Secrecy Laws Leave Insurance Consumers Exposed
The Centers for Better Insurance has submitted these comments in furtherance of the mission of the Advisory Committee on Risk-Sharing Mechanisms (ACRSM) to “provide advice and recommendations to the Federal Insurance Office (FIO) with respect to the creation and development of non-governmental, private market risk-sharing mechanisms for protection against losses arising from acts of terrorism.”
FIO is currently considering whether to create transparency over captive insurance arrangements for the benefit of:
- Itself as the administrator of the Terrorism Risk Insurance Program;
- Congress as the overseer of this $100 billion program; and
- The public as the funder of the Program’s commitments.
The ACRSM should urgently and strongly advise and recommend to FIO that it must exercise its authority under the Terrorism Risk Insurance Act to create transparency into the role of captives in the Program to:
- Promote awareness of promising private terrorism risk solutions developing in the captive space; and
- Protect small businesses from falling into potentially abusive terrorism risk financing schemes.
Avrahami v. Commissioner, 149 T.C. 144 (2017) explains why this second point is so important to American small businesses. In this case, start-up insurance company Pan American Reinsurance Company, Ltd. sold over 100 stand-alone terrorism insurance policies — including coverage for biological and chemical attacks — in its first year. Pan American enjoyed 30% growth in policy count the following year. Like the coverage required to be made available under TRIA, the terrorism coverage sold by Pan American paid out in the event the U.S. Secretary of Treasury certified an act of terrorism. However, because Pan American is ineligible to participate in the Terrorism Risk Insurance Program it had no access to the federal backstop.
As recounted in Avrahami, an owner of several Phoenix-area jewelry stores formed a captive insurance company. Through this captive, the jeweler paid Pan American $360,000 for a one-year terrorism risk insurance policy (including biological and chemical coverage) with a limit of $5,525,000. During this same period, the jeweler paid about $1500 for $2 million of terrorism coverage (excluding biological and chemical attacks) to an insurer participating in the Terrorism Risk Insurance Program.
While the 240x more expensive Pan American policy had the advantage of a higher limit and coverage for biological and chemical attacks, the Tax Court expressed concern over:
- The policy’s exclusion of loss from any attack occurring in a city with more than 1.5 million residents; and
- The option for Pan American to settle claims under the policy by delivering a promissory note that could not be redeemed for three years.
Ultimately, the Tax Court concluded the jeweler had paid “grossly excessive” premiums for the terrorism coverage sold by Pan American. The jewelry store subsequently filed federal and state RICO and fraud claims against Pan American and others involved in designing, pricing, and administering its terrorism product.
While many of the problems faced by the jeweler in Avrahami nominally took place offshore, similar circumstances could (and perhaps do) face the many hundreds or thousands of small businesses obtaining terrorism insurance coverage through onshore captives. Normally we would expect state departments of insurance to serve as the first line of regulatory defense against abusive insurance products, but state insurance commissioners have little authority when it comes to public accountability for captives. For example, the Delaware Department of Insurance is currently locked in a court battle over an IRS subpoena seeking the insurance department’s records relating to potentially abusive captive schemes. According to the insurance department, state insurance law:
[P]rovides confidentiality, immunity from subpoena, and immunity from disclosure, for confidential documents relating to the license application for captive insurance, and forbids the Commissioner or Department from disclosing such documents other than to insurance departments or law enforcement or agencies of a state or the United States with an agreement in writing to hold it confidential in a manner consistent with the section.
In other words, state departments of insurance have their hands tied when it comes to publicly exposing situations like the “grossly excessive” terrorism premiums at issue in Avrahami. If the states are powerless to deliver basic transparency necessary to protect small businesses, surely FIO should feel compelled to step up.
The ACRSM was established to help FIO understand both the potential for legitimate alternative financing of the terrorism risk as well as the pitfalls of dubious terrorism financing schemes. For these reasons, the ACRSM should advise and recommend FIO to use the authority Congress granted to it under Section 102(6)(C) of the Terrorism Risk Insurance Act and fill the void left by state insurance laws barring insurance commissioners from safeguarding consumer protection when it comes to captives.