Tumbling Insurance Industry- Jurisdiction & Domicile Issues for Specialty Insurers

In the United States, the insurance industry is primarily regulated by the regulations of the various states in which the insurer operates. Each state has its own rules, regulations and requirements that need to be complied with in order for the specialty insurers to operate and write policies in such state. The insurance laws of each state of the United States expressly prohibits the sale of insurance policies within their jurisdictions by insurers that are not admitted to do business within such state. The regulatory framework varies from state to state, but generally relates to the standards of solvency that must be met and maintained, including risk-based capital standards, licensing approvals and related matters, restrictions on insurance policy terminations, the nature of and limitations on the amount of investments made with the insurer’s capital and periodic examinations of the financial condition and market conduct of insurance companies. Regulations pertaining to specialty insurance companies may be less onerous than those required of insurance companies engaged in property, casualty, life and health insurance. None the less, this is not to say that specialty insurance companies are not subject to relatively rigid and potentially burdensome regulatory frameworks.

The selection of a domicile is a very fact specific determination based upon the individual circumstances and facts applicable to the particular insurer. A review of the jurisdiction of domicile for the various insurance companies operating in the United States demonstrates that no single state offers an overwhelming distinctive advantage to domicile in a particular state over another (i.e. there is no “Delaware” for insurers). Various factors that seem to come into play include: (i) the physical location of its business, (ii) location of policyholders, (iii) historical remnants and factors that may no longer apply (e.g. an insurer that began operating in only one state and later expanded its business elsewhere), and (iv) the solvency and minimal capital requirements of a particular state (which vary from state to state depending upon the kind of insurance being offered by the insurer). Further, if the proposed enterprise decides to initiate operation by acquiring a shell, the choice of domicile is likely already made and not worth the burden of changing.

An alternative to domiciling the enterprise in the United States would be to select an offshore jurisdiction like Bermuda, Cayman Islands, or the British Virgin Islands. Each of the foregoing are attractive jurisdictions to insurance companies due to favorable regulatory frameworks and advantageous tax policies. In recent years, Bermuda in particular has become a very attractive offshore jurisdiction for insurers. Among other advantages, Bermuda offers an established infrastructure, political stability, trained and educated workers, evolved regulation, and a convenient geographic location. In addition, Bermuda also offers the following specific advantages:

1. Taxation

The governments of Bermuda and the U.S. signed a convention in 1986 relating to the taxation of insurance enterprises, thereby allowing subsidiaries of U.S. Companies to be set up in Bermuda and be taxed as per Bermuda laws.

Bermuda’s taxation system is “consumption based” meaning there are no taxes on profits, dividends or income for companies or individuals, nor are there any capital gains or inheritance taxes. Companies pay a payroll tax rather than being taxed on profit, income or dividends. Companies tend to find a tax advantage by setting up a Parent company in the United States with operating subsidiaries in Bermuda and the United States. Under this structure, the risks and premiums can be shared between the United States subsidiary and the Bermudan subsidiary, allowing the insurer to take part in some of the offshore tax advantages while also maintaining the regulatory advantages of having a domestic domiciled operating company.

2. Speed and Cost

The regulatory framework in Bermuda is very streamlined and efficient and permits enterprises to form and domicile insurers in Bermuda very quickly. The efficiency in Bermuda offers a considerable edge over other jurisdictions. A company can secure capital, obtain a license and be up and running in as little as six weeks in Bermuda. The same process may take over a year in the United States. Also, compared to other jurisdictions, the set-up and formation cost is significantly less expensive. It should be noted however, a Bermudian domiciled insurer would still need to obtain regulatory approval as a foreign insurer in each of the various fifty states in order to operate and write policies in such states.

3. Business in offshore jurisdictions

By establishing an operating company in Bermuda, an insurer can offer and write policies to non United States policyholders without having to comply with potentially burdensome regulatory requirements applicable to United States domiciled insurers. In addition, as a non United States domiciled insurer, it may be possible in certain instances to conduct a totally offshore transaction with a United States policyholder which would not be subject to the regulatory frameworks of the fifty states. Whether any individual policy underwriting could be considered “offshore” is a very fact specific determination but usually involves ensuring that all activities (including solicitation and negotiation) be conducted offshore.

On a precautionary note, the tax benefits afforded by domiciling in Bermuda are only advantageous when the enterprise is making a profit. If the company is incurring losses, as has been the case for many entities affected by the current financial crises, there is a disadvantage because Bermuda, unlike the United States, does not permit the offsetting of losses against future profit. Moreover, it should be noted that in order to take advantage of any tax benefits, the company must meet a 'mind and management' test that includes holding board meetings in Bermuda and other requirements, which may be onerous for some insurers.

Ignored Piece of Legislation

Under the International Investment and Trade in Services Survey Act of 1976 (the “Act”), a U.S. enterprise in which a foreign entity directly or indirectly acquires a 10-percent or more voting interest must file reports with Bureau of Economic Analysis ("BEA"), an agency of the U.S. Department of Commerce. The regulations encompass a wide range of legal structures, such as mergers, acquisitions, asset purchase and stock acquisitions. Though the Act is in effect since 1976, the compliance with these filings has been made mandatory since 2003, whereby penalties were prescribed for non-compliance (ranging from US $2,500 to US$25,000) and imprisonment for up to one year in case of willful failure to file.

Despite this law being in force for than half a decade, many foreign companies establishing a business in the U.S. or the existing U.S. companies having its voting interest held by a foreign entity are not filing these mandatory periodic filings with the BEA. It is disquieting to note that such a pivotal piece of legislation has been flagrantly ignored because many lawyers and other intermediaries in a transaction are not aware of such regulations and continue to believe the compliance is elective in nature. In fact, the Act casts an obligation simultaneously upon the intermediaries[1] along with the Company to make filings under their own name. It is therefore imperative that lawyers are aware of these regulations and are able to advise their clients on the consequences for ignoring this piece of legislation.

For the sake of brevity, the report includes the following forms:

a. Initial reports (Form BE-13)- This report is filed for reporting on a foreign person's direct or indirect acquisition, of a U.S. business enterprise.[2] This report must be filed within 45 days after the transaction is concluded. Such a report must be filed if, (1) “the total assets of the newly created or acquired entity are more than $3 million, (2) the cost of the transaction is more than $3 million, or (3) the transaction involves the acquisition of 200 or more acres of U.S. land.”[3]

However, if the above listed thresholds are not met in a given transaction, then Form BE- 13 Supplement C (exemption form), claiming exemption to file BE-13 should be filed by a U.S. enterprise.

This report requires the Company to provide information such as type of transaction, identification of U.S. business enterprise, financial and operating data of the U.S. enterprise, industry classification, identification of foreign parent and ultimate beneficial owner and the cost of investment.

b. Quarterly reports (Form BE-605) - U.S. business enterprise in which a foreign person had a direct and/or indirect voting ownership interest of at least 10 percent at any time during the quarter is required to file this report every quarter. However, the U.S. enterprise is not required to report if the total assets, annual sales or gross operating revenues, and annual net income of the U.S. enterprise/U.S. affiliate are $30 million or less.

A U.S. enterprise/affiliate that meets the exemption criteria stated above must file a Certification of Exemption. The quarterly reports require the Company to disclose the information about the U.S. Company, information of the foreign parent and foreign affiliates of the foreign parent company, foreign parent’s direct equity share in the U.S. Company, etc.

c. Annual reports (Form BE-15) - The U.S. company/affiliates is required to file this report if a foreign person owns or controls a ten-percent-or-more voting interest, as of the end of the fiscal year. Depending upon the total value of the assets, sales or gross operating revenues, or net income, the Company would have to file either form BE-15 (long form) or form BE-15 (short form). The annual report requires the Company to disclose information about its total revenues, total assets, income, liability, cost, expenses, details about its affiliation with foreign group, etc.

d. Quinquennial reports (Form BE-12) - The quinquennial BE-12 Benchmark Survey is a comprehensive survey which is conducted once every 5 years. Depending upon the total value of the assets, sales or gross operating revenues, or net income, the Company would have to file either file BE-12 (long form) or BE 12 (short form). However, if the threshold limits are not met as prescribed in the above forms, then the Company may file an exemption as provided in the Form BE- 12 Mini.

The Act lays down that reports filed with BEA are confidential and may be used for analytical and statistical purposes only. The reports cannot be used for purposes of taxation or investigation by the U.S. government.

Though the underlying objective of the Act is to collect information on foreign investment in the United States, a detailed and complicated filing may only deter the companies from filing as the compliance cost of such regulations may be more than the civil penalties prescribed by the Act. The law has its own shortcomings and redundant objectives (topic for the next entry on this blog). None the less, this is not to say that companies are not subject to rigid and potentially burdensome regulatory filings.
[1] Intermediary include an intermediary, a real estate broker, business broker, and a brokerage house- who assists or intervenes in the sale to, or purchase by, a foreign person or a U.S. affiliate of a foreign person, of a 10 percent or more voting interest in a U.S. business enterprises, including real estate.
[2] It also includes establishment of a new entity and/or purchase of the operating assets.
[3] Report published by the Bureau of Economic Analysis (April 2008), U.S. Department of Commerce, Economics and Statistics Administration.