Fast forward to 1980-81 when another insurance agent, Lincoln Miller, is seeking a domestic captive option for his client and approaches Vermont. George Chaffee, Vermont’s Commissioner of Banking and Insurance, takes a big risk for a traditional state insurance commissioner and, with the support of the governor and legislature, takes steps to develop Vermont as a captive domicile.

Vermont passes captive insurance legislation based on a model bill developed by the Risk and Insurance Management Society. It wisely sets up a self-financed and knowledgeable regulatory staff. Vermont effectively markets itself and begins attracting captives. An infrastructure of captive managers, auditors, actuaries and legal specialists quickly emerges. The Green Mountain State enjoys additional tax revenue from hotels, restaurants, airlines, etc.

In a process that mirrors the private sector, other states notice Vermont’s success and emulate it. Hawaii has reasonable success attracting captives from West Coast organizations. Washington D.C. competes with flexible regulation. Utah develops a niche for “831(b)” microcaptives. Today there are more than 30 states with captive laws.

Domestic domiciles now house over 2,000 captive insurance companies. The states have shown they can do more than compete with their offshore brethren if given an even playing field.

Changes in the federal income tax code in 1984 and 1986 were helpful in providing domestic domiciles with a more even playing field. Tom Jones, a captive tax expert at McDermott, Will & Emery, says that taxable captive parents now have a tax advantage in domestic domiciles (family owned businesses seeking “pass through” tax treatment may be an exception). But for tax-exempt captive parents (such as hospitals and healthcare systems) there is often a tax advantage in locating offshore.

For onshore captives the tax code allows a tax exempt organization to write only about 10% unrelated business before treating all captive income as taxable. In contract an offshore captive can write up to 50% unrelated business before all its income is taxable.

Many healthcare organizations are integrating clinical, financial and risk management services and want to provide a seamless professional liability insurance solution to unrelated healthcare providers. These organizations may find it advantageous to locate their captives in an offshore domicile. Clearly Congress could find a way to eliminate this unintentional but real bias against domestic domiciles. Doing so could allow onshore domiciles to compete on a level plane with their offshore brethren for this segment of the captive business.

Domestic domiciles do enjoy some advantages. Only domestic captives can write terrorism coverage while accessing reinsurance through The Terrorism Risk Insurance Program Reauthorization Act of 2007. And domestic captives can reinsure employee benefits covered by ERISA. Also, a group captive operating under the Risk Retention Act must be located in a domestic domicile.

What does the future hold for onshore domiciles? All captive domiciles, whether offshore or onshore, must continue to respond as new risks evolve. Over the last decade regulators have allowed captives to address terrorism and cyber risks. Perhaps captives can respond to increased weather related catastrophes by expanding capacity for natural disasters, including permitting more use of innovative risk sharing mechanisms such as catastrophe bonds. Or captives might play a larger role in health insurance financing if federal tax and regulatory impediments are addressed.

Domestic captive domiciles have come a long way from practically no presence to often being the best option, but they cannot rest on their laurels. There are too many competitors and too many risk financing problems to stand pat. States, with targeted federal support, have to look for additional ways to help organizations finance their risks. In a competitive environment, those states that wish to compete must adapt their captive legislation while simultaneously asserting effective oversight.

Even with these challenges, growth in new domestic captives will accelerate as organizations strive to finance emerging risks and more efficiently finance traditional risks. With some modest federal tax code and regulatory changes, the robust U.S. captive domicile market could play an even greater role in addressing risk financing challenges.