Nobody really knows what the IRS was thinking when it proposed a regulation with the potential to undo two decades of legislation and other brick-laying required to build the U.S. captive industry.

The regulation--1.1502-13(e), proposed on Sept. 28, 2007--would have eliminated the tax deduction for reserves established by captives for insurance sold to affiliates, if the insureds and insurer file in the same consolidated return.

The effect would have been to discourage new captive formations and perhaps send a number of existing captives offshore, undermining an industry that now encompasses about 30 states with captive regulations on the books. Also out the door would have been the infrastructure supporting the domestic captive industry, generating jobs and income critical to states such as Vermont, the top U.S. domicile.

Needless to say, the implications of the proposal ran deep and hit the captive industry hard. What's more, the industry was caught by surprise, unprepared.

But the captive industry was not about to leave the outcome of the IRS proposal to fate. In a mere three months time, the industry fortified the castle, filled the moat, and sent out the troops.

In other words, it regrouped--big time.

The two largest domicile organizations--the Vermont Captive Insurance Association and the Captive Insurance Companies Association--banded together in mid-November, inviting other domiciles and related groups to join the Coalition for Fairness to Captive Insurers.

The Coalition quickly gathered about 50 members and supporters, including the Arizona, Delaware, District of Columbia, Nevada and Utah captive associations; the Risk and Insurance Management Society; the National Risk Retention Association and Attorneys Liability Protection Society; large brokers Marsh, Aon and Willis; and big captive owners Johnson & Johnson, Sun Microsystems and Tyson Foods; along with captive management firms and other interested parties.

(For a complete listing of CFCI members and supporters, go to the bottom of this article on the NU Web site.)

Dennis Harwick, president of CICA--who co-chairs CFCI, along with VCIA President Molly Lambert--said CICA and VCIA agreed to backstop expenses incurred. And it turned out there were plenty--to the tune of about $300,000.

He added, however, that the Coalition received "significant contributions" toward covering that amount. "We were thrilled with how much support we got," he said.

The Coalition hired big guns McDermott Will & Emery through lead attorney Tom Jones, and Dewey LeBoeuf through lead attorney P. Bruce Wright, to handle the technical/legal response.

It also hired Jim McIntyre, principal of the McIntyre Law Firm in Washington, D.C., to coordinate the political response and convince the U.S. Department of Treasury and the IRS to drop the proposed regulations.

Next, various groups descended upon Washington to lobby members of Congress, including CFCI and the Self-Insurance Institute of America. For example, SIIA joined captive and domicile representatives to meet with Sen. Max Baucus, D-Mont., chair of the Senate Finance Committee, and with IRS and Treasury Department officials.

And that was just the beginning.

The IRS asked for comments by Dec. 27--and boy, did they get them. Individuals, groups and associations sent the IRS hundreds of pages of comments, describing the U.S. captive industry and detailing how the ruling would undermine the entire sector--to the detriment of commercial consumers. (See NU, Jan. 21, page 34.)

Wonder of wonders, the IRS issued a statement in January that "after consideration of these comments, the IRS and the Treasury Department have decided to withdraw" the proposed change. (See NU, Feb. 25, page 7.)

But even as corks popped in celebration, there was still one caveat: "However," the agency warned, "the IRS and the Treasury Department continue to study whether revisions to the rules for intercompany transactions are necessary to clearly reflect the taxable income of consolidated groups."

Ernst & Young insurance expert Jim Bulkowski said that while the IRS may have withdrawn the regulation, "it probably doesn't mean they won't look at individual circumstances, or that in the future they won't come back with another regulation or change in the tax code."

Bruce Zaccanti, also from E&Y, observed that the IRS never said "why they decided to challenge [the deduction] when they issued the ruling," leaving the question open for further review.

So while risk managers, captive managers, brokers, U.S. regulators and the entire captive industry have earned the right to celebrate, they may want to keep in mind the IRS doesn't give up easily, and that other battles will need to be fought.

So keep that castle fortified, the moat filled, and don't let the armor get too rusty.

As of Jan. 15, 2008, members and supporters of the Coalition for Fairness to Captive Insurers, which organized in mid-November to fight the IRS captive tax proposal included:

oAgrinational Insurance Company

o Alberici Contractors

o Ameren Services

o Attorneys Liaibility Protection Society

o Aon

o Arizona Captive Insurance Association

o Artex Risk

o Beecher Carlson Holdings Inc.

o Carlson Company

o CART Captive Assurance Company

o Champlain Captive

o Cooperative of American Physicians Insurance Company

o Council of Insurance Agents and Brokers

o CSX Insurance

o Delaware Captive Insurance Association

o Dorinco Reinsurance Company

o Embassy Insurance Corp.

o Energy Risk Assurance Company

o Groom Law Group

o Hawaii Captive Insurance Council

o HNI Corp.

o Hubbell, Inc.

o INS Insurance Inc.

o Johnson & Johnson

o Marquis Insurance Corp. (Marriott)

o Marsh

o Milford (Safeways)

o National Risk Retention Association

o Nevada Captive Insurance Association

o Nevada Department of Insurance

o Paul Frank + Collins

o Primer Piper Eggleston & Creamer

o Psychiatric Solutions Inc.

o Risk and Insurance Management Society.

o South Carolina Department of Insurance

o Specialty Transportation Insurance Company

o Spring Consulting

o Strategic Risk Solutions Inc.

o Sun Microsystems

o Titania Insurance Company of America (Wackenhut)

o The Steward Insurance Group

o Tyson Foods

o USA Risk

o Utah Captive Insurance Association

o Vermont Western Assurance Inc.

o Vermont, State of

o Wellpoint, Inc.

o Willis

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IRS Never Knew What Hit Them In Captive Tax Debate

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