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WASHINGTON-The captive insurance industry is getting some high-powered help in its battle to convince the Clinton administration to drop a proposal that would make it more difficult for captive owners to take tax deductions for premiums paid to their insurance subsidiaries.

Vermont's U.S. senators-Patrick Leahy and James Jeffords-as well as Vermont Gov. Howard Dean, have written letters to President Clinton criticizing the proposal, which was included in a budget package the administration released in December, as poor public policy and urging that it be dropped from the budget package.

The administration is proposing that owners can take tax deductions for premiums paid to their captives only if less than 50% of the captives' premiums are generated from risks of "related persons" that own 10% or more of the captive (BI, Dec. 18, 1995).

That new standard would wallop both single-parent and group captives. The proposed 50% unrelated business threshold-an increase from a 30% unrelated business threshold set in 1991 by the U.S. Tax Court-would eliminate tax deductions for single-parent captive owners unwilling to significantly expand their captives' third-party underwriting.

Just meeting the 30% unrelated business requirement set by the U.S. Tax Court has been very difficult for captive owners, and trying to generate enough business to reach a 50% test would prove impossible for many captives, experts say.

Tax deductions for owners of many group captives also would be threatened. The proposed rules would eliminate tax deductions for group captive owners where those owning more than 10% of the captive's stock collectively produce more than 50% of its net premiums.

For example, a one-fourth owner of a four-member captive that draws its business equally from the owners would not get a tax deduction, even though 75% of the captive's business is unrelated to each individual owner.

In his letter to President Clinton, Gov. Dean says raising the amount of unrelated business a single-parent captive must produce in order for its owner to win favorable tax treatment could discourage the formation of captives in U.S. domiciles, which severely restrict captives' third-party business.

"This proposal is bad public policy as it would encourage companies to form captives in foreign jurisdictions which allow more 'unrelated' business," Gov. Dean wrote.

"As most foreign jurisdictions have less interest or capacity to monitor solvency, and captives with a large amount of unrelated business are less able to predict and control future losses, it also could lead to more captive failures," Gov. Dean added.

In addition, Gov. Dean wrote, the administration's proposal would undermine group captives, such as risk retention groups, by making it difficult for policyholders owning more than 10% of the captive to be able to deduct their premium contributions.

Sens. Leahy and Jeffords told President Clinton that raising the threshold level for premium deductibility to 50% unrelated business from 30% would have a devastating impact on the domestic captive industry.

The current threshold, the two senators said, is based on "widely accepted judicial precedents and expert evidence on the nature of insurance.

The administration's proposal, in contrast, is wholly arbitrary. It is not based on any expert judgment or evidence," Sens. Leahy and Jeffords wrote.

It isn't clear yet how much of an impact the letters from Sens. Leahy and Jeffords and Gov. Dean have had on the administration. An aide to Sen. Leahy said no official confirmation has been received on whether the administration continues to support its captive tax provision.

The provision, though, was not included in a brief summary of a more recent administration budget proposal, which some captive supporters say is encouraging.

"It is a positive development that it isn't in the latest draft," said Jeffrey Johnson, a partner with the law firm of Primmer & Piper in Montpelier, Vt., and a former commissioner at the Vermont Department of Banking, Insurance and Securities.

Others say the administration might withdraw the captive tax provision because of concerns of antagonizing Sen. Leahy, a Democrat, and Sen. Jeffords, a moderate Republican.

"The last thing the administration needs to do is incur the ire of two senators" who could be-except for the captive provision-potential supporters of its budget package, said Jon Harkavy, vp and general counsel in the Arlington, Va., office of USA Risk Group, a captive management company.

But Mr. Harkavy notes that summaries, by their very nature, don't necessarily include all provisions in a broader package and that the fate of captive tax provision still is not clear.

"I'm not sure that this issue has yet been put to bed," Mr. Harkavy said.