On October 22, the Tennessee Department of Commerce and Insurance adopted a memo which provides guidance to captive insurance companies domiciled in Tennessee regarding the credit obtained for reinsurance from unauthorized reinsurers. This is significant, not only because Tennessee and North Carolina are adjacent states (which to some degree compete against each other for captive insurance domestications and formations), but also because the statutory language of the North Carolina General Statutes and the Tennessee Insurance Code are identical.

Both Tennessee Insurance Code § 56-13-112 and North Carolina General Statute § 58-10-445 explain that:

Any captive insurance company may take credit for the reinsurance of risks or portions of risks ceded to reinsurers complying with this Chapter. If the reinsurer is licensed as a risk retention group, then the ceding risk retention group or its members must qualify for membership with the reinsurer. The Commissioner shall have the discretion to allow a captive insurance company to take credit for the reinsurance of risks or portions of risks ceded to an unauthorized reinsurer, after review, on a case-by-case basis. The Commissioner may require any documents, financial information, or other evidence that will allow an unauthorized reinsurer to demonstrate adequate security for its financial obligations.

In addition to reinsurers authorized by this Chapter, a captive insurance company may take credit for the reinsurance of risks or portions of risks ceded to a pool, exchange, or association to the extent authorized by the Commissioner. The Commissioner may require any documents, financial information, or other evidence that such a pool, exchange, or association will be able to provide adequate security for its financial obligations. The Commissioner may deny authorization or impose any limitations on the activities of a reinsurance pool, exchange, or association that in the Commissioner's judgment are necessary and proper to provide adequate security for the ceding captive insurance company and for the protection and benefit of the public at large.

The memo from the Tennessee Department of Commerce and Insurance provides a regulatory gloss on the statute. It goes on to state that “Tennessee captives seeking to enter into a reinsurance contract with the same unauthorized reinsurer should likewise include the details of the proposed reinsurance agreement and its proposed business plan or submit a change of business plan.” This obviously has large implications for the risk pools operated by many captive managers.

The Tennessee memo then lays out five factors which it claims will be used in deciding whether to grant credit for reinsurance purchased from unauthorized reinsurers. These factors are:

  • “The policy issued to the original named insured is issued by a traditional admitted domestic insurance carrier acting as a front.
  • The reinsurance agreement is made upon secured collateral. This includes reinsurance agreements made on a funds withheld basis, via a domestic U.S. trust, or via a letter of credit issued by a reputable U.S. based financial institution.
  • The reinsurance agreements are obtained from an accredited reinsurer as defined by Tenn. Code Ann. §56-2-208.
  • Reinsurance is obtained from a reinsurer that is highly rated by a reputable rating agency.  
  • The reinsurer has a paid in unencumbered capital and surplus of at least $20,000,000 and agrees to submit to Tennessee copies of its audited annual financial statements as well as copies of any examination report conducted by its home domicile.”

Two additional factors are also explained: Tennessee will provide additional weight to a reinsurer if it is “domiciled in a jurisdiction with a solid reputation for providing accountability and oversight to its insurers” and the Department will give weight to the “experience and reputation of the captive manager and other service providers selected by the captive owner.”  These factors, of course, beg the question as to what qualifies as a domicile with a "solid reputation."  Does this exclude all off-shore domiciles?  Will Tennessee consider any on-shore domiciles other than itself to be qualified?

This memo continues that “some captives choose to participate in reinsurance exchange pooling arrangements structured in any number of ways. When such pooling arrangements include scenarios where a Tennessee captive insurance company cedes risk to an unauthorized reinsurer, the Department will give the greatest weight to arrangements where the ceded premium is held in a domestic U.S. trust, or where all pool participants are managed by the same captive manager. Any type of proposed pooling arrangement should include information sufficient to satisfy the Department that adequate controls are present and that the pooling arrangement, and its participants, possesses sufficient liquidity and accountability.”

The memo concludes by stating that the Department of Commerce and Insurance retains its discretion to grant credit for reinsurance on a case by case basis.

This memo is important because it applies a regulatory interpretation to statutory language that is identical to North Carolina’s captive insurance law.  It will be interesting to see whether North Carolina's Department of Insurance reacts in any way to this memo.  Even if North Carolina's regulators do not adopt the Tennessee memo outright, would they consider compliance with it as a "plus factor"?  Conversely, depending on whether Tennessee construes its policy memo narrowly or broadly could have implications for North Carolina's captive insurance industry.