Third Circuit Upholds Ruling: Delaware Department of Insurance Must Comply with IRS Summons in Captive Insurance Probe

Issue Discussed: Whether the McCarran-Ferguson Act compels a finding that section 6920 of the Delaware Insurance Code, which requires the Delaware Department of Insurance to maintain the confidentiality of documents and information received from captive insurers, reverse-preempts an IRS summons seeking the production of such documents and information by the Department

Submitted by Michele Jacobson, Beth Clark

Date Promulgated: April 16, 2024

In United States of America v. State of Delaware Department of Insurance, the Third Circuit Court of Appeals affirmed the decision of the United States District Court for the District of Delaware, which held that the Delaware Department of Insurance’s (the “Department”) obligation to maintain the confidentiality of documents and information it receives from captive insurance companies pursuant to Section 6920 of the Delaware Insurance Code (“Section 6920”) does not constitute the business of insurance and consequently, an IRS summons seeking those documents cannot be reverse-preempted by Section 6920 pursuant to the McCarran-Ferguson Act (“MFA”).

This case arises from the Internal Revenue Service’s (“IRS”) investigation into Artex Risk Solutions, Inc. (“Artex”), and Tribeca Strategic Advisors, LLC (“Tribeca”), a wholly owned subsidiary of Artex, and specifically whether they were liable for penalties under 26 U.S.C. § 6700 for promoting abusive tax shelters via the establishment of captive insurance companies in Delaware.

The investigation spawned from two email chains between Artex and the Delaware Department that Artex had been compelled to produce to the IRS in response to two prior summonses that caused the IRS to question whether Tribeca was mass-producing “micro-captive” insurance companies to serve as illegal tax shelters for clients. The first e-mail related to the issuance of a certificate of authority to be issued by the Department to an Artex client, and the second involved a breakfast meeting between Artex and six Department employees.

Given its suspicions, on October 30, 2017, the IRS issued a summons to the Delaware Department for testimony and certain records relating to filings by and communications with Artex, Tribeca, or others working with those companies, including all emails between the Department and Artex and/or Tribeca related to the “Captive Insurance Program.” The summons defined the “Captive Insurance Program” as “any arrangement managed by Artex or Tribeca wherein captive insurance companies, defined by [Chapter 69 of the Delaware Insurance Code], provide either insurance and/or reinsurance.” At the time of the summons, the IRS believed that the Department had issued 191 certificates of authority to micro-captive insurance companies created by Artex and Tribeca.

In response, the Delaware Department issued written objections to the summons, which included an objection to producing responsive documents pursuant to Section 6920. Specifically, Section 6920 provides that the Commissioner of the Delaware Department must keep all portions of license applications reasonably designated confidential by an applicant captive insurer, and all examination reports, recorded information, and other documents produced or obtained by or submitted or disclosed to the Commissioner in connection with an examination confidential, unless the captive insurer provides consent in writing to the disclosure of this material. The statute includes exceptions to this requirement, including allowing disclosure “to a law-enforcement official or agency of the United States of America so long as such official or agency agrees in writing to hold it confidential and in a manner consistent with this section.”  Del. Ins. Law § 6920.

The IRS refused to agree in writing to abide by the confidentiality requirements of Section 6920; thus, the Department refused to produce any emails or other documents related to specific captive insurers created by Artex and Tribeca, and it refused to produce a representative to provide testimony.

As such, the IRS filed a petition in the United States District Court for the District of Delaware seeking to compel the Delaware Department to comply with the summons. In response, the Department argued that under the MFA, Section 6920 reverse-preempts the IRS’s summons.

The U.S. Magistrate Judge who initially heard the case recommended a ruling against the Department. Specifically, the Magistrate Judge concluded that in order for there to be reverse-preemption pursuant to the MFA, the “business of insurance” had to be involved, and it was not in this instance. The Magistrate Judge concluded that, in fact, the conduct at issue in the case was the Department’s maintenance and/or dissemination of information, documents, and communications and, therefore, the Department was required to produce documents in response to the IRS summons. The Department objected to the Magistrate’s Report and Recommendation before the District Court, but it, too, held that the Department was required to produce documents regarding the Captive Insurance Program on the same grounds – i.e., that the Department’s compliance with Section 6920 did not constitute the business of insurance.  Thereafter, the Department appealed to the Third Circuit.

The Third Circuit analyzed whether the MFA applied, focusing on whether the Department’s activity constituted the “business of insurance”. The Third Circuit relied on precedent from the United States Supreme Court which held that the “business of insurance” included policy issuance, fixing of insurance rates, the selling and advertising of insurance policies, the licensing of the companies and their agents, and activities of insurance companies that relate to their status as reliable insurers – i.e., the activity that impacts the relationship between insurers and policyholders. The Third Circuit emphasized, however, that under that same precedent, not all activity that impacts policyholders constitutes the business of insurance; the more remote the activity is from the insurer-policyholder relationship, the less likely it is insurance business.

As relevant to the case, the Third Circuit held that the Department’s refusal to comply with the summons is not the business of insurance because (1) it does not involve core insurance business such as policy issuance or activity that is closely related to an insurer’s reliability and (2) it cannot be understood to constitute other insurance activity that falls in the same class. Rather, the Third Circuit held that the conduct at issue was too removed from the relationship between the insurance company and the policyholder to constitute the business of insurance and fell in a different category.

With respect to the Department’s argument that captive insurers in its jurisdiction would be less forthcoming if Section 6920 does not reverse-preempt the IRS’s summons authority, the Third Circuit found it held no water. The Third Circuit concluded that because the Department will still be entitled to the same type and amount of documentation and information from applicants and established captive insurance companies, nothing would actually change. Accordingly, the Third Circuit rejected the Department’s argument that its adherence to Section 6920 constitutes the “business of insurance” and affirmed the District Court’s decision.