On June 4, 2013, Texas Governor Rick Perry signed a law making Texas the latest state to allow the formation of captive insurers, or "captives." The Government Affairs team at Gardere Wynne Sewell LLP drafted the language for and led negotiations with the Texas Department of Insurance ("TDI") that paved the way for the new law that allows parent companies to form "captive" subsidiaries in Texas to self-insure their affiliates' insurance risks.

The new captive law will give Texas companies (or out-of-state companies operating in Texas) a cutting edge alternative risk management option that has risen in popularity as companies seek to maintain greater autonomy insuring risks that are either expensive or difficult to procure. Captive formation has not previously been an attractive option in Texas because companies have had to domicile their captive in other jurisdictions with a captive law. As a result, those companies have faced multiple state compliance hurdles, uncertain tax consequences, and a host of other administrative and expense burdens inherent in operating an insurance company affiliate outside of a parent's home state.

Scheduled to take effect on September 1, 2013, the TDI will begin authorizing "pure captive" insurers in Texas. The law allows for a parent company that underwrites the insurance needs of its operating subsidiaries in lieu of outsourcing the risk to traditional insurers. Other state laws have expanded upon the "pure captive" model to allow for multiple types of captive formations. Such variations — including association, outside, industry group or branch captives — allow either non-traditional or alien corporate structures to form captives within the given state. Some states also authorize "protected cell" captives in which multiple participants contract for a "sponsored" captive that maintains the assets and funds the liabilities of participants according to the terms of their contracts.

While Texas adopted only a "pure captive" model, the Legislature may set up other forms of captives in future legislative sessions if businesses advocate for them. But for the time being, the Texas captive law affords many attractive options for businesses seeking to form or re-domesticate captives in Texas. Highlights of the new law include:

  • Favorable Tax Consequences: Whereas existing Texas companies with out-of-state captives operate them in Texas by paying the 5 percent self-procurement tax that Texas charges unauthorized insurers. The new law establishes a tax rate of one-half of 1 percent on a captive's taxable premium receipts. The most favorable tax advantage is that the law provides a $200,000 tax cap on premiums. Maintenance taxes will also be imposed on the direct premiums on individual lines of business written by the captive.
  • Greater Taxation Predictability: The capped premium tax applies to "each kind of property or risk without regard to the location of the property or risk." This provides a more certain regulatory structure in the wake of the federal Dodd-Frank legislation's Nonadmitted and Reinsurance Reform Act. Dodd-Frank left some question over whether parent companies could be taxed in their home states for captive insurers based elsewhere, but the Texas law provides necessary predictability by ensuring that captives pay the low Texas rates for all risk underwritten by a captive without regard to the risk's location.
  • Relaxed Regulatory Scrutiny: The new law requires TDI to promulgate rules for the licensing and oversight of captives. The law requires that captives maintain capital and surplus of at least $250,000, the common minimum requirement among other captive laws throughout the nation. TDI will also promulgate rules for annual reporting requirements and standards by which a captive can make loans to its affiliates with the prior approval of the commissioner.
  • Restrictive Confidentiality Provisions: While TDI has the ability to receive and share some of the captive's confidential information, that authority is more limited than what information can be obtained from traditional insurers. For example, the law limits access of a captive's confidential information to only certain entities who are acting in their official capacities, absent written approval from the captives.
  • Registration of Captive Managers: The new law recognizes that formation of an insurance company may not be within the institutional competence of many parent companies since few companies forming captives are in the business of insurance themselves. Thus, captive parents are permitted to hire either an outside insurance company or captive manager to manage the captive, subject to registration with the commissioner.
  • Redomestication of Captives: There is a process by which an existing non-Texas captive can redomesticate to Texas upon the approval of the commissioner. The commissioner is authorized to postpone or waive the imposition of any fees or taxes upon the redomesticating captive for up to two years.

Captives have traditionally been formed by large Fortune 500 companies whose affiliates' national insurance exposure is quite large. But as many small companies become better versed in alternative risk management measures, they find that forming a captive affords greater autonomy when commercial insurance markets are particularly hard. This most often occurs when property/casualty availability stretches thin during times of natural disaster or when costs of specialized coverage for hard-to-insure risks soar. An energy company may form a captive, for example, to guard against environmental claims related to infrequent but potentially high-cost events such as oil spills. Or, health care providers may form a captive to control their own fate with professional liability coverage (i.e., medical malpractice claims).

The new captive law will take effect on September 1, 2013, but many companies are already exploring options to form their captives early so that they can provide input while TDI promulgates its administrative captive formation rules.