Texas Opens Door to Captive Insurance Options

by Reed Smith

Captive insurance companies may now be domiciled in Texas under a law signed by Gov. Rick Perry on Monday. Texas joins more than 30 other states that permit the formation and operation of various types of captive insurance companies. The law provides a straightforward means for companies with significant operations in Texas to form their own captive insurance companies, or to re-domesticate existing captive insurers that were formed out of state.

The law permits a captive insurance company holding a Texas Certificate of Authority to collect premiums and write insurance for its parent and its other subsidiaries and affiliates, as well as unaffiliated controlled businesses. The bill allows captives to underwrite various types of insurance for these affiliated and unaffiliated controlled companies, and then seek reinsurance to offset a portion of these risks. Licensure requirements include, among other things, “significant operations” in Texas, an annual board meeting, and payment of a premium tax with an annual floor of $7,500 and cap of $200,000. Although regulations remain to be written, the cap on the premium tax makes Texas a potentially attractive location for captive formation. The law also provides a means for Texas companies to ease their administrative burdens by re-domesticating the captive insurance companies they set up outside of Texas.

Captive insurance companies are created by a parent company or group of related entities specifically for the purpose of insuring that company or group’s risks. Captives domesticated in the United States and offshore have proved to be popular with numerous corporations for varying reasons. Many types of necessary insurance are unavailable, or are available only at prohibitive prices in the traditional insurance market, which a captive can provide at reasonable cost. Additionally, captives can serve as a centralized vehicle that specializes in: (1) providing claims services under the control of the parent and affiliated businesses, (2) investigating and funding the corporate family’s claims-related payments, and (3) providing greater control over the entire insurance and risk management operation from a cost perspective. Further, captives provide a company with a means to access the reinsurance markets, which typically are unavailable to business corporations that traditionally only purchase insurance in “direct” markets.

Some companies may find additional benefits in tax deductions for premiums paid to their captives for the purpose of managing the captive and paying out claims, though these benefits should not be overstated. Proper funding and management of the captive, including the ultimate function of payment of covered claims, is serious business that typically requires work by a dedicated staff with knowledge of insurance underwriting and claims, or outsourcing to an established captive management service, as well as legal service. Of course, to be profitable, captives require good risk management to prevent large losses and large numbers of losses over time that must be paid. As licensed insurance companies, captives must also expect disputes requiring litigation or arbitration, such as claims brought by policyholders or additional insureds seeking coverage, traditional insurance companies demanding contribution or subrogation, or reinsurers refusing to pay claims settled by the captive, among other things.

These and other implications should be considered by companies large and small that have created a captive or may be considering captive insurance options. With a new office in Houston and insurance coverage attorneys positioned across the country and across the globe, Reed Smith LLP is ready to advise corporations in and outside of Texas concerning the formation and operation of captives, as well as the claims process and resolution of disputes. Reed Smith’s Insurance Recovery Group has vast experience with counseling its clients on various non-traditional insurance, risk transfer, and corporate loss funding arrangements, and has successfully litigated, arbitrated and settled numerous high-level disputes involving captive insurance, excess insurance, and reinsurance, both domestically and internationally. To help avoid problems with future claims, our group has the experience to provide insight and recommendations to reduce potential liabilities, risks and ambiguities that can be created by these arrangements.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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