Contained in the President Clinton's $1.69-trillion budget are specific provisions that may impact Bermuda's captive insurance industry.

Provisions altering the definition of insurance by requiring the writing of more third party business, first raised by President Clinton in two unsuccessful budgets last year, have been resurrected again.

Experts in US tax law have conceded that if enacted, it would incur additional expenses, but the Bermuda market will prevail, because regulation here allows for companies to manage risk better than they could in the US.

The president will be pretty busy trying to sell a package of tax cuts close to $100 billion over five years, and tax increases to raise an additional $76 billion.

The US Treasury seemed to justify their reform treatment of captive insurance arrangements by claiming uncertainty under current laws as to when transactions with captives are considered insurance for federal income and excise tax purposes.

The IRS claim is that the uncertainty has encouraged aggressive planning and resulted in excessive controversy.

Under the proposals, insurance status would be denied for transactions between certain US and non-US captive insurers and their large shareholders. Large shareholders are defined as having at least a ten percent share holding.

Patrick L. Hackenberg, US tax specialist with Ernst & Young in Bermuda, explained that a captive generally would not qualify as an insurance company if more than 50 percent of its net written premiums were derived from insuring or reinsuring risks of its large shareholders.

Jim Blankenship, US tax specialist with KPMG Peat Marwick in Bermuda said, "It runs contrary to what everybody has come to believe was an already definitive set of guidelines laid down by the courts. That included the 30 percent standard from unrelated parties. There are a few other decisions which provided other opportunities for gaining insurance status.

"What's surprising about this provision is that it is really an over-reaction to a problem that a lot of people don't really think exists any more. There is no real uncertainty at the moment.'' Treasury documents cite the reason for the changes in clause 261 of the proposal: "The uncertainty under current law as to when transactions with captives are considered insurance for federal income and excise tax purposes has encouraged aggressive planning and resulted in excessive controversy. The IRS also has experienced difficulty in enforcing section 953(c), in part due to difficulty in obtaining information about foreign captives' operations.'' Said Mr. Blankenship, "We have court cases out there that everybody else believes have taken away the uncertainty. I believe their reasons are historical. They are out of touch. The uncertainty is in the mind of the IRS, not the taxpayers. They seem to be rejecting the widely accepted judicial precedents.'' He believes the document's draftsmen have missed the point behind alternative risk markets and that US business will bear the brunt of the economic fall out. He said, US firms will be forced to take on amounts of third party risks they really don't want, or forced to seek other avenues to cover their risks.

He said, "It puts the US even further behind a lot of the other developed countries in the tax status of these types of insurance arrangement.'' Mr. Blankenship argued that the IRS has blinders on, looking solely to the technical tax ramifications that someone is getting a deduction for something the IRS don't like. He said they should, instead, be looking at the major economic advantages and the major role that captives play in American business.

He said, "They believe in a very myopic way that a lot of captives get an unfair tax advantage.

Captive insurance industry keeps close eye on US budget "They think this allows them to apply a very simplistic, cookie-cutter approach to determine who is an insurer, and who is not. Unfortunately, they are dealing with the very complex business of insurance. It won't be so simple at all in the end.'' He said this will just make it more difficult for some companies to get a tax deduction, even though many of them do not see taxes as the driving force behind captives.

Mr. Hackenberg added, "This proposal met with no real support in Congress last year when it was proposed by the President. It has no real revenue increasing component. The US Treasury is just uncertain of what the US taxpayers are trying to accelerate deductions for these captive arrangements.

But as far as a revenue element, it doesn't do anything for the US government.'' He said, "Getting down to the basics, only insurance companies can set up loss reserves. You can't take from Peter to pay Paul, from one pocket to the next pocket, and then take a deduction for risk management within the United States. That's the whole key to risk shifting and risk distribution.'' In considering the proposal, Mr. Hackenberg said, "I don't think third party business is a good idea. It changes the economics of the risk management arrangement. They want that to happen, more third party business. But they don't understand how that changes the economics of the captive arrangement.

"The advantages of having captives here would still include the risk management benefits and the regulatory benefits of not having onerous reporting requirements and investment requirements.'' BUSINESS BUC