The IRS secured a win in the Third Circuit against a Delaware state agency regulating the insurance industry in a recent decision that arose out of a microcaptive insurance investigation. In United States v. State of Delaware Department of Insurance1, a three-judge panel in the Third Circuit denied the Delaware Department of Insurance's (the "Department") motion to stay the issuance of the mandate enforcing an IRS summons pending the Department's petition for a writ of certiorari to the Supreme Court.2 As part of its initiative to examine microcaptive insurance transactions, which have been designated as "transactions of interest"3 and have found themselves periodically on the IRS's so-called "Dirty Dozen" lists4, the IRS summonsed information from the Department regarding specific entities involved in microcaptive insurance plans.5 The Department refused to comply with the summons, citing a state statute protecting the confidentiality of materials and information that captive insurers submit as part of the application and licensing process.6
Notwithstanding the conflict between federal and state interests and apparent uncertainty regarding the applicable test to determine which law takes precedent, the Third Circuit denied the motion to stay. The IRS's win has been held in abeyance, however, because the IRS agreed to abide by the confidentiality provisions of Delaware law until the Supreme Court rules on the matter if it so chooses. If the Supreme Court were to deny certiorari or uphold the Third Circuit's decision, state insurance regulators would have no choice but to turn over sensitive data involving insurers, insureds, and other participants in the insurance marketplace. Having issued proposed regulations on the subject as recently as April of this year, IRS initiatives to combat microcaptive insurance arrangements show no sign of slowing down.
Relevant Law
As noted above, this case arose from an IRS promoter penalty investigation of alleged promoters of microcaptive insurance transactions. As part of the investigation, the IRS issued a summons to the Department requesting insurance certificates of authority, testimony, records, and electronic mail between the Department and the alleged promoters related to the captive insurance program. Compliance with the summons would have contravened Delaware Insurance Code section 6920 which protects the confidentiality of such materials. Specifically, section 6920 provides that the Department is prohibited from disclosing certain information about captive insurance companies to anyone, including the federal government, absent the companies' consent, unless the federal government agrees in writing to keep the disclosed information confidential.
Generally, when a federal statute and state statute conflict, the state statute yields under the doctrine of preemption. The McCarran-Ferguson Act (the "MFA") provides an exception for circumstances involving the "business of insurance," in which case state laws supersede federal laws unless the federal laws also relate to the business of insurance.7 The MFA specifically provides:
(a) State regulation
The business of insurance, and every person engaged therein, shall be subject to the laws of the several States which relate to the regulation or taxation of such business.
(b) Federal regulation
No Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance, or which imposes a fee or tax upon such business, unless such Act specifically relates to the business of insurance: Provided, That after June 30, 1948, the Act of July 2, 1890, as amended, known as the Sherman Act, and the Act of October 15, 1914, as amended, known as the Clayton Act, and the Act of September 26, 1914, known as the Federal Trade Commission Act, as amended, shall be applicable to the business of insurance to the extent that such business is not regulated by State law.8
Courts have interpreted the first clause in subparagraph (b) to require three elements before reverse presumption is appropriate under the MFA (the "first clause requirements"): "(1) whether the state law is enacted 'for the purpose of regulating the business of insurance'; (2) whether the federal law does not 'specifically relate to the business of insurance'; and (3) whether the federal law would 'invalidate, impair, or supersede' the state law."9 Before analyzing the first clause requirements, however, the lower court determined that subparagraph (a) imposed a threshold question that courts must first assess before analyzing the first clause requirements: whether the challenged conduct broadly constitutes the business of insurance in the first place.
As a result, the Third Circuit considered whether the McCarran-Ferguson test should be applied and, specifically, whether there exists a threshold question of whether the challenged conduct constitutes the business of insurance.
The Court's Analysis
The order denying the motion to stay the mandate gave no details regarding the rationale for the court's decision; however, the court's opinion dated April 21, 2023 provides some explanation for the court's rationale. The court cited as precedent Sabo v. Metropolitan Life Insurance Co.10 and Highmark, Inc. v. UPMC Health Plan, Inc.11, prior Third Circuit decisions that applied the threshold question before proceeding to analyze the first clause requirements. Finding these cases binding, the court determined that the challenged conduct was the Department's refusal to comply with the summons without the federal government first signing a confidentiality agreement. It then considered whether such conduct constitutes the business of insurance under the threshold inquiry; it found the conduct was not "the core of the business of insurance" because it did not relate to the relationship between insurer and insured, the type of policy issued, or its reliability, interpretation, and enforcement. The court furthered that the conduct at issue could not reasonably be understood as involving another activity of insurance companies relating so closely to their status as reliable insurers that it must also constitute the business of insurance. Thus, the court held that the challenged conduct did not involve the business of insurance and the MFA did not apply, and as a result, affirmed the district court's decision to require the Department to comply with the IRS summons.
Conclusion
The summons power of the IRS is very broad and it is generally very difficult to quash a summons. The insurance industry is provided the unique benefit of reverse preemption when the conduct at issue relates to the business of insurance, but absent this showing, the MFA will not apply. In this case, the Third Circuit was unconvinced that the MFA had application in Delaware's case and therefore, the Department could not shield itself under this unique benefit. As noted above, the parties have reached an agreement pending a decision by the Supreme Court on a petition for a writ of certiorari or on the merits if certiorari is granted. It remains to be seen if the Supreme Court will take up the issue and give the MFA a broader ambit than the Third Circuit's interpretation.
Footnotes
1. United States v. Del. Dep't of Insurance, No. 21-3008 (3d Cir. July 18, 2023) (order denying the motion to stay the mandate).
2. Brief for Appellant, United States v. State of Delaware Dep't of Insurance, No. 31-3008 (3d Cir. 2021).
3. Notice 2016-66.
4. Dirty Dozen: Beware of abusive tax avoidance schemes, IRS (Apr. 3, 2023), https://www.irs.gov/newsroom/dirty-dozen-beware-of-abusive-tax-avoidance-schemes.
5. The entities involved with microcaptive insurance plans were not parties in the suit.
6. Del. Ins. Code § 6920.
7. 15 U.S.C. §§ 1011, 1012.
8. 15 U.S.C. § 1012(a)-(b).
9. United States v. State of Del. Dep't of Insurance, No. 21-3008 (3d Cir. Apr. 21, 2023) (precedential opinion upholding the district court's decision granting the petition to enforce the IRS summons).
10. 137 F.3d 185 (3d Cir. 1998).
11. 276 F.3d 160 (3d Cir. 2001).
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