Insurance health plans and the ACA Section 9010 Annual Fee

Health Sciences Tax Conference Insurance insights: captives, health plans and the ACA Section 9010 annual fee December 5, 2012

Insurance insights: captives, health plans and the ACA Section 9010 annual fee Page 2

Disclaimer

► Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.


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Presenter

► Larry Brauer Ernst & Young LLP Washington, DC +1 202 327 6105 [email protected]


Overview

► Affordable Care Act, Sec. 9010 ► Annual fee imposed on all insurance companies in the

business of providing health insurance for US health risks (covered entities)

► Not a tax ► Effective date: January 1, 2014, for net premiums written

as of January 1, 2013 ► Total amounts of annual fees specified in legislation ► Payment due September 30


Covered entity

► Any entity that provides health insurance for US health risks

► Included are: ► Insurance companies taxable under Subchapter L ► Tax-exempt organizations ► Foreign insurers providing health insurance for US health risks ► Insurers providing health insurance for US health risks under:

► Medicare Advantage ► Medicare Part D ► Medicaid


Covered entity — exceptions

► Employers to extent they self-insure the health risks of their employees — but an insurance company that sells health insurance is exempt only with regard to its self-insurance for employees

► A governmental entity

► A VEBA (§ 501(c)(9)) established by other than an employer or union to provide health care benefits


Covered entity — exceptions (cont.)

► An entity that: ► Is nonprofit under state law ► Is prohibited from:

► Private inurement ► Lobbying ► Political campaign activities

► Receives more than 80% of its gross revenue from Medicare, Medicaid, State Children’s Health Insurance Program (SCHIP), etc.

► Comments: ► Is Internal Revenue Service (IRS) recognition under § 501(c)(3)

required? ► Future IRS or Treasury guidance may clarify.


Health insurance

Does not include coverage for: ► Accident, disability income or both only ► A specified disease or illness only ► Hospital indemnity or other fixed indemnity insurance ► Long-term care ► Medicare supplemental insurance


Annual fees to be collected

► 2014 US$8.0 billion ► 2015 US$11.3 billion ► 2016 US$11.3 billion ► 2017 US$13.9 billion ► 2018 US$14.3 billion ► After 2019: indexed to rate of premium growth


Annual fees to be paid

► Annual fees to be paid by each covered entity are apportioned to each covered entity based on a fraction:

► Numerator

► The covered entity’s net premiums written in preceding year for health insurance for any US health risk

► Denominator

► Aggregate of all covered entities’ net premiums written in preceding year for health insurance for any US health risk


Premiums included in numerator

► First US$25 million: disregarded ► Next US$25 million to US$50 million: 50% included ► More than US$50 million: 100% included ► Related entities combined


Partial exclusion from numerator

► 50% of net premiums written for health insurance relating to the exempt activities of certain tax-exempt entities: ► § 501(c)(3): charitable, etc. ► § 501(c)(4): social welfare ► § 501(c)(26): high-risk health insurance pool ► § 501(c)(29): Consumer Operated and Oriented Plan (CO-OP)


Special rules

► The annual fee is not tax deductible ► Reporting

► Covered entities must report to IRS the annual amount of net premiums written for heath insurance for any US health risk.

► Penalty for not reporting: US$10,000 plus lesser of: ► US$1,000 per day while failure continues ► The annual fee imposed for the report required

► There is an accuracy-related penalty for understating the amount of net premiums written.


Comments

► Total fees collected are allocated among covered entities based on market share. Unlike a tax, covered entities will compete to shift fees to one another.

► § 501(c)(4) health maintenance organizations (HMOs) can

exclude 50% of net premiums written. ► Idea: For-profit HMOs — carve out Medicare, Medicaid and SCHIP

into new nonprofit entity and apply for § 501(c)(4) exemption ► Idea: § 501(c)(4) HMOs — if self-declared, apply for exemption


Questions on Insurance insights: ACA Section 9010 annual fee

Insurance insights: captive insurance companies


Background

► Many large tax-exempt health care systems self-insure by creating a controlled subordinate to provide insurance (and/or re-insurance) to subordinates and affiliates: ► Captive insurance companies (captives)

► Purpose: to reduce the cost of insuring various business risks: ► Medical malpractice ► Directors’ and officers’ liability ► Property liability ► Workers’ compensation


Formation of captives

► Captives may be: ► Domestic — formed under the insurance laws of a state

► Foreign — formed under the laws of a foreign country


Insurance activities

► Captives usually: ► Are created as a direct or indirect controlled subordinate of the

health care system parent organization (parent) ► Provide insurance to the parent, its subordinates and, sometimes,

affiliated entities

► Domestic captives qualify for exemption under § 501(c)(3) ► Rationale for exemption: the integral part doctrine

► Foreign captives ► Treated as controlled foreign corporations (Subpart F)


Insurance activities of captives

► A domestic or foreign captive may provide insurance: ► To the parent’s tax-exempt subordinates and affiliates

► To LLCs or joint ventures involving the parent or its subordinates

► To the parent’s taxable subordinates and affiliates

► The parent may or may not own or control these other entities.


Federal income tax issues

► Would any of these insurance activities: ► Jeopardize the domestic captive’s § 501(c)(3) status?

► Result in unrelated business taxable income (UBTI) to the domestic captive or to the parent?

► Result in Subpart F income to the parent?


Federal income tax principles

► A domestic captive that is: ► Controlled by a § 501(c)(3) parent qualifies for § 501(c)(3) as an

integral part of the parent: Regs. § 1.502-1(b)

► Carrying on an unrelated trade or business is taxable on the net income derived from this activity (UBTI): § 511, § 512

► Providing insurance for its controlling parent and related organizations is not precluded from exemption by § 501(m)


Federal income tax principles (cont.)

► A § 501(c)(3) parent: ► Having Subpart F insurance income from a foreign captive is not

taxable if derived from the captive insuring the parent and its exempt affiliates: § 512(b)(17)

► Having Subpart F insurance income from a foreign captive is taxable as UBTI to the parent if derived from the captive-insuring entities that are not: ► Affiliates of the parent ► Tax-exempt


Federal income tax principles (cont.)

► Affiliate — an entity is an affiliate of a corporation if it has: ► Significant common purposes and substantial common

membership

► Or directly or indirectly substantial common direction or control: § 168(h)(4)(B)


Domestic captive — exempt subordinates

► If a domestic captive providing insurance to a parent’s exempt subordinates, LLCs or joint ventures is: ► Parent-owned or controlled (directly or indirectly):

► There is no effect on the captive’s § 501(c)(3) exemption. ► There is no UBTI to the captive.

► Not parent-owned or controlled (directly or indirectly): ► The captive’s net premium income for this insurance is taxable to the

captive as UBTI. ► If substantial, the captive’s § 501(c)(3) exemption may be at risk.


Domestic captive — taxable subordinates

► If a domestic captive is providing insurance to a parent’s taxable subordinates, whether or not parent-owned or controlled (directly or indirectly): ► The captive’s net premium income for this insurance is taxable to

the captive as UBTI.

► If substantial, the captive’s § 501(c)(3) exemption may be at risk.


Foreign captive

► A foreign captive providing insurance to the parent’s tax-exempt affiliates has: ► No effect on the parent’s § 501(c)(3) exemption ► No UBTI to the parent

► If a foreign captive is providing insurance to entities that are not the parent’s affiliates or not tax-exempt: ► The captive’s net premium income from this insurance is taxable to

the parent as UBTI. ► If substantial, the parent’s § 501(c)(3) exemption may be at risk.


Foreign captive — summary

► The net premium income earned by a foreign captive is not UBTI to the parent if the entity insured by the foreign captive is: ► The parent or an affiliate of the parent

► Tax-exempt


Insurance for hospital staff physicians

► The hospital provides medical malpractice insurance through its captive to private practice physicians on its medical staff.

► Percent of time treating patients at the hospital: ► 50% ► 80%

► Issue: Does insurance primarily cover risks associated with the performance of services in connection with the hospital?


Questions on Insurance insights: captive insurance companies

Insurance insights: state taxation of premiums paid to captives


Presenter

► Kevin Owens Ernst & Young LLP Washington, DC +1 202 327 8828 [email protected]


State taxation of premiums

► Premium tax ► Assessed against admitted insurance company ► Based on premiums allocable to state

► Surplus lines ► Insurance company not licensed to sell insurance in state ► Insurance placed by lines broker with non-admitted company ► Surplus lines tax assessed against surplus lines broker

► Independently procured insurance ► Insured acquires insurance directly from non-admitted company. ► Most states assess tax against insured.


Independently procured insurance tax

► Imposed by a majority of states ► Statute varies by state ► Historically, not rigorously enforced by most states

► California, New York, Texas and Florida more active than others

► Generally applies when insurance is purchased from non-admitted insurance company ► May apply to insurance from captive insurance companies as they

are licensed only in state of domicile


Pre-Dodd–Frank (contracts in effect prior to July 21, 2011)

► Typical statute applies tax when insurance is procured from an insurance company not admitted to do business in the state. ► NY: “There is hereby imposed on any person who purchases or

renews a taxable insurance contract from an insurer not authorized to transact business in this state under a certificate of authority from the superintendent of insurance … ”

► CA: “Every person who effects insurance with a non-admitted insurance carrier is required to pay a tax of 3 percent of net premiums.”

► Tax applies only to risks located in that state.


Limitation on independently procured insurance tax — Todd Shipyards

► State Board of Insurance v. Todd Shipyards Corp., 370 US 451 (1962) ► New York corporation did business and owned property in Texas. ► All transactions regarding the insurance occurred outside of

Texas; the insurance was purchased, the premiums were paid and any claims were to be adjusted and paid in New York.

► The insurers were located in London, were not licensed in Texas, had no agents in Texas and did no business in Texas.

► The broad Texas self-procurement statute contained no limitations requiring actions in the state to give rise to the tax.

► The Supreme Court invalidated the tax levied. ► Texas tax may not be constitutionally imposed when the only

connection between the insurance transaction and the state is that the insured risk is located in Texas.


Is Todd Shipyards ruling still valid?

► Associated Electric & Gas Insurance Services, Ltd. v. Clark, 676 A.2d 1357 (R.I. 1996) (AEGIS) ► Premium tax assessed by Rhode Island against Bermuda

insurance company ► Todd Shipyards ruling superseded

► Dow Chemical Co. v. Rylander, 38 S.W. 3d 741 (Tex. Ct. App. 2001) ► Attempt by Texas to impose essentially the same self-procurement

tax statute at issue in Todd Shipyards case ► Texas court rejected argument used in AEGIS ► Todd Shipyards ruling still valid


Limitation on Todd Shipyards ruling

► Coombs v. STP Nuclear Operating Company, 239 S.W.3d 264 (Tex. App. Austin 2007) ► Application of Texas independently procured insurance (IPT)

upheld ► Factual difference with Todd Shipyards case

► Insured headquartered in Texas ► Supervisor of corporate insurance located in Texas ► Direct communications via e-mail and letters between the corporation

and the non-admitted insurer ► Insurance contracts negotiated and approved by the corporation’s

employees in Texas ► Premium payments’ origin: Texas ► Losses payable to insureds in Texas


Non-admitted and Reinsurance Reform Act (NRRA) ► NRRA part of Dodd–Frank legislation ► Enacted into law in July 2010, with most provisions

effective July 21, 2011 ► Reforms the taxation and regulation of insurance between

an insured and an insurance company ► Focus on surplus lines but includes directly procured insurance ► Only the “home state” can tax or regulate insurance with a non-

admitted insurance company

► NRRA provides several key definitions


Key definitions

► Home state ► The state in which an insured maintains its principal place of business ► If 100% of the insured risk is located out of that state, the state to

which the greatest percentage of the insured’s taxable premium for that insurance contract is allocated (this method of allocation is commonly referred to as the “cost of performance”)

► If there are more than one insured from an affiliated group identified as named insureds on a single non-admitted insurance contract, the “home state” means the home state of the member of the affiliated group that has the largest percentage of the premium attributed to it under such insurance contract. “Affiliated group” means any group of entities that share common control. An affiliated group may include entities that share parent-subsidiary and/or brother-sister corporate relationships.


Key definitions (cont.)

► Independently procured insurance ► Insurance procured directly by an insured from a non-admitted insurer

► Non-admitted insurance ► Any property and casualty insurance permitted to be placed directly or

through a surplus lines broker with a non-admitted insurer eligible to accept such insurance

► Non-admitted insurer ► An insurer not licensed to engage in the business of insurance in a

particular state. A non-admitted insurer does not include a risk retention group, as defined in the Liability Risk Retention Act of 1986, 15 USC. 3901(a)(4).


State adoption of NRRA

► Adoption of NRRA varies by state. ► Generally, states have adopted NRRA definitions and

modified the law to use those definitions. ► States adopting NRRA definitions also tax 100% of

premiums, e.g., New York and Texas. ► Prior to NRRA, generally only premiums allocable to a state were

subject to tax.

► Current status of tax is very confusing. ► For example, Virginia has legislated a procedure to collect the tax

but has not placed the tax on its books. ► Not all states have adopted NRRA definitions, e.g., Alabama.


State adoption of NRRA — reaction

► Vermont Captive Insurance Association ► Whitepaper conclusion: NRRA not intended to apply to captive

insurance companies ► Does not address changes in state law


What to do

► Benchmark IPT ► Prepare analysis of locations of risks insured and premiums allocable to

those locations ► Determine home state under NRRA ► Determine law of home state regarding whether home state imposes IPT ► Determine if any risks are in states that have not adopted NRRA

► Planning considerations ► Redomesticate captive to home state ► Control determination of home state, e.g., multiple contracts or contracts

with varying coverages ► Move insurance functions in order to invoke Todd Shipyards ruling

► Possible legal arguments ► Contest tax on 100% of premiums on constitutional grounds? ► Is arrangement of insurance for IPT purposes?


Questions on Insurance insights: state taxation of premiums paid to captives

Economy & Finance

Insurance health plans and the ACA Section 9010 Annual Fee