Delaware Amends Law to Expressly Provide for Special Purpose Financial Captive Insurance Companies
August 16, 2007
Publication| Corporate Trust & Agency Services
On July 18, 2007, Delaware Governor Ruth Ann Minner signed into law legislation that provides a comprehensive scheme for the formation of special purpose financial captive insurance companies ("SPFCs"). Recently, SPFCs have become popular vehicles for the securitization of insurance risk (i.e., funding by the capital markets of carefully defined segments of such risk). Delaware continues to be on the cutting edge in offering the business community flexible legal entities through which to conduct business. Already the forum of choice when it comes to organizing corporations, limited liability companies, limited partnerships and statutory trusts, Delaware intends to achieve a comparable position for Delaware SPFCs by providing the most advanced captive insurance legislation that can be used together with Delaware legal entities, which have long been the favored choice for capital markets transactions.
Under the newly enacted legislation, Title 18, Chapter 69 of the Delaware Code was amended to add a new Subchapter III, providing detail and clarity with respect to the establishment of SPFCs (the "Delaware SPFC Statute"). Although captive insurance companies in Delaware remain subject to the general captive insurance laws, the financial community will now also have the opportunity to utilize the advantages found in the Delaware SPFC Statute in structuring transactions using a Delaware captive insurance company. The Delaware SPFC Statute is the next step in the advancement of captive insurance legislation making Delaware the leading jurisdiction in this area.
What follows is a discussion of some of the more significant provisions of the Delaware SPFC Statute and the benefits of Delaware as a jurisdiction.
Form of Entity
Delaware’s captive insurance law provides an explicit authorization allowing the use of certain business organization forms in the formation of an SPFC or a sponsored captive insurance company, including stock corporation, nonstock corporation, limited liability company, partnership, limited partnership or statutory trust.
When applying for a certificate of authority, the SPFC must file a plan of operation with the Delaware Insurance Commissioner (the “Commissioner”), which is required to include the following:
- A description of the contemplated special purpose financing transaction and the SPFC contract;
- Copies, or at the Commissioner’s discretion a written summary, of all material agreements and documents that are to be entered into or required to effectuate the SPFC contract and the special purpose financing transaction;
- Description of the SPFC’s proposed investment strategy;
- Description of the underwriting, reporting, and claims payment methods by which losses covered by the SPFC contract are to be reported, accounted for, and settled; and
- Pro forma balance sheets, income statements and other financial projections demonstrating the performance of the SPFC under such stress case scenarios as may be required by the Commissioner.
Any material change of the SPFC plan of operation shall require prior approval of the Commissioner. However, circumstances that by statute shall not be considered a material change include:
- The issuance of subsequent securities or securities entered into to continue the activities of the SPFC when such actions were approved in the plan of operation; and
- Change or substitution of a swap counterparty if approved by the plan of operation and if, at the time of the change, the replacement swap counterparty carries the same or higher rating than its predecessor.
A certificate of authority shall not be issued unless an SPFC has and maintains capital and surplus of not less than $250,000. A sponsored captive insurance company, used to establish protected cells and licensed as an SPFC, must maintain capital and surplus of not less than $500,000. Under Delaware’s captive insurance laws, the Commissioner has the power to prescribe additional minimum capital and surplus based upon the type, volume, and nature of insurance business transacted.
Delaware law permits the capital and surplus to be in the form of cash, an irrevocable letter of credit under certain circumstances, or other assets approved by the Commissioner.
An SPFC may issue securities, including any form of debt obligation, equity, surplus certificate, surplus note, funding agreement, derivative, or other financial instrument that the Commissioner designates, by rule or order, as "securities."
The Delaware SPFC Statute explicitly provides that an SPFC security will not be subject to regulation as an insurance contract and that an investor in such a security or a holder of such a security will not be considered to be transacting the business of insurance in Delaware solely by reason of owning a security. The Delaware SPFC Statute also makes clear that persons involved in the underwriting of a special purpose financing transaction shall not be considered to be conducting business as an insurance company.
Dividends and Repayment of Securities
Dividends or distributions may be declared and paid if they do not jeopardize the fulfillment of the SPFC’s obligations or threaten the solvency or liquidity of the SPFC. An SPFC may submit periodic written requests to the Commissioner for advance approval of an SPFC’s making payments of dividends or interest and repayments of principal. The Commissioner may approve in advance such ongoing dividend or interest payments and principal repayments provided that they shall be made in accordance with the plan of operations and its formulas. In addition, if the operation or financial condition of the SPFC deviates from the previously approved formula, interest payment or repayment of principal may be made with the Commissioner’s approval.
Insurance and Reinsurance
An SPFC shall insure only the risks of a counterparty, which may be but need not be the parent or an affiliate of the SPFC. An SPFC may cede risks assumed through an SPFC contract to third party reinsurers through the purchase of reinsurance or retrocession protection if set forth in its plan of operation.
In addition, the Delaware SPFC Statute includes a broad authorization for an SPFC to enter into a myriad of agreements incidental to the purposes of an SPFC contract and special purpose financing transactions contemplated by the plan of operation approved by the Commissioner.
The Delaware SPFC Statute specifies a definition of insolvency with respect to SPFCs. Insolvency under the Delaware SPFC Statute occurs when:
- The SPFC is unable to pay its obligations when they are due, unless those obligations are the subject of a bona fide dispute; or
- The SPFC’s liabilities exceed the value of all assets as determined under the accounting method utilized by the SPFC and in accordance with statutory law.
Sponsored Captive Insurance Companies and Protected Cells
The Delaware SPFC Statute modifies some parts of Delaware’s existing statutes regulating sponsored captive insurance companies and the protected cells established by a sponsored captive insurance company. These changes include:
- A sponsored captive insurance company may be licensed as an SPFC and may establish protected cells to engage in insurance securitizations;
- A sponsored captive insurance company shall have and maintain capital and surplus of at least $500,000;
- A sponsored captive insurance company must segregate the assets of each protected cell from the assets of other protected cells and from the assets of the sponsored captive insurance company’s general account;
- A sponsored captive insurance company may combine the assets of 2 or more protected cells for purposes of investing such assets, and such combination shall not be construed as defeating the segregation of such assets;
- A special purpose financial captive insurance company that is organized as a sponsored captive insurance company may add or eliminate one or more protected cells under a single certificate of authority upon approval by the Commissioner of a plan of operation specific to such protected cells.
As a tax matter, an SPFC pays premium tax at the same rate as non-SPFC captive insurance companies up to an annual maximum aggregate tax of $200,000.00.