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Forming a Captive

In today’s highly networked world, companies of every size are often vulnerable to types of risk that were likely once seen as peripheral as recently as only a few years ago. These include surges in reputational risk, cyber-security risk, and even risks due to climatic as well as international events.

For these reasons alone, the formation of a captive should be a viable consideration or option in a company’s risk management strategy. Forming a captive is a tool that allows companies to effectively manage types of risk that are either difficult or impossible to insure in conventional insurance markets. In addition, if properly structured, a captive insurance company allows business owners to access the reinsurance market directly, reduce costs and even assist cash flow, since the premiums paid on risks insured through a captive are tax-deductible and can generate a profit.

Business owners need not be intimidated by a discussion of the feasibility of forming a captive. Doing so is often the best way to manage the enterprise risks that disturb the sleep of responsible ownership. There are no hard and fast rules regarding the amount of revenue a company should show to consider forming a captive. Importantly, forming a captive can be a straightforward and relatively easy process if owners are prepared to provide some very specific information.

Know thy client

Familiarity with the client and the level of detail provided will determine, not only merely the right captive structure, but how long formation takes. Initial discussions with owners can be as short as one week or can require months of dialogue. Because clients often leave captive formation as a Q4 consideration, the timeline most likely will be more condensed.

This base of knowledge will also go a long way toward determining the structure of the captive, and thus the legal requirements. A stand-alone structure offers ownership the greatest degree of control. A cell structure offers greater flexibility and reduced costs, but generally requires the assets to be held separately.

Finally, due diligence on all principal individuals must be accomplished prior to captive formation. It is critically important that the captive manager know the individuals, and the requirements for offshore jurisdictions are more rigorous than those of onshore domiciles. At
Atlas Insurance Management, we follow the best practices of the most diligent regulatory authority across the board. We do this not only to follow strict anti-money laundering regulations, but because it is the right thing to do.

Develop the Program

Once the structure and principals are known, it is time to commit to a process for determining the feasibility of managing the risks for the organization in question through a formal feasibility study for the chosen domicile. All captives typically engage an independent actuary for this purpose.

Determining feasibility involves full conversations between the underwriting department and the independent actuary which focus on the enterprise risks to be covered. These may include exposure to cyber risks, wind and flood, as well as key employee and supplier risks. This study, in addition to satisfying the requirements of the domicile’s regulatory body, provides the detailed information that allows the business owner to make an informed decision about whether to form a captive.

With the optimal level of detail, the feasibility study provides the foundation for the business plan. For each jurisdiction, there should be a separate business plan filed with the regulatory body, which provides a succinct yet detailed structure for exactly how the captive will run.

The business plan delineates, in detail, exactly and the types of risk the captive is insuring and the individuals being insured, as well as the key service providers and their responsibilities. In addition, the plan describes the capital investment requirements, premium amounts and how capital will be invested. In short, the business plan is the road map for how the insurance program will run.

This detailed information is now ready for submission. It is of critical importance that all completed materials are in the proper order and signed. In addition to the feasibility study, business plan and investment strategy, the application may call for an organizational chart, as well as biographical affidavits on all individuals. In the event that reinsurance is involved, expect requests for agreements and documentation for any company named in the application. Regardless of domicile, the application process can be expected to be both intensive and extensive.

Select the Domicile

Whether a stand-alone or cell structure is chosen, the selection of the domicile is critical, since it will require a resident manager who has a deep familiarity with the jurisdiction. Each jurisdiction has its own legal requirements and offshore jurisdictions have significant differences from onshore ones. Domiciles vary in their regulatory oversight, court and jurisdictional systems and corporate law. They also require a seasoned and respected captive manager who is a resident of the state or jurisdiction.

In addition, it is essential for the resident manager to know the local professional service providers. These can include auditors, tax preparers, legal resources and resident agents. The resident manager must have intimate knowledge of these essential providers to generate the most favorable risk management while also providing proper tax treatment, profitability, and legal compliance.

The Ins and Outs Of Approval

There is a reason for the level of detail. The complexity and responsiveness almost invariably determines the speed of the approval process. In a perfect world, the regulators review the submission and respond, after a few questions, with approval.

What typically occurs, though, is a bit more involved. It is not uncommon for the domiciliary regulatory body to respond with detailed questions that require the captive manager to correspond with the client. For example, expect any mismatches between the feasibility study and the business plan to elicit questions. Additional information regarding, for example, any point in the investment strategy or service provider may be deemed necessary.

Once the appropriate level of response has been achieved, a Certificate of License may be issued dependent, of course, upon the jurisdiction. Often, license approval entails acceding to various stipulations, which can include executed corporate documents, management agreements and other documentation. It is essential that these are handled in a timely manner.

Of course, the captive must be capitalized before it is up and running. How long the entire process takes, from feasibility and underwriting through approval, can vary greatly. While some delays often cannot be avoided, the speed of the process is rather more dependent on how quickly the client is able to focus clearly on providing the proper detail and organization to drive the approval process.

Each step in the formation of the captive can entail sub-steps. These may include details such as opening bank accounts, creating Employer Identification Numbers, further due diligence and more. Throughout the creation process, the seamlessness of the formation depends largely on the transparency and level of open communication between all involved. A client who is equally committed to the goal and to each of the steps to get there will be more apt to understand the timing and be more comfortable with the result.

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