Captive Feasibility Study (CFS)

At several places in this book I've addressed the need for conducting a captive feasibility study ("CFS"). In its most basic form, a CFS answers two key questions: "Is a captive insurance company right for our business?" and "If yes, what's the right organizational structure?"

As you consider forming a captive, there are many issues that must be addressed before you, and your advisors can be fully prepared to recommend a captive formation to the board of directors. The CFS is structured to perform this function. Before we discuss the specific elements of a CFS, let's address some of the most frequently asked questions about this tool.

Common questions about the Captive Feasibility Study

1. Is a feasibility study the same as an actuarial report?
Although the actuarial report makes up a portion of the CFS, it is not the entire CFS. The actuarial report is prepared by the actuary to set an expectation of the potential losses an owner could expect in running the captive. The actuarial study may be the most important part of the feasibility study as far as determining the risks the captive should take, limits, and design of the policies, In addition to the actuarial report, the economic and organizational components of the captive are studied in the feasibility study.

2. What are the main purposes of a feasibility study?
The CFS-process helps companies clarify their risk-financing needs and expectations. It answers the question, "What will be my return on an investment in a captive?" A quality study identifies the potential advantages and the potential risks of running a captive and insures that a company considering forming a captive is financially ready to do so.

Above and beyond the financial aspects, the feasibility study will address the specific concerns of the business. The business owner may be concerned with the business aspects of paying claims, when to deny claims, and quite often, how do they maintain business relationships with customers who feel they have a legitimate claim against the client. They may find it helpful from a business perspective to be able to pay claims to maintain future business relationships.

3. Who conducts the feasibility study?
The CFS can be conducted by a company's internal risk management, accounting, finance and legal staff; it can be conducted by a commercial insurance broker who has expertise in the captive insurance industry; it can be conducted by an independent risk-management advisor experienced in developing captive feasibility studies. Typically, all but the very largest organizations will turn to outside expertise given the specialized nature of the captive insurance industry. But in most all cases, a combination of internal and external resources produce the best product. The internal risk management, financial and legal staff are in the best position to fully communicate the company's current risk profile and the external experts are in the best position to understand the captive markets, the effectiveness of various uses and structures of captives and the differences among the various domiciles.

4. What does a feasibility study cost?
If the CFS is conducted using external resources, the risk management advisor fee will typically range from $15,000 to $25,000 depending on the complexity of the organization and its goals. Additional fees often include those for legal, tax, and actuarial analysis.

5. Is a feasibility study required for getting licensed as an insurance company?
Most U.S. domiciles expect to see (or require) a feasibility study. This requirement is not as prevalent with offshore domiciles. Generally speaking, the insurance officials want to be sure that at least some level of due diligence has taken place before applying for an insurance license and a quality CFS is a good indicator

6. How long does it take to complete a feasibility study?
Depending on the complexity of the organization's business and goals and also depending on the ready availability of loss data, it usually takes between 4 and 12 weeks to complete a feasibility study for a single-parent captive. The initial draft report is often completed in the first 2 to 8 weeks. The drafter will then allow 2 to 4 weeks for all parties to review draft and make appropriate modifications. If there are more investors involved, for example in the case of a group captive, the CFS will almost certainly take longer given the added complexities of multiple parties, multiple loss histories and possibly differing goals.

7. Should I be concerned about confidentiality?
Sometimes, potential captive owners are reluctant to complete a feasibility study as a part of the license-application process because they are not sure who has access to the application information and they naturally want to protect their confidential financial and risk-profile information. Most domiciles recognize this concern and will often address it specifically by ensuring applicants that their information will not be made public. If this is not clear in the domicile regulations, it should be addressed early on in the process so that there are no surprises down the road.

To see an example of a CFS, click here.