Leveraging A Captive to Finance Your Employee Benefits Risk

For most companies today, its people are one of the largest investments its makes. COVID-19 accentuated this point and further showed us how the health of a company depends in large part on the health and wellbeing of its workforce. Providing competitive benefits is not just the right thing to do, but a sound business decision. Employee benefits usually account for one of the largest expense line items on an income statement for organizations. In a world where employee benefits consistently become both more important and more expensive, businesses of all types are looking for an affordable mechanism to finance these risks.  One solution that has become central to discussions about employee benefits has been captive insurance.

To provide some background, a captive is an insurance or reinsurance company – which can help insure or reinsure the risks of its owners, the parent company (or companies).

Employee Benefits & Captives

Over the past decade as healthcare and benefit costs have been rising, captives have become the go-to solution for organizations looking to bend the healthcare cost curve as well as create a more efficient employee benefits program.  More recently, however, organizations are recognizing the many qualitative advantages of a captive that can help attract and retain employees – a company’s most important asset. As we enter a new decade, these qualitative advantages or “soft costs” of human capital will drive the next iteration of captive insurance.

Traditionally, captives have been viewed as purely a funding mechanism for employee benefits that provides the following advantages:

  • Improved cost savings
    • Better control of premium costs
    • Reduce frictional costs (commissions, taxes, insurer profit, administration)
    • Capture underwriting savings
    • Earn investment returns
    • Improve cash flow for parent organizations
  • Improved risk management & increased control
    • Enhanced reporting – captive programs not only provide data transparency, but they also provide reporting in a more timely manner allowing stakeholders to make decisions regarding potential plan design changes for the upcoming year.
    • Centralized risk pool – from an organizational risk perspective, leveraging a captive allows risk managers to have a more complete understanding of the risks associated with the programs. Also, life and disability lines are usually considered to be third party risks and have a positive impact on the captive’s risk distribution.
    • Non-correlated risk – employee benefits usually add non-corelated risk for existing captive programs, thereby reducing the risk exposure to the captive.
    • Quantification of loss prevention programs and wellness initiatives – by utilizing a captive, the organization has the ability to implement data analytics programs, that provide actionable insights on the effectiveness of existing programs and the current cost drivers.
    • Design coverages and provisions for programs that are unique to the parent company – every organization has a unique set of risks and captives can be used to fill in gaps in the existing benefit programs.

While captives are a long-term financial strategy, in our view, the next generation of captive insurance will have a sharper focus on the soft costs of human capital, such as:

  • Attracting and retaining employees through innovative techniques and forward-thinking tools
    • While employee benefits account for large costs for employers, they are running a significant risk by not providing the right benefits. A comprehensive benefits package that’s meaningful to employees is consistently ranked at the top of the list when employees are deciding on a new position.
    • Owner vs. Passive buyer: A captive allows for customized benefits programs to meet the needs of your unique demographic. Employees at a technology company will have different priorities and expectations than, for example, those that work in manufacturing. With a captive you can understand those unique needs and meet them better than you could as a passive buyer with a commercial carrier, in a cost-effective manner. Addressing these specialized needs will go a long way in terms of retention and engagement.
    • By establishing a captive, employers can open doors to focus on human capital and the more qualitative aspects of a program
      • By creating a profit center, captives create cost savings that companies can then allocate towards preventative, wellness, or engagement programs.
    • A captive enables the parent organization enhanced data analytics. This data comes in months sooner than it would with a commercial carrier, meaning you can analyze your programs and make real-time decisions to yield better claims results. For example, if you know one of your biggest population health issues is diabetes, you can establish programs to address diabetes before your renewal is up. As a passive buyer with commercial carriers, the information typically comes in too late to make any relevant changes for that plan year.

Which Benefits Can I Fund Through a Captive?

A wide range of employee benefits may be funded through a captive – the most common coverages are Medical, Life, Disability, Retiree Medical and Voluntary Benefits.

Captives can be used to fund Employee Retirement Income Security Act (ERISA), or non-ERISA benefits. ERISA benefits are primarily the benefit plans sponsored by and contributed to by employers. Life and Disability plans are usually ERISA in nature. These plans are subject to federal oversight, under the auspices of the Department of Labor (DOL) and require express approval from the DOL to fund them in a captive. Approval from the DOL is subject to meeting certain criteria – using an A rated fronting carrier, not paying any more than market rates for the coverages, no direct commissions as part of the contract, requirement for an indemnity contract, to name a few.

Medical stop-loss is usually not considered to be subject to ERISA and has become an extremely popular benefit to add to a captive. The reason for this has been two-fold. Firstly, the rising cost of catastrophic claims. Self-insured organizations are increasingly concerned about the financial impact of high cost claims – unfortunately seeing $1M or $2M claims is becoming commonplace. One such large claim could have a material impact on the financial sustainability of the program. Second, the hardening insurance market is driving employers of all sizes towards a captive based stop-loss solution, as it reduces the opaqueness of the pricing process and helps employers get a much clearer understanding of their premiums and cost drivers. Usually a captive stop-loss program involves the employer creating an annual aggregate limit, and purchasing excess coverage from the commercial markets above the captive’s aggregate retention,, protecting the captive from most catastrophic claims.

Long-tail benefits such as group universal life insurance and long-term disability are ideal captive candidates. Benefits that pay out over multiple years (e.g. long-term disability and retiree medical), provide cash flow stability and loss predictability.

Using a captive for voluntary benefits has recently risen in popularity. This is a cost-efficient way of offering benefits that your employees can choose to participate in, or not. More and more employers are turning to this strategy as healthcare becomes more expensive, as a way to supplement benefits and lessen both their financial burden and the financial burden faced by their employees. One of the most attractive elements of writing voluntary benefits into your captive is that voluntary benefits typically have a very low loss ratio, which means they can generate a lot of savings within a captive. Those savings can then be leveraged to reduce premiums for employees or expand the coverage offered. An example of a prime voluntary benefit often offered in a captive structure is hospital indemnity, which can be critically helpful coverage, but one that is often otherwise too expensive to fund.

 

Retirement

How it Works

Unlike property and casualty lines of coverage, employee benefit lines have a unique value proposition. They allow organizations to recapture dollars that would have otherwise gone to an insurance carrier. Both life and disability coverages use a fronted carrier, i.e. a commercial carrier stands in front of the captive so that from an employee perspective there is no change in the way they interact with the insurance company. On the back end, the carrier cedes risk and premiums to the captive.

The illustration to the right shows how a typical fronted captive program works.Employee benefits captive

 

Under such an arrangement the fronting insurer continues to administer the program. The employer pays the fronting insurer an annual fee for its services, allowing the captive to retain underwriting profit (if any) from the program. Depending on the risk appetite of the organization and the results of the actuarial modeling, the employer may choose to buy reinsurance for the program.

 

In Closing

The typical steps involved in adding benefits to an existing captive or forming a new captive are a feasibility study which outlines qualitative and quantitative factors for consideration, such as potential savings, program structures, design alternatives, insurance considerations, and implementation requirements.

Today those in the insurance industry are facing difficult circumstances on a variety of fronts. The recent pandemic has led to hardening of markets. We are seeing substantial rate increases for clients. Captives offer a solution to mitigate these increasing costs in a sustainable manner. In addition, captives provide access to additional data and insights that can help organizations get a clearer understanding of claims drivers and therefore allow for implementation of solutions and tools that reduce claims costs. Further, captives provide organizations the ability to impact the soft costs of human capital by identifying and crafting unique solutions to meet their employees’ needs, more important now as the pandemic shed light on gaps in coverage many did not realize existed.

Captives are useful and versatile risk financing tools, especially for employee benefits. They provide significantly better cash management than can be provided through a trust and can produce impressive cost savings as compared to fully insured guaranteed cost plans.

5 Questions to Answer Before Renewing Your Health Insurance Plan

Whether you’re an office manager, business owner, or a human resource or benefits professional, renewing your company’s health insurance plan may become automatic. Considering alternatives is a daunting task that many feel they lack the bandwidth to handle. However, at a time when healthcare costs are rising, the market is in flux, and employees are expecting more and unique benefits, choosing the most convenient option is probably not your best bet.

It’s imperative to routinely review your package, your results and rethink your strategies to make sure you’re minimizing your costs while giving employees the best coverage at a reasonable rate. You may think you’ve considered everything, but you probably haven’t. Before your renewal date, make sure to address the following questions.

  1. Does your medical trend align with market standards?

Before you renew, take a hard look at the medical trend being used this year for next year’s renewal. The market has been seeing downward trends, so you’ll want to make sure you’re seeing that in your rates.  For 2019, renewals are in the low single digits.

  1. If you’re self-insured, have you considered medical stop-loss?

While advantages of self-insurance include flexibility and savings opportunities, self-insured companies are also exposed to an extra level of risk – unexpected, catastrophic loss that they’re expected to cover themselves. Stop-loss insurance, sometimes called catastrophic insurance, can help mitigate this risk. Medical stop-loss is coverage specific to healthcare spenEmployee Benefits Communicationd, and involves the establishment of a threshold by the employer over which they have external coverage for.

With an uncertain future for US healthcare, medical stop-loss is something all self-insured organizations should include in their program. Employers will need to consider where the stop-loss program attaches to make sure you don’t over or under purchase coverage.  Also, captive stop-loss solutions should be considered to maximize your savings, providing a savings of 10% or more on your stop loss spend.

  1. Do you have the right tools in place to support and communicate benefits with your employees?

You may have an impressive health plan and competitive benefits offerings, but if your employees aren’t aware of them, don’t know how to utilize them, or find them irrelevant, you’re not going to see the results you’re hoping for.

It might be time to give these questions some thought:

  • How and when are you telling employees about what’s available to them?
  • Do they truly understand their options?
  • Do you know what benefits your workforce finds most valuable? Are you giving them what they want, or what you think they want? Think about your demographics here.
  • Do you have streamlined processes for benefits administration, claims filing, etc.?

Consider a formal or informal survey of employees to find out what is working and not working. Further, there are a number of administrative tools, such as Bswift, that you may want to evaluate. For compliance and HR initiatives, ThinkHR and like platforms may be appropriate.

  1. Is it time to consider an actuary?

An actuary is a certified professional that measures and predicts insurance risks and premium rates. They are math-based risk experts and can help organizations with insurance policy development, forecasting, valuations, audits, and more.

Most small businesses believe they have no need for actuarial services. However as organizations grow and consider more advanced and varying insurance options, the greater the need for an actuary becomes. While the work of an underwriter is crucial, actuaries take a deeper look at the numbers. They are a neutral third party, and can offer crucial information such as how much volatility you can expect over a one and five-year period. These insights allow you to make smarter insurance decisions.

  1. Could your organization benefit from alternative funding strategies?

If you’re fully-insured, have you thought about aiming for a self-funded structure? If you’re self-insured, have you thought about a captive insurance company? If you’re a small businesses, have you thought about an Association Health Plan (AHP)?Employee Benefits Funding

We recommend thinking about these alternatives every couple of years. As businesses change and grow, along with market regulations and options, what once made sense for an organization may no longer be the best fit.

Captives provide unparalleled transparency of and control over an insurance program, which helps with cost savings and customization. Once only an option for jumbo-sized employers, more and more smaller organizations are utilizing a captive structure, either as a standalone captive or part of a cell or group captive.

Further, the AHP market is expanding quickly, due in part to new regulations passed earlier this year. This is a great avenue for a small business to benefit from economies of scale and get the same rates as a large employer. For more information about how to set up or join an AHP, please get in touch.

 

Healthcare is complicated, but with that complexity comes new and exciting opportunities. Before you decide to maintain the status quo and renew your plan, take some time to think about what’s truly best for your organization and its workforce.