The Elements of a Captive Feasibility Study

The first rule to follow in understanding the need for a captive feasibility analysis is the simplest one – if the analysis indicates that your risk financing program cannot be deconstructed, and then reconstructed, using a captive to your advantage, then the feasibility analysis should not move to the implementation phase.

The First Impression

A good captive feasibility study should start with a complete examination of your current insurance and risk financing programs.  Any good consultant can look at two things and learn a lot right away. These two things are:

·         your last audited financial, and;

·         your current insurance schedule.

There is no mystery about this – captives are all about need, premium volume, and the risk/reward of assuming balance sheet liability for insurance exposure you may not have had previously.  If your business is too small, financially unstable, and your insurance portfolio has insufficient premium volume, a good consultant should tell you that fast.  This should not be an expensive exercise. The truth in 90 minutes or less.

 
You Have 90 Minutes

to Tell Me the Truth

What Lines of Coverage Belong in a Captive?

OK – we’ll cut right through a few things for you – unless you represent a significant property exposure, property insurance simply doesn’t work in a captive for most moderate-sized commercial accounts.  The risk/reward exercise is weighted against success.  That is not to say that business interruption risks and certain property co-insurances can be effectively managed in a captive scenario.  The rule of thumb here is not to bite off balance sheet risk without a proportional recapture of premium…that can be hard to do with property insurance.

Also, let us betray some of our prejudices on this subject. The following lines work really badly in a captive program.

There are a few lines of coverage that virtually cry out for captive treatment; these are:

 There are other business-specific forms of liability that work very well in a captive, and you should leave your options open to other lines that may be beneficial to your business, and to a potential re-structuring under a captive formula.

Captives thrive on three things – if you remember these three things you will always make the right decision about captive feasibility.

1.       Claims Volume in Primary or Working Layers of Coverage:  captives operate like all insurers.  They pay claims.  Captives that don’t have an active claims-paying life are essentially investment companies and you can do better in the equities market with your money.

2.       Premium Volume in Primary or Working Layers of Coverage: if there isn’t enough premium income on the income statement, then reserves and G&A expenses cannot be offset, and it will take entirely too much investment income to offset underwriting losses.  Premium volume determines everything in our business.

3.       Access to Reinsurance: the best captives are the captives that directly access the reinsurance marketplace.  Businesses form captives to by-pass the insurance market in key lines of coverage and in difficult market cycles.  If you don’t plan to use the reinsurance market, you may have little long-term use for a captive.

Property Exposure In A Captive?

...It's Kind of Hard to Get Fired Up

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