The captive insurance community was taken off guard by a proposed federal tax regulation that would put captives in the same boat as pure self-insureds, but the alternative risk-transfer sector quickly rallied to fight back and try to head off the potentially devastating move.
As reported by Caroline McDonald, the IRS ambushed captive players, publishing its controversial proposal in the Sept. 28 Federal Register with no advance warning.
What might the change mean for captives? What difference does it make if captives are considered just another self-insured, rather than a separate risk-transfer entity?
Bottom line, those who set money aside in a self-insurance fund, or who choose to simply pay claims as they arise out of general revenue, cannot deduct a discounted reserve for estimated losses and expenses. That’s a huge advantage captives currently enjoy that the new IRS regulation would deny many such facilities.
If this sounds familiar, you might recall the IRS took a similar stand in 1977, and litigated for more than 20 years to defend that position. Observers note that enough cases were lost so that the agency finally conceded the point and allowed the deduction if the captive was properly structured and implemented.
What would happen if the latest IRS proposal is allowed to stand?
South Carolina Insurance Director Scott H. Richardson, in an Oct. 4 letter to U.S. Sen. Jim DeMint, R-S.C., warned that the proposed regulation would “create additional economic burdens on the commercial markets, driving many of these captive companies to offshore domiciles, out of business, or into economically unviable contracts.”
Robert H. “Skip” Myers, general counsel for the National Risk Retention Association, said the proposal would mean that “the vast majority of single-parent captives for large corporations will have to change their insurance programs.”
Leaders in the U.S. captive insurance market—which includes some 1,200 companies in 26 states throughout the country—realize their very survival as an economically feasible alternative risk-transfer option is at stake.
Thus, captive leaders aren’t taking the news lying down. The two largest U.S. captive insurance groups (the Captive Insurance Companies Association and the Vermont Captive Insurance Association) joined forces with about 60 other concerned members to form the Coalition for Fairness to Captive Insurers.
The new lobbying powerhouse “will move aggressively to coordinate an industrywide response to these proposed regulations and educate the IRS about the ramifications and unintended consequences of such a change,” CICA President Dennis P. Harwick told NU’s Ms. McDonald.
“Businesses may continue to use the captive insurance tool, but the U.S. industry would be significantly affected if this proposed regulation were implemented,” warned VCIA President Molly Lambert. Vermont is the top U.S. captive domicile and has much to lose in this battle.
VCIA and CICA officials hired a trio of high-powered law firms to craft the coalition’s response. The coalition was racing to submit arguments against the move to the IRS by Dec. 27.
Meanwhile, fellow “ART lovers” from four other captive groups last month marched up Capitol Hill to make their concerns known directly to Congress, including the Self-Insurance Institute of America and captive associations from Montana, South Carolina and the District of Columbia.
SIIA also led a group that met in late November with Treasury Department officials to plead the captive industry’s case.
SIIA planned to assemble a team of CPA all-stars and tax attorneys to draft a position paper to justify maintaining the status quo. The time frame, SIIA noted, was “the sooner the better—this is top priority for us.”
Given the fact that so many states have passed laws to cultivate a lucrative captive community within their borders, a lot of political muscle will likely be employed by local politicians and private companies to protect their turf and block the IRS proposal.
Whether or not they succeed could very well be one of the top-10 stories of 2008!
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