Captive insurers have intense lobbying on their behalf underway in Washington this week against White House budget proposals that would significantly affect Bermuda's captive insurance industry.

At issue is President Bill Clinton's budget proposal, presented after he vetoed the Congressional budget package.

The White House has proposed that an "insurance'' arrangement between a captive insurer and any other person (related or unrelated) will be respected as a valid insurance arrangement for tax purposes if less than 50 percent of the captive's net written premiums are attributable to the insurance or reinsurance of risks of related persons.

Only if they meet that standard would amounts paid to the captive for the insurance or reinsurance of risks be treated as insurance premiums by all parties.

Amounts paid by unrelated persons to a non-US captive that fails to satisfy the 50 percent threshold would continue to be subject to the federal insurance premium excise tax. Amounts paid by related persons to such a captive would not be subject to the excise tax.

A captive that fails to satisfy the 50 percent threshold would not be eligible for tax exemption.

The proposal would be effective for taxable years beginning after December 31, 1996.

KPMG partner and captive insurance specialist, Mr. James Blankenship, said that there are a lot of captives that already are writing more than half their premiums in unrelated business. But he said there are quite a few that are not.

Mr. Blankenship said: "You have to have more than 50 percent of third party business in the captive, under this proposal, which is higher than what the courts had set, 30 percent.

"I have to consider the bread-and-butter captive, the grass roots captive movement, companies and groups of companies which are setting up captives to accomplish all the legitimate and bona fide business purposes that a captive accomplishes. They are the ones more likely to lose the benefits out of this.'' The effect for those who don't pass the 50 percent threshold, would be that related parties would lose a tax deduction on the premiums they pay to the captive, although they will be treated as bona fide business expenses that are otherwise deductible under general rules as risk management fees.

"Now what that does though,'' said Mr. Blankenship, "is it makes risk management income in the captives, without the benefit of reserves set up against it. So you are really accomplishing nothing. Because you cannot set up reserves, you are getting no deferral of income. There is no tax benefit.'' Mr. Blankenship said that the provision would also be contrary to the aims of the US Risk Retention Act which was enacted with the intent of encouraging groups to manage their own risks.

The proposal would not be bad news for everyone. For those captives which already have more than 50 percent third party business, it establishes a litmus test that US tax collectors would have to abide by. The IRS had previously refused to accept the 30 percent standard.

But Mr. Blankenship said that the proposal was unlikely to stand the test of scrutiny, with weaknesses on several fronts expected to be exposed.

"It's much too simplistic in approach. This is an example which shows how ludicrous this is.

"If you have two companies insuring exactly the same risks and the only difference is that one is owned nine percent each by 11 people, and the other is owned 11 percent each by nine people, then under this proposal one of them is an insurance company and the other is not.

"Any law that comes up with that result is just not appropriate. And that is just one of the ludicrous situations that will result from the proposal. I don't think this law is good for captives, because it is not good law.

"It's not something that will change captives as we know them, because captives are not established for tax purposes. That just happens to be one of the benefits, and this would just make it a little more difficult for some people to get that deduction.'' Those who don't, could simply modify their book by doing more third party business.

Mr. Blankenship is optimistic that the proposal can be defeated, especially because the courts have wrestled with the definition of an insurer for decades.

"We're working closely with captive groups in the US to simply have our views heard. We don't believe that this is even the appropriate place for a bill like this.

"Something that has this kind of broad-based impact on American business and competitiveness, so widely over an industry, should not be slipped through in a rushed bill.

"The budget is a rushed bill. They are about to enact another emergency spending bill and there is a big rush to get this budget settled.

"I can't help but think that within the US itself, this would cost more than it would save in taxes. It would cost more jobs, revenues etc. to the citizens of the US.

"For example, in Vermont, Hawaii, Colorado and Illinois, the captive states, they have a reasonable size industry which may be hurt by this. Plus, its going to hurt American business, because it is contrary to the more generous tax treatment of captives by the rest of the world.''