Introducing: Ask Dana


Oxford is excited to bring you the first in the series of the “Ask Dana” column. We asked Dana Sheridan to join us for some discussions on hot topics in the world of captive insurance and are starting with the question:

“What is Insurance?”

Oxford:  How do you think the captive industry or Federal authorities should define “Insurance?”

Dana:  I think the key elements to any insurance transaction are (and in no particular order):

  • the contracts of insurance,
  • the presence of fortuity,
  • the existence of insurance regulation,
  • anticipated losses,
  • claims and actual losses,
  • premium payment as the consideration for the risk transfer under the contract, and
  • distribution of risk.

I think any definition of “Insurance” should place the insurance policies themselves as the seminal element to insurance or the “business of insurance.”  So, here is my shot at defining “Insurance:”

Dana Sheridan is an authority in insurance law and is principal at her own consultancy business, CIRA Solutions, LLC. She started her career as an insurance coverage lawyer in a law firm practice, but eventually found her way to captives and is based out of Los Angeles, California.  Dana has 27 years of experience in insurance, including corporate and regulatory compliance.

Insurance is an agreement to provide payment for amounts associated with covered claims against specified, contractually defined categories of future fortuitous losses or damages. Claim payments are made by an insurer. Insurers are entities licensed by an insurance regulator to transact the business of insurance. Consideration for the agreement to pay claims is a premium to be paid by the insured to the insurer.  Premiums are calculated based on anticipated probabilities of individual and aggregate losses that the insurer can likely bear. The main purpose of an insurance transaction is to transfer the risk of future fortuitous losses from the insured to the insurer. Risk is transferred under the insurance policy contract from the insured (who has the risk) to the insurer (who is willing to take the risk) upon consideration of an actuarially sound premium being paid to the insurer.

Oxford: Who should decide if something is “Insurance?”

Dana: Get ready for a mini history lesson here. In the United States, insurance is part of the financial services industry. But unlike the other two areas that are also part of financial services – banks and securities – insurance is regulated by the states and not the federal government. The idea that state, and not federal, regulators govern insurance dates back to 1868 when the Supreme Court found that insurance did not constitute interstate commerce and thus did not fall under the powers granted to the federal government under the Constitution. Paul v. Virginia, 75 U.S. 168 (1868). Chaos ensued in 1944 with the decision in United States v. South-Eastern Underwriters Association, 322 U.S. 533 (1944) which negated the states’ exclusive right to regulate insurance.  Congress acted swiftly on the heels of South-Eastern Underwriters to pass the McCarran – Ferguson Act of 1945 which codified and reaffirmed that the states are the principal regulators of insurance. Thus, as a matter of U.S. law, it has long been recognized that the regulation of insurance is of such importance to the states that it is under the exclusive authority of the states to govern and regulate the business of insurance. I think this means that it is insurance regulators who decide if something is “Insurance.”

Oxford: But, don’t states – or insurance regulators – all do things differently when it comes to regulating insurance?

Dana: Sure they do, all states have their own insurance codes, though frankly, captive code from state to state can be very similar.  Some examples of differences are, some states allow a certain type of policy as a permissible line of insurance, while other states would not allow that same policy line. State insurance regulators control all aspects of the structure, including policy form, pricing, reserves, etc., and oversee all responsibilities of the captive management company. In the captive context, this more than any other reason, is why you need a good manager with strong relationships with insurance regulators. But I think your point here is that if we have states that regulate insurance differently, doesn’t that also mean they define insurance differently?  Insurance people know insurance.  So, while states may conduct the business of regulating insurance differently, I imagine all could agree on what is – and is not – insurance.

Oxford: Any closing thoughts on Captive Insurance?

Dana: I am not a tax practitioner, nor do I give tax advice. With that said, and sounding a bit like Spock from Star Trek, I think that – as a matter of pure logic – any federal regulator, court, or agency, in attempting to answer the question of whether or not a captive is an insurer conducting insurance business, should not, and need not, start by attempting their own definition of insurance as that job has already been done for them. Whether or not a captive is an insurer is easily answered by whether that captive has a Certificate of Authority or license to transact insurance business in the state or domicile. Naturally, I am making the assumption that the insurance company conducts operations in a reasonable fashion and as such should be respected as a valid insurer. It would surely provide clarity and avoid the need for speculation if federal agencies would accept what a state regulator has decided that something is an insurance company, and conduct any tax – related inquiry from there, giving appropriate deference to what the experts have decided. Insurance regulators are experts on what is insurance or what is the business of insurance or whether or not policies are insurance contracts, with valid insurance terms and provisions.

If you have any questions you’d like to ask Dana, please feel free to submit them and we will do our best to fit them into a future column.