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Wesley Sierk - Captive Expert Insights
February 03, 2009

The Captive Feasibility Study

The Captive Feasibility Study


Why conduct a feasibility study?


A feasibility study is important because it answers the essential question; “What will my return on investment be by using a captive?” Prospective shareholders of the captive should have a clear understanding of what to expect when their capital is used to establish an insurance company.

Once the strategic purpose for a captive has been established the feasibility study is conducted to determine the pay back period and rate of return on capital deployed and to answer the key organizational and operational questions that will have an impact.


What is contained in a feasibility study?


The focus of the study will depend on the motivating factors for establishing the captive. In general the feasibility study is a financial and risk management analysis that will always contain the following:


Assessment of potential risk to be insured

Actuarial report including premium rates, rating methodology and loss pick

Analysis of loss reserve requirements

Fronting carrier options/availability

Reinsurance options/availability

Consulting regarding capitalization requirements

Analysis of options for entity structure, formation and operation

Expense projections for various operational structures

Evaluation of appropriate domicile, both foreign and domestic

Overview of relevant tax considerations

Five year prospective financial statements

Dividend and/or profit allocation system


The study later becomes the business plan for the captive with actuarial support for the loss assumptions, a description of how reinsurance will function behind the captive and how much capital will be required to make the captive financially viable.


What does a feasibility study cost and how long does it take?


A feasibility study requires not just the retention, but coordination of actuaries, attorneys, public accountants, reinsurance intermediaries and captive managers. If the program contains only one or two lines of coverage and does not require fronting or reinsurance it is possible for the study to be done free of cost.  This is often contingent upon the client’s agreement to move forward with a formation if the program design meets their specifications.  (Maybe put this paragraph in a callout box)


More involved studies typically involve a retainer, which is paid to the captive management firm or actuarial firm that will be responsible for spearheading the work.  Depending on the scope of the project a study can range from $10,000-$100,000. 


Once a client information request is fulfilled it typically takes 4-8 weeks to complete a feasibility study for a single parent captive. If there are multiple companies or investors involved additional time may be required to collect data or for all parties to provide input, review drafts and make appropriate modifications.


What are the common mistakes companies make in evaluating a captive?


Having a feasibility study completed and forming a captive should not be overly time consuming or especially challenging from the business owner’s perspective.  If complete data is provided by the client and put in the hands of the right service providers the process can be a smooth and seamless one.  Despite this fact, many companies that would benefit from a captive and welcome the opportunity establish one miss out on the opportunity. 


Mistake #1:  Waiting until renewal time. 


It makes sense that a business owner would want to evaluate the cost of a captive in the context of what the renewal premiums will be in the traditional market.  Unfortunately, a businesses’ renewal period is the four weeks before the policy’s expiration date and is typically nothing more than a pricing exercise where one or more brokers attempt to negotiate the lowest premium.   


As you can see from the information above, a great deal more goes into the design of a captive and the actual premium paid to captive is only one consideration. 


Mistake #2:  Waiting until the end of the year. 


Many employers view the set-up of a captive as a great way to create additional expense items for the parent company, thereby reducing the amount of taxable income for the year.  For example, many trucking companies have sinking funds to cover collision on their fleet of trucks.  By establishing a captive and formalizing the collision coverage as an insurance contract the parent company can obtain a deduction for the premiums paid. 


Depending on the facts and circumstances of each company’s situation, this may or may not work.  Finding out becomes a challenge when the prospective captive owner waits until December or the month before the end of their fiscal year end to initiate the discussion. 


The rapid pace at which information must be provided and decisions need to be made often leads to everyone feeling rushed. 


Mistake #3:  Failing to clarify objectives and project scope.


This often happens when the client engages a provider that specializes in a single discipline.  A comprehensive feasibility study should have a thorough evaluation of domiciles, tax issues, actuarial analysis, fronting and reinsurance.  Steps should be taken to ensure that the report will cover all of these issues.  Clients should determine that the person or group they are hiring to do the study have the necessary resources to structure all of the components.  If this is not clarified up front it is possible that the client will end up with a report that has thorough examination of premiums and rating programs, but little or no discussion on the most suitable domicile.  Alternatively, the analysis may be content rich in how best to comply with IRS guidelines for tax treatment, but not address reinsurance pricing or available fronting carriers. 


For more information on captive’s and feasibility studies you can contact our office or go to www.takencaptive.com.

Feasibility Study