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The uh-oh moment came a day before Sept. 28, the day the Internal Revenue Service released a proposal to change how most domestic captives do taxes. The joint tax advisory committee of the Captive Insurance Companies Association and the Vermont Captive Insurance Association was finishing up a review of some "obscure" IRS ruling, recalled Dennis Harwick, CICA president, when it got word of this new issue. They learned the proposal didn't come from the IRS' insurance side, but from corporate consolidated returns.

"That's when the lights came on," said Harwick, an amiable veteran of the trade group business able to chuckle in the face of danger. "This is going to be a very intricate, complicated thing."

So let's talk upbeat--about how the captive industry rose up against the feds' surprising and seemingly capricious effort to prohibit captives from being able to deduct their discounted loss reserves. They could only deduct an incurred loss after its payment if the proposal passes. In effect, captives would become self-insurance funds.

You would think, right, the industry would put aside everyday competition and unite. Amazingly, it did--sort of.

"Sort of" because divisive voices could still be heard. The divisions weren't coming from familiar sources. It wasn't the nippy small domiciles versus the fat and happy big states, or the politically correct onshore domiciles versus vacation-destination offshore islands.

No, the split opened between big trade groups. On one hand, CICA and VCIA teamed up. On Nov. 12, they formalized their cooperation, forming the Coalition for Fairness to Captive Insurers.

CFCI, according to Harwick, includes "virtually all" other domestic captives (including Nevada, Arizona, Delaware, South Carolina and Hawaii); state regulators; single-parent captive owners; and the National Risk Retention Association.

On the other hand, the Self-Insurance Institute of America launched its own effort, along with the captive trade groups from Montana, Washington, D.C., and South Carolina.

Why the two camps?

At the SIIA national convention in Chicago this past October, where, inside the Sheraton, hundreds of attendees fretted about the IRS and Hillary Clinton rather than enjoy the Indian summer outside, Dick Goff, president-elect of the association, said that his group had approached CICA to tackle the IRS proposal together. But CICA gave SIIA the "cold shoulder," said Goff.

SIIA responded with we-don't-need-you-anyhow defiance. After all, said SIIA Executive Director Mike Ferguson, SIIA is the only alternative risk organization with an actively engaged lobbying group already on Capitol Hill.

VCIA and CICA countered that their partnership was a result, in part, of prior cooperation over tax issues. Their joint tax advisory panel, after all, had already been hard at work when the IRS side-swiped them with its latest edict in September.

Then again, the two big trade associations were the only ones capable of marshalling the needed resources, said Lambert, so they had to "spearhead" the effort. She added in late November, however, SIIA would be welcome to join CFCI if it wanted.

Thus, the coalition's shoulder, according to Goff in a Dec. 6 phone interview, was not so cold anymore. Yes, as the holiday season approached--and the Dec. 27 deadline for public comment on the IRS proposal loomed--cooperation between the camps finally coalesced, better late than never.

"There is a bonding happening, and it's wonderful," said Goff. "It's not a turf issue. Let's get our egos out of the way."

Goff admitted "total harmony" still didn't exist in their approaches, but between what SIIA was doing and what the coalition was doing, "we're covering all our bases." Harwick agreed, although the groups' tactics were different, their goals were the same.

"All of the organizations representing captives are on board with the same message," said Larry Smith, chairman, the Captive Insurance Council of the District of Columbia. Smith has lobbied with SIIA, but noted that the CIC-DC board also voted to support the VCIA efforts (though had not formally joined the CFCI as of this writing).

The parties were sharing intelligence as well. Harwick mentioned how the coalition's lead advocate on the political side, Jim McIntyre of the eponymous Washington-based law firm, had been in touch with SIIA's political folks.

SIIA's Goff recalled a recent phone call from Tom Jones, the legal guru from McDermott Will & Emery's Chicago office who was synthesizing the CFCI's technical response to the IRS. Jones asked for information on the "nuts and bolts" of a meeting SIIA recently had with the IRS and Treasury, a request Goff obliged. The president-elect said he'd be happy to continue sharing information, too, even when not asked for.

But SIIA would still not be joining the coalition. And, by the way, everyone get it straight?SIIA spearheaded the effort against the IRS, and its work on the matter is the most prominent.

Take that aforementioned SIIA meeting with the IRS and Treasury, which took place on Nov. 28. Or the lobbying SIIA and its partners did directly with Sen. Max Baucus, D-Mont., chairman of the United States Senate Finance Committee, and members of the House Committee on Ways and Means--the two congressional bodies that oversee the IRS.

"Our organization was the first to bring this up to those important members and groups," said SIIA Director of Government Relations Cliff Roberti. "We took the lead on it."

Great. But remember those resources that only the CFCI could muster? Harwick estimated that they had to ante up $350,000 just to get off the ground against the IRS. The funds were used to bring in the "best and brightest minds" in tax and captive law to create a technical response to the IRS' proposal.

This technical response, stressed Lambert, was critical, more so than any Hill lobbying efforts. The IRS, she said, has the authority to act without congressional approval. So it's more important to talk directly to the IRS, with the legal arguments its bureaucrats can understand.

Lambert used an analogy to illustrate:Lobbying efforts are the guns, but the technical efforts are the bullets. "A strong technical argument refuting the IRS will result in the withdrawal of the proposed regulation," said Lambert.

SIIA was not submitting such an important technical argument, as far as Lambert and Harwick knew.

But wait a second. SIIA said it was producing a technical response too--a better one. SIIA's technical paper will be "exactly what the IRS and Treasury wants," according to Goff. The CFCI's paper? Goff called it a more entertaining read, better suited to consumers.

The holes in the two sides' stories could simply result from communication between the groups that, although better, is not good. Or it could simply be that, despite increasing cooperation, prestige is on the line--as in, who best represents the industry?

In the past couple years, SIIA has made a push to be more inclusive of the entire alternative risk transfer industry, not just the world of self-insurance. And CICA, which touts itself as the biggest nondenominational captive association, and VCIA, the trade group for the largest onshore domicile, have obvious interest in maintaining their clout.

Whatever the reason, circumstances are grim. As Jeff Cassell, vice president of corporate risk management for Laidlaw International Inc., said during a trade show session on international captives, the IRS is basically saying, "Whatever you do, don't put your captive in America."

Laidlaw, the Naperville, Ill.-based bus company recently acquired by the British transport corporation FirstGroup PLC, has delayed plans for a Vermont captive until further notice from the IRS. John Constantine, global risk manager for Ernst & Young, revealed to Risk & Insurance® at another industry event that his U.S. operations also altered its captive plans because of the proposal.

Companies with existing domestic captives could start creating new offshore entities to transfer their onshore portfolios to, said Bob Davies, Willis senior vice president.

"It could bring a screeching halt to the economic development initiatives" that the captive industry represents in each state, said Goff. The IRS regulation would reverse all of the "inertia" currently driving offshore captives onshore.

Sure, it would only affect certain captives: namely, onshore single-parent captives and offshore captives taxed as domestics that are part of their parent company's consolidated return. Captives of tax-exempt groups, risk retention groups and captives writing 95 percent unrelated business won't be affected.

But this narrow proposal could lead to broader ones. Dan Towle, director of financial services for the Vermont Department of Economic Development, wondered where the IRS could go next. "Everybody has a vested interest in this," said the bespectacled former banker.

Of course, the industry could be laughing next year about all this danger if the Coalition for Fairness to Captive Insurers and/or SIIA succeed at keeping the IRS at bay.

"Hopefully," said Goff, "this will become a moot point."

MATTHEW BRODSKY is Web editor/senior editor of Risk & Insurance®.

January 1, 2008

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