Captive Insurance Industry Fears IRS Rule Change on Reserves

By | October 17, 2007

Captive insurance industry insiders say proposed changes to Internal Revenue Service rules could hurt the industry that in Vermont alone supports 1,400 high-paying jobs.

The IRS rules would end the deductible status of “reserves” kept by captive insurance companies — essentially money in the bank set aside to pay claims. The captives are so-called because they are subsidiaries of larger companies that have their parent companies as a sole customer.

Forty-two of the top companies making up the Fortune 100 have captive insurance subsidiaries based in Vermont, which set up its tax laws to favor their growth and began aggressively to market itself as a home for the companies in the early 1980s. Today more than 520 captive insurance companies operate in the state — mainly in Chittenden County — making it the national leader in the industry.

But there’s worry that the proposed IRS rules changes could make it more favorable for parent companies to set up their captives in Bermuda or the Cayman Islands, the other two main locations where the captive insurance industry has flourished, said Molly Lambert, a former state commerce secretary who now is president of the Vermont Captive Insurance Association.

“We think the impact could be that it would change the playing field. Right now if you were to locate a captive in an onshore domicile like Vermont, the playing field (with the offshore captives) would be even.”

She said the “initial impression” of industry tax lawyers and accountants who are studying the issue is that, “If the proposed regulation were to go through, that playing field could be altered.”

Lambert added, “I think the important thing to note is that it’s a proposal, it’s not a done deal. The industry experts are looking at it and will be formulating a formal response,” before the end of the IRS comment period in December.

Stephanie Mapes, a partner in the Burlington law firm of Paul Frank + Collins who has worked with the captive insurance industry, said a major corporation can deduct the premiums it pays to its own captive insurance subsidiary — a tax law provision unlikely to change.

She said what’s at stake is the captive subsidiaries’ current ability to enjoy another tax deduction on its reserves, just as commercial insurance carriers can do. For many of the captives, including those set up to serve some of the biggest corporations, that deductible status of the reserves would be lost if the IRS rules changes go through.

An IRS spokeswoman, Nancy Mathis, said of the issue, “We don’t have much to say at this point. We have proposed new regulations and we welcome comments.”

She also pointed to some agency literature saying the IRS had concluded it didn’t think the deductibility of insurance reserves should extend to companies’ insurance subsidiaries when they were mainly insuring other subsidiaries under the same corporate umbrella.

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