What Should a Captive Feasibility Study Contain?
While a captive insurance entity can provide many benefits, a solid business case must be prepared for owners considering its creation.
To provide the needed answers, an in-depth captive feasibility study must be conducted containing both an Actuarial Analysis and a Financial and Operations Evaluation.
1. Actuarial Analysis – This document quantifies whether the prospective captive owner is being overcharged by the commercial insurance market. Performed by a third party actuary, it consists of a detailed review of the prospective captive owner’s loss exposure information, historical loss patterns, frequency and severity of loss activity, and schedule of large losses. Three to five years of loss information must be analyzed, and complemented with related industry data.
The actuarial report will project both the premium to be charged and estimate the ultimate incurred losses under expected and adverse scenarios. This range of possible outcomes will be used to compute the appropriate amount of capital required for the captive to assume the risk being contemplated.
2. Financial and Operations Evaluation – This document determines whether a captive could best manage potential risk. Performed by a captive manager or consultant, it will review both the financial and industry information of the prospective captive owner. Typically elements include an organization chart, annual report, or financial statements; industry specific regulatory hurdles or barriers; a schedule of anticipated insureds and their current deductible (or self-insured retention levels); the current accounting and tax situation; and program philosophy.
Results should include pro forma financial statements for the captive; a net present value cash flow analysis of the captive compared to alternative options and status quo; a report showing the effects of the captive on consolidated earnings before income tax, interest, depreciation, and amortization (EBITDA); and a schedule of operation and other non-financial benefits or shortcomings of the captive program.
In addition to the above, a captive feasibility study should review one or more proposed captive insurance structures and include a comparison of captive domiciles and available ownership configurations.
With a well-prepared captive feasibility study, owners can decide if a captive makes sense for their organization. If a decision is made to move forward, the study will become the basis for the captive’s application with domicile regulators and its eventual formation.
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Wilmington Trust neither claims to nor provides legal or tax accounting services. Clients should consult professional tax and legal advisors regarding favorable tax treatment of any particular strategy.