Unauthorized Insurance And Unpaid Premium Taxes in Washington State

The Office of the Insurance Commissioner of the State of Washington has issued an Order to Cease and Desist (“Order”), and a Notice of Intent to Collect Unpaid Premium Taxes (“Notice”), to Microsoft’s captive insurance company, called Cypress Insurance Company.

Both the Order and the Notice make similar allegations. Cypress has been an Arizona captive since 2008, and it only sells insurance to Microsoft Corporation, including its various subsidiaries and related companies. Microsoft, of course, has its principal place of business in Washington.

The Board of Directors of Cypress has five directors, of which four are also Microsoft employees in Washington. Similarly, Cypress has five officers and four of those are also Microsoft employees in Washington.

From 2013 to 2018, Microsoft paid $71,194,935 in insurance premiums to Cypress. However, Cypress did not remit any premium taxes to Washington (as the Insurance Commissioner claims that it should have), which would have been 2% of premiums, or $1,423,898 in total premium taxes.

It is further alleged that the risks of Microsoft which Cypress insures are located in Washington, and that Cypress neither has a license from Washington to act as an insurer in that state, nor holds a surplus lines broker’s license to allow it to place insurance in Washington.

The Order demands that Cypress quit selling insurance to Microsoft in Washington, and the Notice seeks to have Cypress fork over $1,423,898 to the Insurance Commissioner for the unpaid premium taxes.


The law in this area is dominated by a series of cases arising out of Texas, beginning with the Todd Shipyards case which made its way all the way to the U.S. Supreme Court and was decided in 1962. The opinions in three other cases, all decided by the Texas Court of Appeals, flesh out the law in this area.

Why Texas? Like many states, Texas imposes a premium tax on in-state companies when they purchase insurance from an out-of-state insurance company, known as the Independently Procured Insurance Tax (commonly known as the “premium tax”). Unlike the rest of those states, however, Texas has largely been the only state to have aggressively pursued the collection of those taxes, including against captive insurance companies.

As an aside, when Texas adopted its own captive insurance enabling legislation in 2013 and started to build its own captive insurance business, its aggressive stance towards the collection of the premium taxes seems to have gone into remission, as Texas then began to fear that captives domiciled in Texas would be hit with similar taxes in a tit-for-tat by other states. It would therefore be somewhat of a surprise were Texas to make law in this area again anytime soon. But, prior to Texas’ coming to the light, it undoubtedly did make the law in this area. Which is to say that the development of law in this area will now be left to those few remaining states such as Washington which have yet to adopt captive legislation or otherwise move their insurance laws out of the last century or the one before it.

Todd Shipyards

The majority opinion of Justice Douglas in the Todd Shipyards case came about because the Todd Shipyards Corporation, which was a New York corporation, was doing business in Texas but was purchasing its insurance from outside of Texas. The only connection that Todd Shipyards’ insurance had with Texas is that Todd Shipyards had property in Texas which was covered by non-Texas insurance policies. In other words, there Todd Shipyards did business in Texas and had a risk of loss in Texas, but nothing more. More specifically:

The insurance transactions involved in the present litigation take place entirely outside Texas. The insurance, which is principally insurance against loss or liability arising from damage to property, is negotiated and paid for outside Texas. The policies are issued outside Texas. All losses arising under the policies are adjusted and paid outside Texas. The insurers are not licensed to do business in Texas, have no office or place of business in Texas, do not solicit business in Texas, have no agents in Texas, and do not investigate risks or claims in Texas.

The Texas State Board of Insurance sought to collect the Texas 5% premium tax against Todd Shipyards. The Texas Court of Appeals held that the tax as applied to Todd Shipyards was unconstitutional, for reasons that I shall next explain, and the Texas Supreme Court agreed thus setting the stage for the State Board’s appeal to the U.S. Supreme Court and the decision of Justice Douglas, which affirmed the two Texas courts’ rulings.

The grist for the mill here is the McCarran-Ferguson Act of 1945, which left the regulation of insurance to the states, and not the federal government. The State Board argued that McCarran-Ferguson meant that Texas could regulate (and thus also tax) any insurance activities which basically touched Texas in any way.

But McCarran-Ferguson and the right of Texas to regulate and tax insurance activities has its own boundaries, and one of those boundaries is the Due Process Clause of the U.S. Constitution. U.S. Supreme Court decisions prior to the passage of McCarran-Ferguson had stated to the effect that, as recited in the legislative history of that Act:

a State does not have power to tax contracts of insurance or reinsurance entered into outside its jurisdiction by individuals or corporations resident or domiciled therein covering risks within the State or to regulate such transactions in any way.

McCarran-Ferguson did not change, or even seek to change this, and at any rate Congress could not through legislation have overridden the Due Process Clause anyway.

The upshot is that if somebody wants to go out-of-state to buy insurance on their in-state risks, they can do so without being subject to in-state regulation and tax on insurance. This is what Todd Shipyards did by purchasing insurance outside of Texas, even if that insurance covered Texas property. It was thus unconstitutional for Texas to impose its premium tax on Todd Shipyards in these circumstances, and the State Board lost.

But every case is only as good as its own facts, and the Texas Court of Appeals was in 1993 about to demonstrate this principle with great clarity.

Risk Managers International

In the Risk Managers International case, an insurance company in the Turks & Caicos called Corporate Underwriters, Ltd., would sometimes accept inquiries from Texas businesses which had heard about the company though industry trade journals or word of mouth, even though it was not licensed in Texas. In response to these inquiries, Corporate Underwriters would then call, fax or mail information to the Texas businesses. If they chose to buy the insurance, then the Texas business would cut a check to either Corporate Underwriters, or to Risk Managers International, which was a Texas company with its offices in Dallas, that acted as a third-party administrator (TPA) in which capacity it basically worked for Corporate Underwriters and investigated and resolved the latter’s claims. Later, the Texas businesses would be sent their Corporate Underwriters’ policy into Texas by fax or mail.

The Texas State Board of Insurance decided that Corporate Underwriters was conducting the business of insurance in Texas without a license, and that Risk Managers International was assisting them, and so sought an injunction against both companies to make them stop, oh, and also unpaid premium taxes, various fines, etc. The Texas District Court agreed with the State Board, as did the Texas Court of Appeals, the latter of which stated:

The facts of Todd Shipyards differ from those involved in the present litigation. The insured in that case was an out-of-state corporation, while in the present cause, the insureds were physically located in Texas. Corporate Underwriters sent insurance information to and negotiated contracts with prospective clients in Texas. Furthermore, in some instances, Corporate Underwriters received premium payments in Texas. The decision in Todd Shipyards does not prevent the State of Texas from regulating insurance transactions in which the insured is physically located in Texas during the negotiations leading to formation of an insurance contract.

We conclude that the statutes and facts involved in the present action are distinguishable from those in Todd Shipyards. The United States Supreme Court has never held that a state may not regulate transactions that occur within its borders. Therefore, we conclude that the State of Texas may regulate insurance transactions where an insured domiciled in Texas obtains insurance by negotiations occurring in whole or in part inside the borders of Texas.

The Texas Court of Appeals similarly rejected Corporate Underwriters’ and Risk Managers’ argument that the Due Process Clause kept Texas from regulating them or imposing premium taxes:

Appellants contend that the district court’s ruling violates Corporate Underwriters’ due-process rights under the Fourteenth Amendment. Specifically, they argue that the trial court’s injunction impermissibly interferes with their activities outside of the State of Texas. The power of the states to regulate the business of insurance must be kept within the limits established in Todd Shipyards. The due-process clause restricts a court’s power to render a personal judgment against a nonresident defendant. * * * A court, however, has the authority to render such a judgment if the defendant has established minimum contacts with the state. * * * For the reasons mentioned earlier, we conclude that the trial court’s judgment complies with the requirements set forth in Todd Shipyards and that Corporate Underwriters has sufficient contacts with Texas to meet due-process requirements.

The upshot of the Risk Managers decision is that if any part of the marketing or consummation of the insurance contract occurs in-state, then the state may regulate the entirety of insurance relationship even if the insurance company is outside the state. The more pragmatic might add that in these cases you can’t just mutter “Todd Shipyards!” and state regulators will flee.

Dow Chemical

In 2001, the Texas Court of Appeals decided the Dow Chemical case, which involved Dow Chemical as a Michigan company purchasing insurance outside of Texas for Dow’s risks on its Texas properties and activities. The Dow Chemical case was not brought by the Texas State Board of Insurance, but rather was brought by the Texas Comptroller of Public Accounts, i.e., the Texas taxman. The Comptroller audited Dow for the years 1991 through 1997 and then assessed the Texas premium taxes on Dow for those years, seeking $427,148.

Factually, this case was much closer to Todd Shipyards since the insured company was not itself domiciled in Texas but simply had some assets and operations in the Lone Star state. Thus, the Texas Court of Appeals:

The factual similarities between Todd Shipyards and Dow are also readily apparent:

In both instances the insurance in question covered property in Texas owned by a foreign corporation.
All of the insurers are domiciled outside of this state.
All of the insurance agreements made the basis of the tax were contracted for, signed, issued, delivered, paid for, and accepted out of this state.
None of the insurers has a permit or license from Texas to write insurance in the state and none of the insurers are subject to examination or subject to any control by this state.
None of the insurers has an office or agent in Texas.
None of the insurers investigated or adjusted claims within Texas.
None of the insurers ever solicited Todd Shipyards’ or Dow’s insurance business or policies within Texas.
None of the insurers communicated with either Todd Shipyards or Dow within the state.
All decisions relative to the purchase and renewal of insurance, extent and amount of coverage, the selection of insurers and confirmation of insurance contracts are made outside of Texas.
Under the policies, all losses are payable out-of-state and all premiums are paid out-of-state.

Very simply, because the Comptroller failed to prove that Dow Chemical purchase of insurance had violated any of these factors, the Comptroller was poured out (to use that quaint Texas litigation phrase for losing). But that case did leave us with this list of things that companies buying insurance from out-of-state should comply with if they want to avoid in-state regulation, and which were known thereafter throughout the captive insurance industry as variously the “Dow Chemical factors” or the “Dow Chemical test”.

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