In a stunning surprise to the captive industry, the Internal Revenue Service announced last month that it is withdrawing a proposed captive regulation that would have effectively eliminated a key federal tax benefit for insurers that cover other members of the consolidated group, included in a consolidated federal return.
This close call gives me cause to reflect on the tremendous growth of the captive market over the last 25 years, and its response to a similar threat in the 1990s.
When I began helping companies form captives more than 25 years ago, many single-parent captives had already been around for quite awhile, and group captives were in their infancy.
Captives were considered a very small segment of the industry, which at any given moment could simply disappear. To say the least, it was not considered by most to be a significant growth area.
At that time there were basically three major domiciles for captives: Bermuda, the Cayman Islands and the state of Vermont. There were a few insurance companies providing services to those brave pioneers, and a very limited number of insurance professionals who decided there just might be a career in this field.
When I say that an insurance company "provided services," it was not uncommon to find a department of a major insurer employing one-to-five people working in the captive market. They were just far enough out of the sight of senior management so that no one really knew what they were doing.
Early organizations such as Captive Insurance Companies Association (upon whose board I was privileged to serve), the Vermont Captive Insurance Association and other local domicile organizations also were small groups that really believed this was the future of the industry.
The IRS proposal brings back memories because our industry was similarly tested by a tax proposal forwarded by the Clinton administration to Congress in the mid-1990s that could have had similar, possibly devastating tax consequence for captives.
This proposal would have treated certain "insurance" transactions between domestic and foreign captive insurance companies and their large shareholders as "other than insurance" for certain tax purposes.
Adoption of this legislation would have had severe consequences for certain captives, and could have dramatically affected the growth of the industry.
To combat this, a loosely organized group called the Coalition of Alternative Risk Funding Mechanisms, or CARFM, was formed. It was composed of volunteers from the various captive organizations, and they solicited money from numerous sources to fight the proposal.
The sponsoring organizations funded what they could, and the group obtained domicile support as well. Very little of either was available, as the industry and its influence was much smaller.
In the end the tax proposal died for a number of reasons–not the least of which was the work of CARFM.
This group was a precursor to the industry's recent challenge. Within days of the IRS tax proposal, released in September 2007, every one of these now well-run and well-funded organizations sprung into action.
They sought help from the nearly 30 captive domiciles–which represent thousands of jobs and significant state tax revenue. They solicited help from every corner of the industry that similarly provide thousands of jobs supported heavily by captives.
They received immediate support from senators, congressional leaders and governors. They also requested, and I presume received, significant funding for those efforts in a very short period of time.
This immediate and sizable response to the IRS indeed served to thwart its proposal. There is no doubt this highly sophisticated, well-funded segment of the industry has come a long way in a short time.
Considering that in the early 1980s all alternate-market insurance represented about 18 percent of the industry, and that by most accounts now represents more than half, we should not be surprised at the changes that have occurred.
I have to say, it sure has been a fun industry to watch–especially now that it's obvious the good guys are winning.
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