Illinois will soon begin taxing self-procured insurance premiums for the first time, as required by Senate Bill 3324, now Public Act 98-0978 (the Act).  The Act, which was signed into law by Governor Quinn on August 15, was quietly ushered through the General Assembly as a supposed technical amendment. The Act is anything but—it substantively amends Illinois law to tax Illinois-based companies who self-procure insurance as though they were surplus lines brokers, imposing a 3.5 percent self-procurement tax, together with additional fees and charges.  In addition, the Act makes it harder for Illinois companies to self-insure by narrowing the definition of an “industrial insured” and increasing the qualification requirements for risk managers.  The new law applies to policies of insurance effective on or after January 1, 2015.

As we explained in a prior post, the Act hurts Illinois-headquartered businesses that manage risks using captive insurance arrangements. With the 2011 enactment of the Nonadmitted and Reinsurance Reform Act (NRRA), a company’s home state – typically its principal place of business – has exclusive authority to tax and regulate nonadmitted insurance. See 15 U.S.C. § 8201. For Illinois-headquartered businesses, this arrangement worked well because Illinois law previously allowed “industrial insureds” – companies meeting minimal size and sophistication requirements – to transact nonadmitted insurance without paying tax. An Illinois-headquartered company thus could obtain insurance from its captive domiciled overseas or in a captive-friendly U.S. state without paying any tax on its premiums.

The Act ends this business-friendly state of affairs. An industrial insured transacting nonadmitted insurance for a policy taking effect on or after January 1, 2015, will now have to withhold (or pay out-of-pocket if it does not withhold) a 3.5 percent premium tax on insurance contracts. Two additional charges increase the total effective rate to anywhere from 3.6 percent to 4.6 percent: a countersigning fee of 0.1 percent to support the Surplus Line Association of Illinois, and for certain lines of insurance, a fire marshal tax of anywhere from 0.01 percent to 1.00 percent of premium.

The Act also makes it more difficult for Illinois companies to self-insure by narrowing the definition of an “industrial insured,” where companies must qualify as an “industrial insured” in order to have the right to self-insure. Until now Illinois company could be an “industrial insured” if its annual premium for insurance of all risks except life and accident and health insurance exceeded $100,000 and it had either (a) at least 25 full-time employees, (b) more than $3 million of gross assets, or (c) gross revenues of more than $5 million. Under the Act, an industrial insured now must meet the requirements of an “exempt commercial purchaser” under 215 ILCS 5/445(1), which include having nationwide commercial property and casualty insurance premiums in excess of $100,000 annually and having either (a) net worth of more than $20 million, (b) more than $50 million of annual revenues, (c) more than 500 full time employees or more than 1,000 employees in an affiliated group, (d) a nonprofit with at least a $30 million budget, or (e) a municipality with a population in excess of 50,000 persons. In addition, the Act increases the qualification requirements for the “qualified risk managers” that must be used by industrial insureds to manage their self-insurance policies.

With the Act on the books, presumably the Department of Insurance and the Surplus Line Association of Illinois will begin preparing forms and guidance for industrial insureds to comply with the new requirements. An effort is underway to pass legislation during the post-election veto session to repeal the Act or ameliorate its effects.

A New York City Tax Appeals Tribunal Administrative Law Judge (ALJ) recently ruled in favor of Aetna, Inc. (Aetna) on the question of whether a health maintenance organization (HMO) was “doing an insurance business” in New York State, thereby exempting it from the New York City General Corporation Tax (GCT).  In Matter of Aetna, Inc., the ALJ determined that the HMO at issue was “doing an insurance business” in New York because insurance risk was present in contracts covering the members of the HMO, the members of the HMO spread the risk of loss due to unforeseen medical expenses to the HMO and the HMO was subject to significant regulation under New York State Insurance Law and Public Health Law.  Aetna Health, Inc. (Health), a subsidiary of Aetna, qualified as an HMO under Article 44 of the New York State Public Health Law.  Though the New York City Department of Finance (Department) argued that HMOs were subject to the GCT because they do not conduct insurance business, the ALJ engaged in a thorough examination of federal and New York State authorities on HMOs and concluded that Health was doing an insurance business in New York.  Of particular note, the ALJ, relying on the United States Supreme Court decision in Rush Prudential HMO v. Moran, noted that HMOs could be (and were) “both insurer[s] and corporation[s] which arrange[] for the provision of medical services.”  The Department has 30 days from the determination date to file an appeal.

McDermott is pleased to have represented Aetna, Inc. in this favorable ruling.   If you have any questions regarding this determination and its past, present, and future impact on your company, please contact a member of the McDermott State and Local Tax group.  For more please see McDermott’s On the Subject regarding this case.

Illinois Senate Bill 3324, an insurance bill that would impose a premium tax on Illinois companies obtaining unauthorized insurance, has passed the General Assembly and is awaiting Governor Quinn’s signature. If signed into law, the bill will have a significant negative impact on captive insurance and any other unadmitted insurance arrangements used by businesses with a home state of Illinois.  Such companies will be taxed on 3.5 percent of their premiums paid on unadmitted policies effective January 1, 2015, and thereafter.

The Favorable Status Quo for Illinois “Industrial” Insureds under the Nonadmitted and Reinsurance Reform Act of 2010 (NRRA)

A state’s premium tax structure typically has three components:

  1. A tax on the premiums received by insurers that are admitted to transact insurance and are regulated by the state;
  2. A tax on the premiums received by surplus lines brokers (typically at a higher rate than the premium tax for admitted insurers); and
  3. A tax on the premiums paid by insureds who obtain their own insurance from unauthorized insurers (sometimes called a self-procured insurance tax), often at the same rate as the surplus lines tax.

Until now, Illinois has not taxed self-procured insurance.  Illinois traditionally has allowed “industrial insureds” – companies meeting certain thresholds of size and sophistication – to obtain coverage from non-admitted insurers without violating the prohibition against the unauthorized transaction of insurance in the state (see 215 ILCS 5/121-2 (prohibiting transacting insurance without a certificate of authority), 121-2.08 (excepting transactions with “industrial insureds” and defining the term)) and without the imposition of premium tax.

This exception became particularly beneficial to companies headquartered in Illinois after the enactment of the NRRA, which was part of the Dodd-Frank Act. See P.L. 111-203, tit. V, §§ 521-527, 124 Stat. 1589 (codified at 15 U.S.C. § 8201 et seq.). The NRRA provides that “[n]o State other than the home State of an insured may require any premium tax payment for nonadmitted insurance.” 15 U.S.C. § 8201(a). The “home state” is generally a company’s principal place of business. See 15 U.S.C. § 8206(6) (a detailed discussion of the definition of “home state” is beyond the scope of this post). With the enactment of the NRRA, companies having Illinois as their “home state” have experienced a significant savings:  If they qualify as industrial insureds, they effectively can obtain unauthorized insurance coverage of their nationwide risks without paying any state premium tax, as Illinois doesn’t impose a premium tax and other states are precluded from collecting tax from non “home state” companies.

S.B. 3324 Would Impose a 3.5 percent Tax on Premiums Paid by Illinois Industrial Insureds

S.B. 3324 would end this happy state of affairs. It amends 215 ILCS 5/121-2.08 to require industrial insureds to pay tax at the 3.5 percent of premiums rate that is applicable to surplus lines transactions (imposed at 215 ILCS 5/445(3)(a)(ii)).  The adverse impact of the tax could be significant, particularly for Illinois home state industrial insureds with captive insurance arrangements.

S.B. 3324 also requires an annual filing with the Surplus Line Association of Illinois. If it becomes law, S.B. 3324 will apply to contracts of insurance effective January 1, 2015, or later.  Governor Quinn received the bill on June 19, 2014, and he has until August 14 to sign or veto the bill. If he takes no action, then the bill will become law without his signature.

Illinois is one of a small number of states that impose both an income tax and a premium tax on insurance companies.  Disputes have arisen between insurers and the Illinois Department of Insurance (Department) regarding the proper treatment of income tax refunds in the calculation of retaliatory tax.  The dispute typically concerns whether an income tax refund should be included in the Illinois Basis of an insurer’s retaliatory tax computation for the year in which the income tax refund is paid or in the Illinois Basis for retaliatory tax computation for the tax year to which the refund relates.  The Department has taken the position that the income tax refund must be applied to Illinois Basis for the year in which the refund is paid, based on language of a Departmental regulation (50 Ill. Adm. Code Sec. 2515.50(b)) providing that Illinois Basis used to compute retaliatory tax must include “the amount of Illinois corporate and replacement income tax paid, decreased by the amount, if any, of any corporate and/or income replacement tax cash refund received in the same calendar year if that cash refund has been considered part of the Illinois corporate and replacement income tax paid in the calculation of the annual retaliatory tax in a preceding year.” (50 Ill. Adm. Code Sec. 2515.50(b)(5)) (emphasis added).

On March 3, 2014, the Illinois Appellate Court for the Fourth District issued an unpublished ruling in which it found that 50 Ill. Admin. Code Sec. 2515.50(b) was invalid because it conflicted with the state’s mandate that the retaliatory tax include corporate income tax imposed, not paid, in a particular year.  The opinion authorized the taxpayers who challenged the Department’s interpretation to calculate their retaliatory tax by applying their corporate income tax refund to the tax year to which the refund related, regardless of the year in which it was paid.

In its opinion, the appellate court twice noted that if the Department’s interpretation had been upheld, the taxpayers would have been required to pay more retaliatory taxes than they would have originally owed simply because they initially overpaid their corporate income tax.  This point of equity appears to have been a strong supporting factor for the appellate court in its decision to invalidate the regulation.  United States Liability Ins. Co., et al v. The Department of Insurance, 2014 IL App. (4th) 121125-U (March 3, 2014) (Opinion issued pursuant to Illinois Supreme Court Rule 23).