7 Ways Captives Provide Clients a Competitive Edge

A recent report from AM Best concluded that, based on their ratings, captive insurance companies outperformed commercial market carriers yet again in 2017. This finding was based on a hard look at balance sheet strength, operating performance, and business profiles of captives as compared to their commercial counterparts.

As long-time captive consultants, we’ve seen a range of clients benefit from a captive structure and are well-versed in their advantages. The AM Best report is a testimony to the positive role captives can play and how they’re able to provide a competitive edge to the organizations using them.  Some of the key advantages include:

  1. Homogeneous Risks

Whether a Single Parent Captive or a Risk Retention Group (RRG), the insureds of a captive are going to have similar risk profiles and diversity. A Single Parent Captive insures the parent company, so all its risks belong to one entity. RRGs are made up of like companies with similar missions and business products/services, such as a group of universities. In both cases, the homogeneity of risk will benefit the captive by establishing a certain level of predictability which helps with the consistency of rates and an unsurprising loss ratio.

 

  1. Underwriting Profit/Results

According to AM Best, the Captive Insurance Composite (CIC) experienced a 86.4% five-year combined ratio, while the Commercial Casualty Composite (CCC) had a 99.9% five-year combined ratio. Captives enjoy such underwriting profits for a number of reasons, primarily the fact that risk management, control, prevention and mitigation are all at the heart of the captive’s purpose. Organizations are able to benefit from their own good experience. Captives facilitate transparency and more access to data. This allows organizations to act in a proactive manner and implement risk mitigation and control protocols in an almost real time basis. Comparatively, a fully insured commercial market policy may result in a delayed information transition – most commercial insurance arrangements provide reports a quarter after year-end.  In addition, frictional costs are lowered with a captive.Captive Insurance Advantages

 

  1. Return on Investment

A major advantage that organizations with captives have over commercial carriers is the opportunity to recapture part of the premiums. Captives require capital infusion to start and get off the ground. The profits/savings from the insurance carrier accumulate in the captive and can, over time, begin to yield impressive returns on investment. Most feasibility studies use an internal rate of return or a hurdle rate to help visualize potential savings. This makes captives a great alternative for deploying capital and earning a consistently positive return on income, in addition to being able to use it strategically for reinsurance purposes.

Another pro of captives is the ability to evaluate their ROI evaluated against  their hurdle rate as their internal rate of return. A company can determine if an investment will give them adequate benefit or savings over a given timeframe based on their rate of return, and then decide if that investment is worth following through with, or if another solution is more economically sound.

These factors combined allow captives a healthy sum of capital and positive balance sheets.

 

  1. Competitiveness

Commercial carriers are sometimes unable to understand the true needs of the insureds and are limited in their offerings. Captives create competitiveness in the market and can compel commercial carriers to offer better terms and costs by virtue of a captive’s existence. In many instances, commercial carriers are threatened by the captive’s ability to take on all the risk and become willing to create quota share arrangements. Captives are a unique, tailored solution for the insured(s) and offer an unbeatable level of customization and very little changes in premiums. They have the ability to insure unique risks and are able to fill in the gaps of coverage where commercial markets are unable to do so.

 

  1. Enterprise Risk Management

AM Best defines Enterprise Risk Management (ERM) as, “establishing a risk-aware culture and using tools to consistently identify and manage, as well as measure risk and risk correlations.” An organization that utilizes a captive is likely to have a stronger ERM system in place, when compared to its captiveless peers, since it is partaking in its own experience and thus is more motivated to better manage its risks. In most cases, the captive is a vital cog in the ERM wheel. This close alignment allows for better results for both parties, and a lower total cost of risk for the captive.

 

  1. Retention

Many rated captives have a retention rate of 90% or higher. This is, in part, because policyholders are routinely rewarded through dividend payments from the captive that are significantly higher than any seen in the commercial market. These profits can be used in a multitude of ways to further benefit the captive. For example, policyholders could underwrite additional lines of coverage without the need for more capital, or provide premium holidays on programs, or fund FTEs.Innovative Insurance Strategy

This, combined with the lack of competition means that captives don’t need to shop around for business each year, creating savings in acquisition costs which can then be returned to the captive (e.g. in the form of loss control) to further benefit the insureds.

 

  1. Ability to Identify Emerging Risks

A captive’s structure and foundation in ERM gives it an added advantage of foreseeing emerging risks. Typically, all key stakeholders and the entire risk team of an organization will be involved in the captive’s management and activity. Having a strong alignment between the parent company, the captive, the IT team, the risk experts, the actuaries and other main players means that everyone is on the same page. A captive can make long-term assessments while also flagging and resolving issues quickly. There is no fragmentation of knowledge in a captive setup, and all stakeholders have the same interests. In sum, captives allow organizations to be nimble and react to changing market conditions quicker than commercial market carriers.

 

Conclusion

As AM Best states, captives performed well in 2017, as did RRGs, and it’s projected that success will continue into 2018 and beyond. The US captive market has grown substantially over the past few years, with domiciles like North Carolina and Hawaii experiencing an uptick in captive formation. Further, we’re seeing captives being used more frequently for nontraditional lines of coverage, such as cyber and medical stop-loss, adding to the list of use cases.

Captives are a great tool for insureds to create unique, custom-made solution in partnership with the commercial markets. They facilitate better management of claims – their expenses and adjustments – through accurate estimations.

Lastly, one of a captive’s most important attributes is its flexibility and ability to be swift and proactive, without the typical issues in a commercial insurance relationship.

Don’t Risk Missing These 3 Hot Topics from RIMS

RIMS 2018Each year, the Risk Management Society (RIMS) hosts one of the largest industry events. The annual conference and tradeshow brings together thousands of insurance and risk experts, and for the 11th year in a row, the Spring team was among them. We were happy to take a break from Boston’s not-so-springy weather and head to San Antonio for RIMS 2018.

Over the course of the 3-4 days, I was able to a) meet and greet insurance colleagues, both new and familiar, b) party like a true Texan (in case you thought Risk Managers would make for a dull crowd – you may want to rethink this notion), and c) get a gauge on the most popular industry trends and concerns.

For this writeup, I’m focusing on point C, because between various networking and social events, there was a lot to learn at the RIMS annual conference, and I’d love to share some takeaways. Here are the most buzz-worthy topics, in my opinion.

  1. Cyber & Tech

As it has with conferences and news headlines over the past 5-10 years, technology took center stage at RIMS. However, I’m using “technology” as an umbrella term to represent a range of digitally-centric, Internet of Things (IoT) subjects, such as:

a) Cyber

During Berkshire Hathaway, Inc.’s annual shareholders meeting, Warren Buffett Chairman, President and CEO said, “Insurance is very early in the game in determining how to cover the risk of data breaches, ransomware anCyber RIsk Mitigationd other hacking perils”. He then went on to say that the risk itself is a “very material risk” that didn’t exist 15 years ago one that will get worse. The world of cyber threats and attacks continues to keep risk professionals up at night. From my actuarial perspective, the probability and severity of cyber loss events are becoming better understood, although there still is tremendous uncertainty due to the rapidly changing nature of the risk. The following Cyber sessions were presented at RIMS:

  • In “Are You Prepared for a Cyber Extortion Event?”, audiences were walked through different ransomware threats and a checklist for getting through such an attack.
  • Jason Trahan went into further detail in explaining the “Anatomy of a Cyber Event Claim”, which provided a preparation process for cyber claims as well as an extensive list of possible claims expenses.
  • A representative from Willis Towers Watson highlighted the importance of corporate culture when it comes to combating cyber risk.
  • A woman from The Washington Post Risk Management team led a discussion on the different insurance policies that intersect when it comes to cyber risk, and how to manage these overlaps.
  • Jeffrey Sharer of EY revealed some startling statistics such as: “89% say their cybersecurity function does not fully meet their organization’s needs”.
  • Joon Sung and Kevin Kalinich stressed the importance of recognizing and addressing your third party/vendor cyber exposures, nothing that cyber resilience is not just an internal matter.
  • During “Pay Up or Else: Ransomware Risks”, John Coletti and Anna Ziegler explained the latest trends and scams in the ransomware sphere and offered advice on how to be both proactive and reactive.
  • One session focused on communicating a cyber attack to your C-suite, board of directors, and/or other superiors. Ten best practices were shared, such as: “Have a customer notification plan and procedures in place.”

b) Autonomous Vehicles

In March, a self-driving Uber car killed a pedestrian in Arizona, and an autonomous Tesla vehicle caused another death in California. These two incidents are just a couple of many news headlines involving self-driving cars, which certainly pose a variety of risks. As such, they were discussed on several occasions at this year’s conference.

  • In a session entitled, “Driving Insurance Forward”, Katherine J. Henry provided an overview of how autonomous vehicles are covered, the consequences they can bring and ways to confront this emerging risk.
  • Representatives from Liberty Mutual and Ford Motor Company teamed up to explain the different industries that will be affected by the rise in self-driving cars, from oil to advertising companies. Their presentation spoke to the broader trend of disruption in the automotive industry, pointing out 4 facets to consider: autonomous driving, electrification, connectivity, shared mobility/economy.

c) Social Media & Mobile Apps

Considering the recent Facebook privacy scandal, it was important to look at social media and mobile issues from the perspective of risk management and mitigation.

social media risk

  • Gregory Bangs of XL Catlin spoke to the topic of “Social Engineering”, which can incorporate a range of scams such as vendor impersonation and malware. He explained what these fraudulent activities can look like and their implications for insurance coverage and employee preparedness.
  • In “Swipe Right on Insurance”, Cort T. Malone and Stephanie Hyde discussed the risks and insurance options related to social media platforms and mobile apps, as used by employees. They covered things like harassment, privacy, reputation, business torts, intellectual property and the regulatory environment.

d) Wearables

  • Thomas Ryan highlighted the opportunity a “wearable” device poses from a workers’ compensation coverage standpoint and guided the audience on selecting a wearable vendor for corporate use.
  • Two experts from Modjoul Inc. and Cotton Holdings Inc. explained wearables in detail – why use them, how to use them, how they work with insurance carriers, etc. Through a case study, they also endorsed wearables as an option to keep employees safe and productive.

e) Drones & Other Tech Matters

  • Chris Proudlove of Global Aerospace and Vincent Monastersky of Fox Entertainment Group presented the challenges and opportunities associated with the widespread growth of drone use, both commercially and personally. It turns out, over 75% of drone-related claims were caused by operator error. Further, they outlined coverage types and options.
  • A session on emerging technologies, including smart sensors, wearables, drones and artificial intelligence gave audiences a broad but detailed landscape of how all of this connectivity affects the “risk ecosystem”, and tips on drones business riskhow to prepare for the future.
  • Another discussion, led by Tim Yeates, covered the “Fourth Industrial Revolution” and the benefits and risks of the level of information being shared today. Thought-provoking questions like, “Who do we trust – human intelligence or artificial intelligence?” were posed.
  1. Natural Disasters

In 2017, the U.S. was hit hard with Hurricanes Maria, Harvey and Irma as well as wildfires in California. Outside the U.S., the Caribbean was crushed with those same hurricanes, a devastating earthquake hit Mexico, extreme flooding impacted areas like Bangladesh and Sierra Leone, and areas of China suffered from landslides and typhoons. Unfortunately, this is not an exhaustive list.

As risk professionals we need to look at these occurrences from a different lens, so it was no surprise that the word “catastrophe” was rampant at the RIMS 2018 conference.Catastrophic Loss

  • Stephen Moss explained the anatomy of a catastrophe risk model and pointed out the large protection gap, noting that about 50% of the losses incurred from 2017’s most impactful natural disasters were uninsured.
  • An attorney from McCarter & English, LLP focused on business interruption losses resulting from catastrophic loss, discussing pitfalls that could cause your claims to be undermined as well as best practices for getting coverage.
  • Robert Nusslein of Swiss Re explained parametric natural catastrophe insurance for hurricanes and earthquakes, how it differs from traditional insurance and how it can help fill in gaps.
  • In “The Future of Climate Risk Management”, audiences learned about their company’s climate risks – the size, scale, complexity and reach. Then, the speaker introduced solutions and tools for such risks.
  • James Pierce spoke on “Mother Nature’s Onslaught” and speculated on whether a new norm is needed in combatting natural disasters.
  • One session, “The Sky Fell”, went into further detail on catastrophic claims: common claim mistakes, communication issues between layers of insurance, crisis management tactics, TPA management and more.
  • The CEO and Founder of Orbital Insight, a geospatial analytics company, outlined how technologies like satellite and drone imagery as well as AI and cloud computing can provide insight into catastrophic risk assessments. He even showed audiences imagery showing flood detection for Hurricane Harvey, as one of several illustrations.
  1. Compliance

Compliance is always a key concern in this industry. What changes year to year are the specific areas of compliance focus, some of which are below.

  • Lisa Kerr and Bruce Wineman led a session on multinational program compliance – highlighting regulations, tax law, offshoring and variability as things to look out for.
  • A different presentation focused on Medicare and Medicaid compliance, going over the boatload of associated acronyms, lien compliance, reporting and what to look for in a partner.
  • In “Risk Management, Compliance and Preparedness”, attendees received an overview of SRM and ERM, examples of strategic risk, automation advice and more.

 

If you were able to make it to the RIMS conference this year, I hope this helps you retain they event’s key takeaways. If you couldn’t make it to San Antonio, well, now it’s almost as if you were there!

Please feel free to reach out with any questions, actuarial or otherwise. In the meantime, put RIMS 2019 on your calendar – April 28th – May 1st – in Boston (our backyard). We’re already excited for it!

Spring to Sponsor RIMS 2018 Annual Conference

RIMS 2018

Spring team at RIMS 2017

It’s been a busy conference season for us here at Spring, and it’s not over yet! We are excited to be sponsoring and exhibiting at this year’s RIMS (The Risk Management Society) annual conference in San Antonio, Texas from April 15th – 18th. Spring has been actively involved with the RIMS organization for over a decade and we are pleased to continue this partnership. Further, after having just endured three Nor’Easters in a two-week span, we are ready to pack our bags for warmer weather!

The event boasts an incredible turnout each year, and we’re sure this year will be no exception with an expected audience size of almost 3,000. This ties in well with the 2018 theme, “Go Big.” RIMS is one of the best events for risk managers to network, learn and share ideas. The four-day conference combines a good mix of work and play and brings an impressive list of talent when it comes to speakers and content. We’re particularly excited to see Jay Leno!

If you’re reading this, there’s a decent chance you will be at RIMS too, so please don’t forget to come say hi to us at booth #753. We’ll have giveaways, raffle prizes and more, and we’d love to chat with you!

Watch the Webinar: Time for a Captive Checkup?

Most of us stay on top of things like dental cleaning appointments and routine car maintenance without giving it much thought, but we’re afraid a lot of companies aren’t treating their captives the same way. Our team recommends regular “captive check-ups” every few years for a variety of reasons, and have a clear, proven system for taking organizations through this refeasibility process.

Spring Partner and Chief Actuary, Steven Keshner, along with our Senior Actuarial Consultant and property & casualty expert, Peter Johnson, led an educational session on captive optimization through

Captive Optimization

refeasibility studies. With a combined 40 years of experience in the insurance, actuarial and captive industries, the two have a wealth of knowledge to share, and we wouldn’t want you to miss it.

Fill out the form below to view and listen to our webinar, “Time for a Captive Checkup?” which was conducted live in September of 2017. You’ll take away valuable learnings, such as:

  • The importance of refeasibility and the different factors that make it necessary
  • A recommended, step-by-step refeasibility process including suggested strategies, modes of measurement, and how to piece everything together
  • Questions to be answered through your captive check-up
  • Resources for getting started

 

Your Captive is Riding High. Now What?

captive refeasibility studyYou’ve had your P&C captive for years and it has continued to perform well throughout. So what is next? How do you capitalize on this success and build on your captive or rebuild an underperforming aspect of it?

Enter refeasibility.

Much like your family car, a captive should have a check up on a periodic basis. Are you writing the right lines in your captive? Are you in the right domicile? Would a different structure be more profitable? Would other service providers make a difference? Have your claims changed significantly? Have regulations changed over the years? All this and more can be answered with a good review of your captive by a professional consultant.

Related Case Study: Captive Refeasibility Study for Fortune 500 Organization

Here are a few things to consider as you ponder a refeasibility study:

Domicile:

The Dodd Frank Act changed the landscape for a lot of captives.  Rather than incur a self-procurement tax for risk out of state, some captive owners are redomesticating their captive back to their corporate home states or establishing a fronting captive in that domicile to lessen the premium taxes due.  An additional dimension in captive domicile selection is the enormous growth in U.S. domiciles. Countless states have recently set up new domiciles and there are still many quality offshore options. You’re pretty sure you are in the right spot, but a “refeasibility” might show you otherwise.  For example, some states have created innovative cell legislation that might work for you or your clients. Some assets held in the captive maybe more liberal, so depending on what you are using for collateral, states need to be studied for the best match.

P&C Programs:

Ten years ago there were pretty much only large P&C captives writing pretty much only property, general liability and workers compensation and occasionally a rouge auto or warranty program. Captives stuck to high deductible programs and some small quota share coverages to fill out a line slip.

Today, you can write almost anything that is an insurable risk and makes good business sense.  You still can’t write lines of coverage that just don’t make sense (like tidal wave coverage in Kansas), but you have a great deal more flexibility and room to be creative in how you define and insure your risk.

Contingent business interruption is sometimes an uninsurable or underinsured risk, and a good candidate for the captive.  Some use their captive to front their global or international property program, selling off pieces out the back and taking a nice fronting commission for themselves: the market would have gotten this if they didn’t.   Others write business specific coverage like lost in hole drill coverage for oil companies.

Cyber Risk:

Cyber risk is another good candidate for a captive. Cyber insurance in a captive insulates an organization from the market becoming less competitive in the future. It also gives a captive owner a great opportunity to diversify their existing captive portfolio. The captive can also be used to provide coverage that might not be really available in the market, such as future lost revenue of first-party loss of inventory due to technology failure.

Benefit Programs:

Now we have benefit programs that are really taking off as captive programs.  Prefunding retiree medical, group term life, medical stop-loss coverage, foreign coverage are just a few of the programs that make sense to add to the captive portfolio. And with some of these programs, the premiums qualify as third-party business and may boost your captive returns with a positive tax affect.

Additionally, for U.S. employers, the regulatory hurdles to funding ERISA-covered benefits in a captive have never been lower with the renewal of the expedited process for securing a prohibited transaction exemption. Couple that with the growing costs (and concerns) surrounding the Affordable Care Act in the U.S. and now is clearly the time to at least be considering funding benefits in your captive.

Find out more about funding benefits in a captive here.

Conclusion:

Regardless of how old or new your captive is, there are a number of internal and external factors that have changed since it was created. Now is a great time to have a professional come in and not only take a snapshot of how your captive is currently performing, but also help you project and strategize where your captive should be in the future. Now is a great time for a captive refeasibility study.

If you agree that it is time to re-evaluate your captive, Spring is poised to step in and help out. Our team of captive consultants, actuaries, underwriters, strategists, accountants and lawyers have decades of experience helping companies similar to yours not only set up their captives, but also conduct through and thoughtful refeasibility studies, which have helped our clients realize continued success with their captive.

Find out more about Spring’s Spring CARE captive optimization product and related services here.

Please contact us using the form below if you’d like to chat with a member of our team about your captive’s current and future performance.

Webcast: A Look at How and Why Colleges are Funding Health Insurance Using a Medical Stop-Loss Captive

medical stop-loss captive

Recently, Spring Senior Partner John Cassell presented a session on colleges funding health insurance using a medical stop-loss captive. The session covers how to create a medical stop-loss captive, the economies and efficiencies that can be achieved and why colleges and universities should have this on their radar.

In this webcast, John is joined by Spring Partner Teri Weber and Tracy Hassett who is Vice President, Human Resources at Worcester Polytechnic Institute in Worcester, Massachusetts.

Worcester Polytechnic Institute is a member of Ed Health, a successful example of a group of colleges and universities that banded together to form a captive to fund their medical stop-loss coverage. Ed Health has completed its first year and is already generating significant savings for its expanding base of members.

Photo by 401(K) 2013

IRS Revenue Ruling 2014-15: More Opportunity to Fund in a Captive

IRSBy: Tom King and Josepha Conway

For companies that provide retiree benefits, administration and funding tend to be dually burdened by the requirements imposed by the Employee Retirement Income Security Act (“ERISA”) and the often significant financial reporting standards of the U.S. Generally Accepted Accounting Principles (“GAAP”).  Adding further to the burdens are the significant cost increases over the last decade, primarily as a result of lower discount rates.  As a result, plan sponsors are faced with the difficult decision of choosing between reducing or eliminating retiree medical benefits.

Luckily for sponsors of retiree medical plans, a potential solution exists that promises to add financial efficiencies, while potentially lowering costs and lowering cost volatility.  That solution is a captive insurance company writing a fronted Trust Owned Health Insurance (“TOHI”) Program, which according to the May 9th, 2014, Internal Revenue Service (“IRS”) Revenue Ruling 2014-15, may be just the right mechanism for funding retiree benefits.

Previous State:

Plan sponsors have traditionally funded retiree medical benefits through pay-as-you-go funding (paying current retiree benefits without any advance funding) or through one of the following funding vehicles:

  • -Voluntary Employee Beneficiary Association (“VEBA”)
  • -VEBA with Trust Owned Life Insurance (“TOLI”) through a captive  (rather than holding traditional investments, the VEBA can purchase life insurance policies)
  • -401(h) account
  • -Trust Owned Health Insurance (“TOHI”) through a captive  (rather than holding traditional investments, the VEBA can purchase health insurance policies)

VEBAs

Pre-funding retiree benefits through a VEBA is often inefficient.  Employers who fund a portion (or all) of the APBO are able to offset the liability.  However, while contributions to the VEBA may be tax-deductible, the investment income from the VEBA may be subject to the Unrelated Business Income Tax (“UBIT”), which taxes investment earnings on funds supporting non-collectively bargained benefits.

TOLI in a Captive

Purchasing life insurance through a VEBA to cover retiree medical benefits, while cost-effective, has a number of drawbacks.  It requires that the plan sponsor deliver the challenging message that they are purchasing a life insurance policy on an employee who may not be eligible for retiree medical benefits.  In addition, the policy is mismatched to the liability (life versus health) and requires a significant amount of cash flow management. Ultimately, it is the trust and other employees and retirees that receive the payment of the death benefit of an employee versus the employee’s beneficiary.

401(h) Account

Funding retiree medical benefits through a 401(h) account requires that plan sponsors meet high Qualified Pension Plan funding levels (typically, in excess of 125%),  set by ERISA, in addition to more stringent funding requirements.  In addition, contributions made to a 401(h) account are permanent, and restrict the Plan Sponsor’s ability to reduce or eliminate benefits in the future.

TOHI in a Captive

Prior to the IRS issuance of Revenue Ruling 2014-15, plan sponsors seeking to fund retiree benefits through a captive arrangement with TOHI were required to obtain both a  Private Letter Ruling (“PLR”) from the IRS for the tax treatment of the TOHI policy and a Prohibited Transaction Exemption (“PTE”) from the United States Department of Labor (“DOL”).

In addition to these regulatory requirements, employers were required to fund ERISA governed employee benefits through an audited captive that covered property and casualty (“P&C”) insurance. In other words, employers could not establish a new captive specifically for funding ERISA benefits.

As a result, the use of captives to fund retiree health benefits has been limited to employers with already established captives or to employers funding non-ERISA employee benefits which do not require DOL approval.  In short, the regulatory and established captive requirements have historically resulted in the under-utilization of a captive for the financing of retiree benefits.

Summary of RR 2014-15:

With the issuance of IRS Revenue Ruling 2014-15, employers can now fund retiree medical benefits with a non-cancellable accident and health insurance policy (i.e. TOHI) and have it receive life insurance treatment without obtaining a Private Letter Ruling.  The impact of life insurance tax treatment is that reserves grow tax-free.  In order to receive life insurance treatment without obtaining a PLR, the following facts and circumstances must be met:

  • -The Company maintains a VEBA Trust that satisfies the requirements of 501(c)(9) (the VEBA code section) and contributes directly to the VEBA for the provision of retiree health benefits
  • -The Company purchases a non-cancellable accident and health coverage policy from an insurance company, who then reinsures the policy through the Company’s captive
  • -Both the Company and the VEBA retain the right to cancel the retiree health coverage at any time

The result is:

  • -The Company’s captive is regulated as a life insurance company and gets life insurance company tax treatment (i.e. tax free accumulation if used to pay benefits)
  • -VEBA Assets used to purchase the policy are no longer subject to UBIT
  • -The policy receives life insurance reserving treatment, which is effectively tax free growth in reserves if held until the benefits are paid
  • -Employers may receive accelerated deductions subject to an IRS limit
  • -Reduction in ASC 715 Expense (formerly FAS 106)
  • -Overfunding in the captive can be used to fund active employee health benefits

A few things to note:

1.)  The non-cancellable accident and health insurance purchased by the VEBA is deemed life insurance because under 26 USC §816(a),  captive that writes more than 50% of its business in life insurance during the year is treated as a life insurance company.

2.)  Risk shifting occurs because the retiree health benefits provided by the plan are spread across a large group of retirees.   By pre-funding the retiree medical benefits in a captive, this risk is transferred from the retirees to the captive.

3.)  While the issuance of a PLR from the IRS is no longer required, the PTE requirement remains as the funding of the benefits is a prohibited transaction.

Impact on Retiree Medical funding:

U.S. GAAP sets out stringent employer requirements when it comes to accounting for the accrual of estimated total retiree medical and other benefits.  This includes retiree medical and retiree life insurance payable to current employees throughout their lifetimes, which must be listed on the company’s balance sheet (the Accumulated Postretirement Benefit Obligation, or APBO).  This requirement, however, does not force employers to fund these obligations. Employers are merely required to recognize them.  Recognition nonetheless creates a liability without an offsetting asset, and always begs the question, “How will the company pay for these benefits?”

Employers offering retiree medical benefits often respond to the above question by either restricting eligibility requirements, closing the plan to employees who retire after a certain date, increasing the retirees’ portion of the premiums, increasing co-insurance payments and deductibles, and/or modifying or reducing plan benefits.

Due to IRS Revenue Ruling 2014-15, however, employers may be more easily able to use funds from the VEBA to purchase a TOHI or non-cancellable accident and health insurance policy which is then reinsured through a captive.  The captive will then hold the assets that were previously held by the VEBA, and properly offset the liability, decrease ASC 715 Expense, and minimize the net present value costs of operating the plan.

How this works:

When a contribution is made to the VEBA, employers can deduct the contribution, subject to the Qualified Asset Account Limit (“QAAL”).  For post-retirement medical and life insurance benefits, the QAAL for any taxable year may include a reserve funded over the working lives of the covered employees and actuarially determined on a level basis, and typically covers 30%-50% of the APBO.  If a company’s unfunded APBO is $100 million, the company will generally be able to contribute up to $50 million into the VEBA while deducting the contribution.  At a 35% effective tax rate, the value of the tax deduction is $17,500,000.  As a result, the net cash required to offset $50 million of liabilities is $32,500,000.

When the VEBA in turn purchases a TOHI policy, benefits may include tax-free reserve accumulation (due to the captive being treated as a life insurance company for tax purposes), reduced balance sheet volatility, and increased operating income through the reduction of retiree medical costs.  Moreover, a company engaging in pre-funding retiree medical liabilities demonstrates a clear financial commitment to retirees’ welfare.

Summary:

In closing, the IRS Revenue Ruling 2014-15 explicitly permits companies to use captives for the purpose of funding retiree health benefits without obtaining a PLR from the IRS provided certain conditions are met.  This ruling, while specific to retiree medical benefits, could potentially be extended to pension plan benefits. While further analysis is required, employers with funded or unfunded retiree benefits should take note of the ruling and take a closer look at funding their retiree benefits through a captive.

Image credit: Simon Cunningham via flickr

Congress Moves to Exempt Expatriates From ACA Requirements

UN member flagsAnother day, another Affordable Care Act (ACA) exemption…

This week, Congress passed legislation that exempts expatriate health plans from the health care coverage mandated in the ACA. H.R.4414 ensures that U.S. nationals working abroad, and the companies that employ them, are now exempt from the requirements and penalties of the ACA providing they do provide an expatriate health insurance plan.

The exemption was made to ensure domestic insurers offering coverage to these companies and employees were able to compete with foreign insurers that do not have to comply with ACA regulations.  Some of these insurers had been considering moving the divisions and employees that write these expatriate plans overseas.

Expatriate health insurance is an excellent fit for captives and this exemption is great news for employers that have expatriate workers and are considering writing their employee benefits into a captive.

Of course, this is just another reminder that the ACA is very much a work in progress and there are many wrinkles and nuances still to be ironed out. You can be sure that we will stay on top of the ACA developments that matter most to employers and bring you summaries like this one as things develops. For ACA updates in your inbox, as they happen, please sign up for our email updates in the box to the left of this article.

Image credit: WorldIslandInfo.com via flickr