Traditionally, commercial insurance was provided by insurance companies licensed to write coverage in the taxpayer’s state(s) of operation. However, there’s been a growing trend to place insurance through nonadmitted, i.e., unlicensed, insurance companies, as this allows taxpayers the ability to better control risk management, mitigate insurance costs and price volatility and/or obtain coverage for risks traditionally not available or economically feasible. Nonadmitted insurance operations generally take one of the following forms of commercial insurance:
- Surplus Lines – This is coverage for hard-to-place, unique or high-capacity, i.e., high-limit, risks that are declined by the standard underwriting and pricing processes of admitted/licensed insurance carriers. These transactions involve the nonadmitted insurer, an in-state broker and an in-state insured. All states impose a surplus lines premium tax on the broker, which is usually a significantly higher tax rate than the premium tax imposed on a standard licensed insurer, e.g., 0 to 6 percent compared to 2 percent on average.
- Direct Placement/Self-Procured – This coverage is generally the same as surplus lines insurance. The difference is the insurance is directly acquired by the insured, who must meet some general requirements to validate being financially savvy regarding insurance transactions. In these transactions, the premium-based tax responsibility falls on the insured and is typically otherwise identical to the surplus lines tax. Forty-four states currently have a self-procurement tax.
- Captive Insurance – A captive insurer is generally defined as an insurance company that is wholly owned and controlled by its insureds, with a primary purpose to insure (or reinsure) the risks of its owners. The captive structure benefits the affiliated group as the underwriting profits are retained in the group and the captive may receive certain federal income tax benefits. Captives are generally solely licensed in the state of domicile and subject to that state’s specialized premium-based tax, which: (1) is imposed at a significantly reduced tax rate compared to a standard licensed insurer and (2) carries a relatively low maximum tax. Note that if the captive and its affiliated insured aren’t located in the same state of domicile, the self-procurement tax may apply in the home state of the insured(s).
- Reinsurance – These transactions are insurer-to-insurer (or self-insurer-to-insurer) transactions designed to further diversify and spread insurance risk. Reinsurance premiums aren’t typically subject to a premium-based tax.
Since nonadmitted insurance companies aren’t subject to states’ standard premium tax, they generally don’t qualify for any “in lieu of” exclusion. As such, nonadmitted insurance companies are subject to income, franchise or excise tax in those states that: (1) don’t statutorily exempt an unauthorized insurer from the aforementioned taxes and/or (2) require a unitary combined income tax return. Note that in the case where income tax is imposed on nonadmitted insurance companies by states that don’t directly tax insurers, no special insurance provisions are usually present. This leads to lack of clarity of the proper tax treatment in some circumstances.
While insurance is typically regulated and taxed on a state-by-state basis due to the McCarran-Ferguson Act of 1945, the tax regime on nonadmitted insurance has recently been affected by federal legislation. The Nonadmitted and Reinsurance Reform Act of 2010 (NRRA), contained within the Dodd-Frank Wall Street Reform and Consumer Protection Act, pulled back some of the states’ regulatory authority over nonadmitted insurance companies as of July 21, 2011. Specifically, the NRRA stipulates that only the insured’s home state has the authority to impose a premium-based tax on the policy. Further, the federal provisions permit the insured’s home state to tax 100 percent of the policy premium regardless of where the insured risks are located—previously, states were limited to the portion of premium attributable to insured risks located within that state.
BKD can assist taxpayers affected by the uncertainties of state taxation of the nonadmitted insurance market. Specifically, BKD can assist with:
- Compliance with nonadmitted insurance premium-based taxes
- Insurance policy/nonadmitted insurance tax review
- Insurance risk management structure analysis
- Income tax nexus analysis for groups containing nonadmitted insurers
Contact your trusted BKD advisor, Michael Palm or Bob Johnson to learn more about these taxes and how BKD can assist.