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Fronting, captives and employee benefits.

Those who have been following the National Association of Insurance Commissioners' (NAIC) consideration of its model statute now entitled "Fronting Disclosure and Regulation Act" have come to know that the most consistent thing about this proposed statute is the recurrent changes to its provisions -- the last revision of the model act is dated June 22, 1993. The most recent version again affects captive insurance companies that participate in "fronting arrangements" pursuant to which "underwriting authority" of "claim settlement authority" is delegated by the fronting company. If such a delegation is involved, the fronting company must comply with the provisions of the model act (which, in essence, involves either reporting the transaction or seeking prior approval for the transaction) unless the exception for "single-parent captive" insurers applies.

In the latest draft of the model act, the term "'single-parent captive insurer' shall mean an insurance company owned by one or more affiliated persons and domiciled in a jurisdiction which is accredited under the financial regulation standards of the National Association of Insurance Commissioners, provided that such captive insurer writes directly or reinsures only one or more of the following: (1) risks of the owners of the insurance company and affiliates of the owners; or (2) risks related to or arising out of the business or operations of the owners and affiliates; or (3) risks derived from a pool (or other similar arrangement, whether or not organized as an insurance company or a reinsurance company) formed solely as a mechanism to cede, distribute or allocate among insurance companies risks described in Paragraphs (1) or (2) above with regard to which at least one such insurance company has assumed or has been distributed or allocated risks from the pool, provided that all risks placed in the pool are similar or related and provided further that each captive participating in the pool retains more than 50 percent of all other reinsurance cessions."

Transactions Covered

As such, the following types of transactions with captives would be excluded from the exception -- that is, they would be covered by the model act's provisions. One would be transactions involving captives not located in a jurisdiction that has been accredited under the NAIC's accreditation program. To date, only two such jurisdictions have a captive insurance company law -- Colorado and Illinois. Accordingly, if the captive is formed in any other jurisdiction, including any foreign domicile, the exception does not apply.

The provisions of the model act would also cover transactions with a group captive. Even if the captive is formed in a jurisdiction that has been accredited, the exception will not apply if the captive is a group-owned captive to which only its owners cede business.

Certain pooling arrangements with respect to which a fixed minimum of related business is retained are another circumstance that would be covered under the model act's provisions. Under the recent amendment, captives participating in pooling arrangements will be considered to come within the exception only if the pooled business is similar or related and the captive retains at least 50 percent of all reinsurance cessions. It should be noted that based on certain past comments, whether risks are similar or related may not be determined by the type of the risk (e.g., workers' compensation liability) but will be based on the nature of the cedent's underlying business and the type of risk.

Captives and Employee Benefits

It is now permissible for an employer to take a deduction under Section 162 of the Internal Revenue Code of 1986, as amended, for premiums paid to a wholly owned insurance subsidiary to insure the lives of its employees under a group term life insurance contract. At least that is the indication from the Internal Revenue Service and its publication of Revenue Ruling 92-93 in December 1992.

In order to write such business in a wholly owned subsidiary, it is necessary to ensure that the prohibited transaction rules of the Employee Retirement Security Act of 1974 have not been violated. In Prohibited Transaction Exemption (PTE) 79-41, the U.S. Department of Labor took the position that the prohibited transaction rules would not apply provided that several requirements were met, among them the requirement that the insurance company be licensed in a state.

PTE 79-41 is a class exemption dealing with direct insurance transactions. Thus, if transactions come within its parameters, a separate individual exemption need not be sought from the Department of Labor. If, however, transactions are structured as a reinsurance transaction with respect to which the employer places business with an admitted carrier that then cedes all or a portion of the business to an insurer wholly owned by the employer, a separate individual exemption will have to be obtained because the transaction does not come within the parameters of the class exemption.

Vermont Amends Statute

PTE 79-41 requires, among other things, that the insurance company owned by the employer be licensed by a state. Until recently, although some domestic captive insurance company statutes would have permitted reinsurance of group term life insurance to a captive, few, if any, such statutes would have permitted this type of business to be written directly.

Recently, the Vermont Legislature approved an amendment to the Vermont Insurance Law that would permit a company formed as a captive insurance company under the Vermont Insurance Law to write various types of employee benefits directly. The regulators have indicated, however, that it is their intention to administer the statute, at this time, in such a manner as to permit only group term life contracts to be written directly.
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Title Annotation:Rules & Regulations
Author:Wright, P. Bruce
Publication:Risk Management
Date:Sep 1, 1993
Previous Article:Accounting for the lender's environmental exposure.
Next Article:Risk, Insurance, Reinsurance Lexicon, 1993.

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