Feasibility studies should be carried out before captive creation, says expert

A captive expert has warned that a feasibility study should be carried out before the decision to form a captive is even made.

Lance Wallach, a legal consultant on life and captive insurance who has his own firm, said that it is important to carry out a feasibility study that looks at all aspects of the captive to valididate its viability and economics, as well as see whether the captive will meet critical tests for risk-shifting and risk-distribution.

“If for no other reason, a feasibility study that carefully documents the non-tax purposes of the captive (to distinguish it from a tax shelter masquerading as a captive) should be done, since the IRS on audits of captives routinely asks for such documents as part of its evaluation,” he said.

“A good captive feasibility study will go a long way in showing the IRS that the captive is founded on solid business economics and does not exist merely to try to save some bucks in taxes.”

Wallach also gave further advice on captives, warning that policies should be drafted properly.

“The policies underwritten by a captive should not be substantially different in their form than policies underwritten by any other insurance company,” he said.

A good captive manager will use modified standard industry forms to draft policies. By contrast, bad captive managers will draft simplistic policies that often omit key insurance contract terms or else unnecessarily expose the captive to lawsuits by third-party claimants.”

The recommendations came from a longer article written by Wallach warning of the pitfalls to be avoided when creating a captive.