Washington state allows companies to purchase two types of insurance: traditional policies through licensed insurers or specialized coverage for extraordinary or unfamiliar risks. In both cases, the companies must pay a 2% tax on the premiums paid.

But an unknown number of large Washington-based companies are self insuring using arrangements that fall outside Washington law. These “captive” insurance companies are wholly owned subsidiaries that help manage the parent company’s risk.

Now state lawmakers are considering legislation to tax and regulate the use of captives in Washington. A proposal backed by the Office of the Insurance Commissioner has alarmed some private businesses, whose leaders warn it could drive companies to adopt less rigorous forms of self-insurance or push headquarters out of state. An alternate business-backed proposal lacks necessary protections to mitigate potential risk, the OIC says. Lawmakers should craft a solution that takes both perspectives into account.

Captive insurance is a formalized method of self-insurance, used by companies and organizations to protect against risk that would be more costly or unavailable through commercial markets. In a pure captive, a parent company pays premiums to its captive — money that is invested and used to pay future claims. This federal tax-advantaged risk-financing instrument is distinct from traditional insurance, which transfers risk to a third party. In most states and in the eyes of the Internal Revenue Service, it is an entirely legal arrangement, provided the premiums are appropriately priced and policies protect against legitimate risk.

Washington is one of a minority of states without a law explicitly governing captives. For three years, the OIC has been pursuing enforcement actions against these unlawful insurers. Regulators have reached settlements with Cypress, a captive insurer for Microsoft Corp., and NW Re Limited, a captive insurer for Costco Wholesale Corp. They have ordered captive insurers for Alaska Air Group and Starbucks to pay back taxes and penalties — both companies are contesting. The OIC has set up a mechanism for companies to self-report this activity. This has revealed more than a dozen other captives. Because they are unregulated, there is no comprehensive data about Washington companies’ use of captives, but OIC officials say it is likely that most of the state’s largest companies use captives to insure against some types of risk.

The OIC-supported legislation, SB 6241 and HB 2291 would establish a legal framework allowing exempt commercial purchasers to use captives for specific types of insurance, subject to reporting and a 2% premium tax. A coalition of companies including Microsoft, Amazon, Starbucks, Alaska Airlines, TrueBlue and T-Mobile oppose the bill, saying it would place them at competitive disadvantage.

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Two industry-backed proposals, SB 6331 and HB 2493, are advancing through committee. These bills would levy a 2% tax on premiums covering in-state risk only, beginning on Jan. 1, 2020. The industry-preferred bill would require captive insurers doing business in Washington to register with the OIC, but agency analysts question whether the bill would allow for riskier forms of captives that have been flagged by the IRS for potential abuse.

While it is time for Washington to join states in permitting and regulating the use of captive insurers, these are legitimate issues that must be negotiated.

OIC should work with lawmakers to clearly articulate their regulatory concerns.