Fifteen years ago, captives were not commonly used for financing employee benefits, as regulatory obstacles and reinsurance restrictions limited eligibility to only the largest of captives.
The DOL must approve the placement of ERISA benefits into pure-parent captives. Many well-known organizations have obtained funding approval, including ADM, Alcon Labs, Alcoa, AGL Resources, Astra Zeneca, Banner Health, International Paper, Memorial Sloan-Kettering Cancer Center, Sun Microsystems, and United Technologies.
Many more companies have used captives to fund other non-ERISA employee benefits that do not require DOL approval. Moreover, employer groups and associations are establishing captives to fund employee benefits, thus offering an alternative to the commercial insurance markets and providing an incentive for membership growth.
For companies with property & casualty captives, certain employee benefits may be “unrelated business,” i.e., insurance business unrelated to the captive’s parent. Adding unrelated business to a single-parent captive can improve the captive’s overall financial efficiency; satisfy the need for third party business allowing the parent to deduct its captive premiums from its U.S. federal income taxes; and create additional cost savings.
Regulatory changes have led to increased employee benefit captive funding. Some of these changes include the following:
- Internal Revenue Service clarifies risk shifting/distribution and unrelated business requirements
In 1993, the IRS ruled that certain employee benefits insurance written in a pure captive is unrelated business (to the captive’s parent) since it benefits the employee and not the employer. In 2002, the IRS issued three revenue rulings clarifying the qualification of captives as insurance companies for federal income tax purposes, including discussions of third party business, brother-sister arrangements and group captives.
- The DOL review process provides a roadmap to funding
If the proposed transaction is subject to ERISA, the DOL has a streamlined process for approval.
- GASB 45 and FASB 158 requirements raise awareness of post-retirement liabilities
Accounting rules such as GASB 45 and ASC 715 (formerly FAS 87/106 and amended by FAS 158) require that organizations account for retiree medical and pension obligations. These requirements encourage employers to not only account for the liabilities, but also to seek efficient funding methodologies. In addition, GASB statements 74 and 75 are increasing the required disclosures for public retiree medical obligations.
- Court rulings clarify the parameters for funding retiree medical programs
In Wells Fargo & Co. v. Commissioner 224 F.3d 874 (8th Cir. 2000), the tax court clarified the amount that can be set aside to fund retiree medical benefits, expanding the potential funding allowed to employers.
- Revenue Ruling 2014-15 clarifies funding opportunities for retiree medical programs
In 2014, the IRS ruled in Revenue Ruling 2014-15 that Non-cancellable Accident and Health Insurance policies will receive life insurance tax treatment as long as the following facts and circumstances are met:
-The Company maintains a VEBA Trust that satisfies the requirements of 501(c)(9)
-The Company purchases a Non-cancellable Accident and Health policy from an insurance company and reinsures the policy through the captive
-Both the Company and the VEBA retain the right to cancel the retiree health coverage at any time
As a result, insuring non-collectively bargained retiree medical benefits through a captive allows for tax-free growth of reserves without the need for a Private Letter Ruling.
Want to Learn More?
Download our Risk Manager’s Guide to Employee Benefit Captives to find out all you need to know about this increasingly popular funding option.
 IRS Revenue Ruling 92-93  IRS Revenue Rulings 2002-89, 2002-90 and 2002-91