Onshore US captives have won the latest tax battle, but the war isn't over yet, explains Jean-Paul Louisot.

The growth of the captive industry in the US is a major trend of the last two decades. This growth is largely due to a greater acceptance of captive insurance by the medium-sized corporations. They are largely responsible for the sustained growth as these regional firms are beginning to embrace the captive mechanisms as part of their overall finance strategy. That may be one of the driving forces behind the growing interest for “onshore” domiciles.

A large number of onshore US captive domiciles were represented at the 2008 Captive Insurance Companies Association (CICA) International conference, which took place in Arizona in March. The event attracted well over 500 participants.

What strikes the first timer from Europe is the number of states of the US represented with booths and participants. Of course the veteran, Vermont, offered the traditional Maple syrup and Hawaii the Macadamia nuts, however many western states were also there, including Nevada and the local rising star on its own territory, Arizona, home to several hundred captives.

A total of 30 of the 50 states have now enacted legislation to facilitate the incorporation of insurance and reinsurance captive companies on their books. The latest to join the band is Michigan, which had its new legislation approved while the conference was taking place.

“The proposed captive regulation would have eliminated a key tax benefit for insurers

Clearly, the latest trend in domicile choice is onshore. No wonder then that the proposed IRS regulation was fought tooth and nail by an alliance lead by CICA. The proposed captive regulation would have eliminated a key tax benefit for insurers that cover another member of a consolidated group, included in a consolidated federal return.

The tax benefit of incorporating an insurance company would have been wiped out and the reserves (especially the incurred but not reported) treated as a non tax deductible expense. Clearly this would have severely penalised the onshore domiciles.

The IRS withdrew its proposal even before letting it go into public hearings. It seems that the technical argument developed by the lawyers hired by CICA and associates convinced the tax authorities behind closed doors. In the words of Les Boughner, outgoing CICA chairman: “We have won a great battle, but the war goes on”.

Jean-Paul Louisot is senior director, Knowledge Resources at the Insurance Institute of America/CARM Institute.