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Steven Beeghly, Esq.
KREGER BEEGHLY PLLC
(206) 618-6110

DIRECT PROCUREMENT & SURPLUS LINE INSURANCE LAW IN WASHINGTON STATE; AN OVERVIEW OF WASHINGTON STATE TREATMENT OF SELF PROCUREMENT AND THE MICROSOFT CONSENT ORDER

Introduction

Many Washington State insureds have been pitched the idea that an insured has the right to buy insurance from any insurer of their choice regardless if that coverage is sold locally and without regard to whether the insurer is licensed in Washington State. Many of these suggestions concentrate on the argument that local compliance is not required, as only the law in the place of where the insurer is controls for insurance compliance purposes. This is frequently called “self procurement”, “direct procurement”, or “independent procurement” interchangeably. This article addresses some of these arguments and authorities compared to Washington State regulatory treatment and Microsoft’s recent election to sign a Consent Order, paying back taxes and interest, and agreement going forward to be compliant with Washington State regulatory requirements.

Microsoft is headquartered in Redmond, Washington. Microsoft owns an Arizona domiciled captive insurance company named Cypress Insurance Company. According to Microsoft, from 2008 to 2018, Cypress underwrote $91,677,500 of premium directly from Microsoft in Washington to its Arizona based captive insurance company. [i]

From 2008 until 2018, Cypress Insurance Company did not remit any premium tax to Washington State until settling and agreeing to this Consent Order in 2018. Microsoft admitted to not placing coverage into Cypress through a surplus line broker until execution of the Consent Order, nor was an admitted insurance company utilized before 2018 for policy issuance purposes (“fronting”). [ii]

Cypress Insurance was the target of two regulatory matters in Washington State leading up to this Consent Order. [iii] One was an order from the Insurance Commissioner to stop insuring directly from Microsoft in Washington State to Cypress. [iv] The companion order was a self-generated regulator demand for an administrative hearing by the Insurance Commissioner to seek an order (through hearing) to obtain back taxes, interest, and penalties. [v]

Microsoft and Cypress, (through counsel) initially plead a number of defenses before signing the Consent Order. [vi] Arguments included defenses that Cypress transacts business outside of Washington State in Arizona, and thus there is no need for regulatory compliance in Washington State. [vii] Another argument made included the theory that if this captive insurer transacted business for its parent Microsoft in their home state of Washington, use of Cypress is “self insurance” and thus not within the regulatory grasp of Washington as the Insurance Commissioner’s authority is limited to “insurance” and not “self-insurance”. [viii] Microsoft also argued Cypress is not subject to insurance regulation locally since there is no insurance transacted due to lack of risk shifting, as the captive only exists for Microsoft and there was generally no selling the captive’s insurance coverage outside to unrelated parties. [ix]

Alternatively, if this is insurance, argument was presented (but untested) that interstate commerce protection based on McCarran-Ferguson Act of 1945 [x] and related case law grants Microsoft the right to buy insurance from any insurer, anywhere, under a theory of self procurement. [xi] In the end, however, none of these arguments were tested in an adjudicative proceeding or in a court of competent jurisdiction as Microsoft settled both orders with the Washington Office of the Insurance Commissioner in the form of execution of this Consent Order. [xii]

...

 

The balance of this article attempts to highlight self procurement and related arguments in light of the Cypress matter, along with related theories of insurance regulation for issuance of coverage in Washington State.

 

Mentioned above, self procurement of insurance is the notion that an insured is entitled to find and buy insurance from any insurer, anywhere, regardless whether the insurer holds a requisite license locally or the coverage is otherwise purchased in compliance with local law such as through a licensed surplus line broker. [xiii] The ability of an insured to self-procure insurance from any insurance company anywhere is often codified in law in many states with a permitted statutory method to self-report taxes due. [xiv] Washington State is not one of these states with self procurement statutory authority. In fact, the State of Washington takes the position that if any part of an insurable interest involves Washington State, then the entire transaction and all parties are subject to state law and insurance regulation. [xv] Many captive insurance companies and their service providers have made arguments similar to the ones made in the Cypress Insurance Company matters. As of the date of this publication, we are aware of no existing judicial challenge to assert these arguments in a court of competent jurisdiction or in an administrative hearing in Washington State.

Self Procurement Arguments Presented in Washington

Arguments have been presented that the Supreme Court’s 1962 opinion in Todd Shipyards upholding due process rights of an insured to buy insurance from any insurer anywhere trumps state law. [xvi] Washington regulatory treatment instead has indicated that subsequent judicial opinions have “eroded” Todd Shipyards, to the point that this case does not preclude Washington State insurance law. [xvii] No court we are aware of in Washington State has yet ruled whether the Insurance Commissioner is correct.

Some have argued that in addition to their Constitutional due process rights outlined in Todd Shipyards, Congress meant to specifically exempt captive insurance companies (such as Cypress Insurance) from “home state” insurance regulation (Microsoft’s “home state” is Washington) [xviii] The thrust of this claim of “captive insurance” being exempt from state law is because the Nonadmitted and Reinsurance Reform Act of 2010 (“NRRA”) lists only “insurers” and “reinsurers”, and not specifically “captive insurance” entities. The argument continues if Congress meant to include “captive insurance” it could have and would have done so, and therefore captive insurance is exempt. [xix] Central to this argument is an analysis of payment of surplus line taxes under the NRRA and the claim that captive insurance is not within included the terms, and by argument, it is silently excluded from regulatory oversight. [xx]

This argument that Congress intended “insurers” and “reinsurers” to not include “captive insurers” has not been tested judicially in Washington to our knowledge. Rather, the Insurance Commissioner argues that Washington law specifically grants the state jurisdiction as the insurance code covers any insurable interest touching the State of Washington. [xxi] Secondly, Washington State asserts if any part of the insurable interest is in the state, the insurer must be licensed as an insurance company, or be surplus line eligible as a nonadmitted insurer placed through a licensed surplus line broker, or otherwise exempt (more on this below), and if Washington is the “home state”, then all surplus line premium taxes are solely due to Washington State. [xxii]

It is worthwhile to compare the NRRA with Washington State law to look at arguments of self procurement and whether there are conflicts. For example, the NRRA defines self procurement (styled as “independently procured insurance”), but then defers to individual states to determine the jurisdictional authority. [xxiii] The NRRA specifically grants jurisdiction to the “home state” where “placement of nonadmitted insurance shall be subject to the statutory and regulatory requirements solely of the home state.” [xxiv] Stated above, Washington State takes a slightly broader definition of “home state” and indicates if Washington is the home state, and if the insurable interest in part or whole is in the state, the lack of any permissive authority for the insured to self procure insurance from a company that lacks a license or is surplus line eligible, through a licensed surplus line broker, renders the transaction in violation of state law.

Exempt Commercial Purchaser in Washington: Only Some Surplus Line Broker Requirements Removed

Under both Washington and federal law, there are some options for large insureds that meet the definition of “exempt commercial purchaser”. [xxv] The NRRA allows for an exempt commercial purchaser meeting the definition requirements as to size, amount of revenue, amount of insurance coverage premium, net worth, and use of a qualified risk management individual to independently procure insurance from a nonadmitted insurer. [xxvi] Washington State includes similar definitions as are found in the NRRA, but then Washington law specifically limits and restricts the exempt commercial purchaser to a reduction in the requirements of a licensed surplus line broker making a surplus line placement, and not the ability to self procure or place coverage with an insurer that is not surplus lines eligible. [xxvii] Washington State’s version of the exempt commercial purchaser reduction in regulatory requirements includes primarily the removal of the diligent effort requirement of the surplus line broker to ensure and certify that the surplus line coverage was placed where there not any licensed insurers willing to underwrite the risk and that surplus line coverage is not being purchased for a lower premium amount limited to when the insured meets the definitional requirements. [xxviii] All surplus line placements enjoy elimination of rate and form regulation required of admitted insurers in Washington, regardless whether the insured qualifies as an exempt commercial purchaser. [xxix]

Other Methods to Consider When Insurance Coverage Involves Washington State

Assuming the insured has insurable interests in Washington State, or the “home state” is Washington, there are other statutes that may be of interest to the reader to assist in lawful placement of insurance, even if self procurement is not available. For example, if it is ocean marine or foreign trade insurance, these are to a certain extent excluded from parts of the insurance code. [xxx] And if the insurance transaction is “wholly outside” of Washington, meaning there is no insurable interest in whole or part in Washington, and there is not a “home state” of Washington under Washington law and an analysis under the NRRA, then the transaction might be exempt from Washington regulatory compliance altogether. [xxxi] There are also some exemptions for railroad and aircraft operations and ownership. [xxxii]

The Federal Liability Risk Retention Act for risk retention groups and risk purchasing groups also could be a possibility for exploration. A properly formed and registered liability risk retention group enjoys federal preemption and a Washington state law corollary. [xxxiii] A liability risk purchasing group allows for reduction of certain rate and form regulation if properly organized and approved. [xxxiv] And there are also specific statutes for local government, affordable housing, and nonprofit risk pooling in Washington State. [xxxv] Health care sharing ministries are also afforded statutory protection. [xxxvi] And private air ambulances and rescue coverage when the insured is more than one hundred miles from home are also recognized under Washington law. [xxxvii]

Conclusion and Simple Decision Tree To Determine if Washington Compliance Should Be Examined

Self procurement for Washington State risks is not a settled right of the insured to buy insurance anywhere from any insurer. Judicial review of a claim of right to self procure from Washington would be a case of first impression for a court of competent jurisdiction in Washington State to render an opinion on state law validity compared to Todd Shipyards and related federal caselaw precedent. Great care and caution should be embraced by the practitioner trying to review whether an insured would be compliant to self procure any part of a Washington State insurable interest.

A simple decision tree for state law could be a good starting point. The first question to ask is if the transaction is insurance. [xxxviii] If so, then ask whether any part of the insurable interest touches Washington. [xxxix] If that is the case, then it is usually safe to assume Washington insurance law will apply according to the regulator, unless clearly exempt. [xl]

References

[i] See Consent Order 18-0356

[ii] Id.

[iii] See Order 18-0220 (Cease & Desist) and 18-0221 (Demand for Hearing to impose taxes, interest & penalties). Orders and related filings (including Demand for Hearing and Consent Order referenced below) may be found online at https://fortress.wa.gov/oic/consumertoolkit/Search.aspx?searchtype=ord

[iv] See Order 18-0220

[v] See Order 18-0221

[vi] See Demand for Hearing.

[vii] See Demand for Hearing

[viii] Demand for Hearing, (Citing Stamp v. Labor & Industries, 122 Wn.2d 536, 859 P.2d 597 (1993) for the principle that self-insurance is not insurance in Washington. And Wash. Rev. Code § 48.01.050, for the definition of “insurance”.)

[ix] Demand for Hearing, (citing Bordeaux v. Am. Safety Ins. Co., 145 Wn.App. 687, 186 P.3d 1188 (2008)).

[x] 15 USC § 1011

[xi] See Demand for Hearing,

[xii] Consent Order 18-0356.

[xiii] Self Procurement, Independent Procurement, and Direct Procurement are terms often used synonomymsly. A general definition is found at https://www.irmi.com/term/insurance-definitions/direct-procurement.

[xiv] Nearby to Washington examples include Alaska Stat. § 21.33, Idaho Code Ann. §41-1233, and Or. Rev. Stat. § 417.

[xv] Wash. Rev. Code § 48.01.020 (Scope of Insurance Code: “All insurance and insurance transactions in this state, or affecting subjects located wholly or in part or to be performed within this state, and all persons having to do therewith are governed by this code.”)

[xvi] See, Board of Insurance v. Todd Shipyards Corp., 370 U.S. 451, 8 S. Ct. 1380 (1962).

[xvii] The Washington Office of the Insurance Commissioner has previously cited Dow Chemical Co. v. Rylander, 38 S.W. 3d 741 (Tx. App. 2001) and other cases in support of this argument.

[xviii] See, White Paper Discussing the NRRA and Its Potential Application to Captive Insurance, McIntyre & Lemon, PLLC (Oct, 6, 2011), page 6. http://www.vcia.com/Portals/0/Files/Legislative/WhitePaperNRRAapplicationtocaptives100611.pdf

[xix] See, Id.

[xx] The NRRA is part of the Dodd-Frank Wall Street Reform and Consumer Protection Act codified at 15 USC § 8101.

[xxi] See, Cease & Desist Order 18-0220, citing Wash. Rev. Code § 48.01.020 (“All insurance and insurance transactions in this state, or affecting subjects located wholly or in part or to be performed within this state, and all persons having to do therewith are governed by this code.”)

[xxii] Wash. Rev. Code § 18.015.010 (Washington State has received payment for back unpaid premium taxes. Examples include orders 13-0332, 15-0231, and 17-0017).

[xxiii] NRRA 15 USC § 8101(c) and § 8202(a)

[xxiv] 15 USC §8202(a).

[xxv] See 15 USC § 8205, § 8206, and RCW 48.15.010(4)(a)

[xxvi] See 15 USC § 8206

[xxvii] See Wash. Rev. Code § 48.15.010(4)(a) and RCW 48.15.040 and RCW 48.15.043

[xxviii] Wash. Rev. Code § 48.15.043

[xxix] Wash. Rev. Code § 48.18.196

[xxx] Wash. Rev. Code § 48.15.160(a)

[xxxi] Wash. Rev. Code § 48.15.160(b) and Wash. Rev. Code § 48.01.020

[xxxii] Wash. Rev. Code § 48.15.160(c)&(d)

[xxxiii] The Federal Liability Risk Retention Act 15 USC §3901 et seq. and Wash. Rev. Code § 48.92

[xxxiv] Wash. Rev. Code § 48.92.070

[xxxv] Wash. Rev. Code § 48.64, Wash. Rev. Code § 48.62, Wash. Rev. Code § 48.180

[xxxvi] Wash. Rev. Code § 48.43.009

[xxxvii] Wash. Rev. Code § 48.01.280

[xxxviii] Wash. Rev. Code § 48.15.040, and Wash. Rev. Code § 48.01.060

[xxxix] Wash. Rev. Code § 48.01.020

[xl] See , Wash. Rev. Code § 48.05.030