excess of $100,000, and access to the full-time services of an insurance manager) and $750,000 for an “association” captive insurance company (insuring the risks of the member organizations of an association and their affiliated companies). 

The Illinois Insurance Code (Code) currently requires Illinois-licensed captive insurance companies to meet the minimum capital requirements for Illinois domestic insurers, which are much higher than the minimum levels set forth in the Bill (generally $1 million). See 215 ILCS 5/13. In addition, the Code imposes detailed restrictions regarding how capital must be maintained by captive insurers, requiring in all cases that at least 20 percent be held in cash or cash equivalents. 215 ILCS 5.132C-3(B). In contrast, the Bill would permit captives to meet the minimum capital and surplus requirements via an irrevocable bank letter of credit approved by the Director, Illinois bonds or by US-backed securities.

2. Expanded scope of representation

The Bill authorizes Illinois-licensed captives to write insurance covering the risks of a “controlled unaffiliated business,” in addition to the risks of a captive’s affiliates. A “controlled unaffiliated business” is defined as an unaffiliated entity with whom an affiliate of the captive has a contractual relationship under which the affiliate bears a potential financial loss and whose risks are managed by the captive insurer pursuant to standards that may be established by the Director.

3. Expanded coverage

The Bill authorizes Illinois-licensed captive insurance companies to issue contractual reimbursement policies to affiliated certified self-insurers authorized under the Illinois Workers’ Compensation Act or an analogous law of another state, as well as affiliates that are insured by workers’ compensation insurance policies with a negotiated deductible endorsement. In contrast, the Code currently provides that Illinois captives can insure an employers’ liability to its employees only to the extent there is legal liability under the Federal Employers’ Liability Act. 215 ILCS 5/123C-2(A)(4)(iii).

4. Enhanced lending capability

The Bill provides enhanced lending flexibility to Illinois-licensed captive insurance companies, providing that, with the prior approval of the Director, the captives may make loans to their affiliates, although not of the minimum capital and surplus amounts required by the Bill.  

5. Accepting and ceding risks to a captive reinsurance pool

The Bill authorizes Illinois licensed captives, with the approval of the Director, to accept risks from and cede risks to or take credit for reserves on risks ceded to an approved affiliated captive insurer or a captive reinsurance pool. The affiliated captive insurer must be licensed to operate in Illinois or by a similar law of another jurisdiction; similarly, any captive reinsurance pool must be composed of other captive insurance companies licensed to operate in Illinois or by a similar law of another jurisdiction.

6. Significant rate drop for self-procured insurance

The Bill also substantially drops the premium tax rate for contracts of insurance independently procured directly from an unauthorized insurer by an industrial insured (self-procured insurance) from 3.5 percent to 0.5 percent of gross premium. The tax is imposed on the insured, although it may be deducted from an insured’s premium payments. Insureds subject to the tax would continue to be subject the Surplus Lines Association of Illinois’ countersigning/stamping fee (currently .125 percent of gross premium) and any applicable Illinois Fire Marshall tax.

If it becomes law, the Bill would take effect for policies with an effective date on or after January 1, 2018. The Bill effectively drops the self-procured insurance tax rate from the surplus lines insurance rate (215 ILCS 5/445(3)(a)(ii)) to the rate imposed on most Illinois domestic admitted insurance companies. (215 ILCS 5/412).

The current Illinois’ self-procured insurance tax was roundly criticized when it first took effect in January 2015, due to the potential tax burden it created for Illinois home state companies. (See our prior coverage.) While the Bill does not eliminate the tax, as some proponents had hoped, it significantly reduces the burden of the tax by dropping the rate to match Illinois admitted insurer levels. It is also significantly lower than the rate imposed by many other states that instituted a tax on self-procured insurance in response to Congress’s 2011 enactment of the Nonadmitted and Reinsurance Reform Act (NRRA), which provided that a company’s home state—typically its principal place of business—had exclusive authority to tax and regulate nonadmitted insurance. See 15 USC § 8201.

Comment

Illinois’ underdeveloped captive law and its high self-procurement tax rate have meant that Illinois has never been a viable option as a captive jurisdiction, even for large Illinois headquartered companies with pure single parent captives. The Bill, if enacted, will be a positive step forward, and will certainly warrant consideration by Illinois-based enterprises that have previously had no real option but to locate their captives elsewhere. Whether Illinois is able to become a favored captive jurisdiction remains to be seen and will depend upon whether the Department acts in a supportive manner in adopting regulations, handling applications and providing interpretations, as well as whether service provider infrastructure develops. Fortunately, many captive service providers already have a presence in Chicago and other Illinois locations. We view this Bill as an important and exciting development for the captive community, and strongly support its enactment.

© 2018 McDermott Will & Emery

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About this Author

 Mary Kay McCalla Martire, Mcdermott, Tax attorney
Partner

Mary Kay McCalla Martire focuses her practice on state and local tax disputes. She helps clients with audits, tax-related litigation, letter rulings and settlement conferences. Mary Kay has experience resolving disputes involving income, sales and use, utility and telecommunications taxes, as well as premium and retaliatory tax.

Mary Kay has an extensive litigation background in state and federal court, as well as administrative tribunals. She has particular experience in the defense of qui tam (whistleblower) claims filed in the state tax arena, and has won the dismissal...

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Thomas M. Jones, Partner, McDermott
Partner

Thomas (Tom) M. Jones advises clients on federal and state tax, insurance regulatory and legal matters concerning captive insurance and other alternatives to commercial insurance. He counsels multinational corporations, private businesses, taxable and exempt health care providers, trade associations, joint ventures, government instrumentalities, labor unions and enterprises of all types.

Tom has extensive transactional experience in major US and offshore captive insurance jurisdictions, including Arizona, the District of Columbia, Hawaii, Nevada, South Carolina, Texas and Vermont, as well as Barbados, Bermuda, the British Virgin Islands and the Cayman Islands.

A frequent guest speaker at international seminars and conferences, Tom makes numerous offshore and onshore presentations on captive insurance and related topics.

312-984-7536
Lisa Kaderabek, McDermott Law Firm, Chicago, Healthcare Law Attorney
Partner

Lisa M. Kaderabek focuses her practice on captive insurance, risk transfer, reinsurance and related matters for health care entities and other businesses. Other practice areas include health care transactions, including securities offerings, joint ventures, physician/hospital syndications, tax-exempt bond financings, mergers and acquisitions, partnerships, corporate governance and formation. 

Lisa advises and represents a wide variety of clients, including

  • Captive...

312-984-7649