Forming a captive insurance company: The feasibility study

By F Hale Stewart, JD, LLM, CAM, CWM, CTEP

The Law Office of Hale Stewart

Now that we’ve talked about who should form a captive, let’s move onto the process of forming a captive. The first step in captive formation is to perform a feasibility study. The best way to think of this is as a business plan for the captive. It will contain work from an actuary, a lawyer and an accountant and will include the following information:

An analysis of the current insurance policies

Here, the actuary and the lawyer are looking for the following things: the existing coverages, existing limits, holes in coverage and general contract terms. Most businesses already have a commercial general liability policy and if necessary some type of property insurance. However, the devil is in the details.

For example, one company that I formed a captive for had an existing employment liability policy with a $100,000 maximum payout. In the event of an employment liability claim, this ceiling was far too low and would barely cover litigation costs in a prolonged legal battle, let alone payout in the event of a loss.

Some employee theft coverages are written very narrowly; while they would probably cover petty theft, it’s possible they wouldn’t cover an advanced identity theft situation (at least, if I were advising the insurance company I would certainly make that argument). In short, an in-depth reading of existing policies from a legal and actuarial perspective often highlights potential policy and coverage shortcomings that can be addressed by the captive’s policy.

An actuarial analysis of the business

This is a central reason for the feasibility study. Part of the documentation requested from the potential captive owner is a history of insurance claims. The actuary combines this information with general industry information to develop an actuarial profile of the company from which insurance rates are derived.

A legal explanation of basic insurance law and regulation

Remember, a central goal of the feasibility study is to provide the potential owner with a road map on operating the captive. Since most owners have never considered owning an insurance company, it’s imperative to give them some insight into the legal environment in which they’ll be operating.

The report should also contain information regarding insurance company taxation. From a tax perspective, insurance companies operate in a slightly different manner. It’s important that the owners at least have a high-level view of these issues in order to be informed owners. The report should also contain an outline of several jurisdictions, explaining the pros and cons of each.

Accounting projections

Business owners like numbers; it helps them to quantify their decisions. Accounting projections simply place the captive decision into the broader corporate group context, and allow the potential owner to see the captive’s impact on his bottom line.

As you can tell from all the above points, there’s a lot of information to look at. And that’s really the central point. Remember, the client is forming an insurance company. They need to be given detailed information on all the relevant aspects of this endeavor in order to make an informed decision.