Proposed IRS Rules Alarm Captive Insurance Industry

Proposed Internal Revenue Service (IRS) rule changes could adversely affect an captive insurance companies, an industry that fuels more than 1,400 high-paying jobs in the state of Vermont, say industry onlookers.  
  
If enacted, the IRS rules would effectively eliminate the deductible status of the "reserves" held by captive insurance companies, which is basically money in the bank that insurers set aside to pay claims. The captives are named thusly because they are subsidiaries of larger companies whose parent companies are their sole customer.  
  
More than 520 captive insurance companies are based in Vermont (mainly in Chittenden County), which established tax laws to favor these companies’ growth and set out in the early 1980s to actively encourage captives to make their home in the state. Forty-two of the top companies comprising the Fortune 100 have captive insurance subsidiaries based in Vermont, making that state the national leader in the industry.  
  
However, according to Molly Lambert, a former state commerce secretary and current president of the Vermont Captive Insurance Association, the proposed IRS rule changed could make it more favorable for the parent companies to move their captives’ home base to alternate locations such as Bermuda or the Cayman Islands, the other two places where the captive insurance industry has prospered.  
  
"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." According to Lambert, first reactions of industry tax attorneys and accountants who are analyzing the proposed rule change are that "If the proposed regulation were to go through, that playing field could be altered."  
  
"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," she says, prior to the IRS comment period which ends in December.  
  
Clarifying what is at stake is Stephanie Mapes, a partner in the Burlington law firm of Paul Frank & Collins, with a long history of working with the captive insurance industry. According to Mapes, what captives are at risk of losing is their subsidiaries’ existing ability to take another tax deduction on their reserves, just as commercial insurance carriers are allowed to 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 are effected. Mapes says a tax law provision that is unlikely to change is one allowing a major corporation to deduct the premiums it pays to its own captive insurance subsidiary.  
  
Nancy Mathis, a spokesperson for the IRS, only commented, "We don't have much to say at this point. We have proposed new regulations and we welcome comments." Mathis also presented IRS literature concluding that the IRS believes the deductibility of insurance reserves should not extend to companies' insurance subsidiaries when they were mainly insuring other subsidiaries under the same corporate umbrella.