Large Companies and Medical Stop-Loss

Medical stop-loss coverage protects self-insured groups from catastrophic medical claims. Medical stop-loss has long been used as risk management tool by small- and medium-sized organisations to limit their exposure to medical claims above their desired retention levels. This strategy has been used by single parent programs as well as group captive programs.

The reason this strategy has been more popular in the mid-market is because of two primary reasons. First, businesses have wanted to insulate themselves from catastrophic claims risk, as one large claim could have a material impact on the financial sustainability of the program. Second, the relatively small size of the groups means greater variability from an actuarial perspective. In comparison, large companies have stronger balance sheets allowing them to take on a more aggressive risk management strategy and reduce third party spend with insurers.medical stop-loss captives

As I write this in April of 2020, there are a myriad of unprecedented challenges facing both small and large employers and medical stop-loss can help mitigate some of these concerns. Recently, we have seen a shift in the market where large employers are increasingly becoming interested in reviewing the possibility of leveraging a captive to provide medical stop-loss coverage. I anticipate this trend to continue. Here’s why:

  1. Hardening markets

This past renewal season, we saw that markets are starting to harden, and given the current Covid-19 pandemic and the financial and economic climate, this is bound to continue. A variety of factors have contributed to this including regulatory changes (ACA and healthcare reform) and many recent natural disasters (Hurricane Harvey, California wildfires, etc.). Insurers for a large part of the past decade have benefited from the favorable financial markets world over, thereby reducing their need to increase rates to continue to make their target earnings per share (EPS).

As we stare towards the possibility of a recession and reduced economic output, poor investment income will have an adverse impact on insurance company financials. Further, as markets tighten, access to inexpensive cash is becoming harder. Since most insurance companies are public, the increased pressure to keep their share prices buoyant is going to result in them wanting to beat their expected EPS – which requires higher profit margins. Finally, as reserves balances diminish due to market conditions, principles of conservatism are going to require them to shore up financials, and the easiest way to do this is by increasing premiums.

These factors coupled with the ongoing pandemic, which will likely result in an increase in aggregate claims, led me to believe hardening insurance markets are upon us. This is likely to result in an increase to reinsurance costs for employers who are currently self-insured. A well-structured medical stop-loss solution can help employers navigate these market conditions by providing them greater control over the program and creating an alternate avenue for reinsurance.

Hardening markets make captives more favorable, as they allow for customized coverage otherwise unavailable in the commercial market. Employers currently using captives have been provided an opportunity to leverage the captive program to fund for Covid-19-related expenses. For non-captive employers, this impact is felt directly on their financial statements.

  1. Cashflow volatility due to higher claims costs

Claims costs have been increasing at an aggressive pace. The US has long been criticized for poor population health management, with rising chronic conditions like diabetes that are expensive to treat. In addition, the pricey cost of medication has made extremely high cost claims a reality of healthcare. Claims in excess of $1m are becoming commonplace. For large employers, who are traditionally self-insured, such claims cause volatility from a cashflow perspective, making it harder for finance teams to budget and build expected proformas. Using a medical stop-loss program eliminates this volatility as claims above the self-insured retention level are funded in the captive, creating a level funded premium plan.

  1. Upwards healthcare trend

According to studies by , while medical cost trend has been flat for a couple years, it is expected to increase from 5.7% to 6% in 2020. This rise in healthcare costs is attributable to an increase in the utilization rates. Medical trend increases are outpacing those of inflation, which was 2.07% in 2018 and 1.55% in 2019.

As a result, employers have had to leverage solutions such as high deductible health plans and other forms of cost sharing to bend the healthcare cost curve. The crux of the issue is that now organisations are having to combat both rising medical trends as well as increasing claims costs, while still needing to retain talent and provide competitive benefits.

A well-crafted medical stop-loss solution can help ease the burden for employers and provide them a sustainable way to bend the healthcare cost curve. Development of a formal reserve mechanism is an efficient way for employers to set aside dollars to mitigate large cost increases in the future. While an employer cannot control what happens in the insurance and healthcare markets, they can make the decision to put themselves in a position to be able to navigate the landscape more efficiently. We are seeing an increasing number of CFOs drive conversations around better managing employee benefits spend as it is becoming one of the largest expense items for organisations.

  1. Control

By writing stop-loss into a captive, an employer can leverage captive savings to focus on initiatives most useful for its employee demographic. We have seen employers use the captive savings for wellbeing initiatives as well as cost control programs focused on disease management for conditions like diabetes or musculoskeletal problems. This kind of structure can then be tied with programs dedicated to population health management, wellness and health advocacy for a robust, employee-first package aimed at gradually reducing claims costs.

Using a captive provides employers access to data in a timely manner, allowing them to better analyse and review drivers of claims, in turn providing them an opportunity to implement measures that would focus on addressing those drivers. While this is possible without a captive, we have seen employers are more engaged when using a captive — meaning they are more likely to create a structured approach to claims and cost management leveraging the captive. In my view, this is because of lack of funds for such initiatives and the lack of a structured risk framework in some cases. Using a captive to underwrite medical stop-loss addresses both of these aspects.

Transparency is one of the core benefits of a captive. Once organisations begin to use a captive funding solution for its medical spend, they usually begin to expand their horizons for other cost reduction initiatives. One such initiative has been carving out drugs (Rx). Using a pharmacy benefit management (PBM) solution can generate additional savings ranging between 15% to 30% of Rx spend. These savings are in addition to those that an employer may recognize by restructuring their funding approach. Further, these savings have a multi layered benefit, reducing the overall medical trend and generating additional reserves for the program to offset possible cost increases in the future.

In general, large employers are more accustomed to customization and retaining control, so a captive program for medical stop-loss aligns with their needs and enhances their ability to control their healthcare programs. Better data analytics and understanding of claims also provides employers the ability to be more reactive and make necessary changes quickly, in a much more agile setup. A captive provides monthly and quarterly reports which are usually much more detailed and timelier than those provided by a commercial insurer. Finally, adding additional risk to the captive also helps the risk managers develop a more comprehensive understanding of enterprise risk at large.

Medical stop-loss coverage in a captive continues to be a prudent business strategy for companies of all types and sizes. It creates multi-layered protection. Large employers are beginning to realize the attractiveness of such a program, whose advantages have been especially highlighted lately due to market and global economic shifts and conditions.

3 Unique Use Cases for Captives, From VCIA 2019

Every year for over a decade, Spring has sent team members to Burlington, Vermont in late summer for the annual Vermont Captive Insurance Association (VCIA) conference. As a leading US Captive domicile, Vermont has long been at the forefront of captive expansion and policy, and their yearly summit brings together some of the best and the brightest in the industry. This VCIA in particular was special for me personally, as I was recognized as an emerging professional in the field. It is always special when you win an award, more so, when it is your peers who recognize you.Captive Review Award Winner 2019

As per usual, seminars covered a wide range of topics, from drones and artificial intelligence, to ROI, reinsurance negotiation and tax updates. However, after taking the time time to reflect on what really stuck with me from the conference (and to jot it all down), I realized that many were interested in the different, perhaps untraditional ways to use a captive. As such, I am sharing some key takeaways centered around that theme below.

  1. Product & Program Innovation

Not only are captives in and of themselves are a mode of innovation, but they also serve to proliferate further innovation, in terms of coverage lines, products and program structures.  In one Innovation Spotlight session, edHEALTH and HCMS Group highlighted their use of captives to reduce health spend, implement population health management and develop predictive modeling. In “Captive as Laboratory”, Steve McElhiney and Ed Koral covered emerging and future risks, encouraging the audience to think about what unique risks their organization faces, both internally and externally. They then discussed how to use a captive to provide a tailor risk
offering with potential risk support, for risks such as TRIA or contingent business interruption.

  1. Group Health Plans

Unfortunately for both employers and employees, the unaffordable healthcare trend doesn’t appear to be going anywhere. Reducing healthcare spend is a key component of many organizations’ captives, as they allow for more control and transparency. Beyond that, there is an opportunity for captives to serve as a group health exchange structure for like organizations who band together. As mentioned above, edHEALTH is a great example of a group of higher education institutions joining together for group purchasing power for health and other benefits. Further, Spring’s Managing Partner, Karin Landry, spoke on Association Health Plans, which have hit some regulatory hurdles, but have a clear tie to the self-insured captive model. This session featured a case study on Agri-Services Agency, a subsidiary of the Dairy Farmers of America, who is in the process of using a captive to allow for the provision of group healthcare for its diverse membership, many of whom reside in rural areas or are sole proprietors.

 

  1. Retention

“Utilizing a Captive as a Talent Retention Tool” brought a different angle to the benefits and use cases of captives. The presentation emphasized how captives can boost employee benefits in a noticeable way to the end-user: the employee. Captives also create unique roles and responsibilities within an organization that enable valuable experience and growth for employees.

 

As you see, in between an exciting awards ceremony for myself and Spring, and plenty of dinner and cocktail receptions, I was certainly still able to further my industry knowledge and I met a lot of great people along the way. We are already looking forward to VCIA’s 2020 conference and hope to see you there!

Syzygy Insurance Co. v. Commissioner of Internal Revenue

What You Should Know

Recently, the Courts ruled that Syzygy Insurance Company (“Syzygy”), a micro captive created by Highland Tank & Manufacturing Co. and its Associates (“HT&A”) did not qualify as an 831(b) micro-captive entity between the years of 2009 and 2011. Federal courts have been especially assertive outlining bad fact patterns for certain captives, as seen in similar case results such as Avrahami v. Commissioner (“Avrahami”) and Reserve Mechanical Corp v. Commissioner (“Reserve”).

Understanding the criteria and results of these court rulings is imperative to ensure that your clients’ captives, or even your own, are appropriately managed and operated.

In this whitepaper, we outline an in-depth analysis of the court case and decision, and provide you with a checklist for ensuring compliance and validity for your captive, no matter its size. Download to learn more about:

  • Circular flow of Funds
  • Arm’s-Length Contract
  • Valid and Binding Policies

and more, so that your captive isn’t the next one getting negative press!

 

CICA 2019: Preparing for the Future by Learning from the Past

Event Recap

We are off the heels of another great Captive Insurance Companies Association (CICA) annual conference. This year, I was happy to escape Boston’s cold and head to Tucson, Arizona from March 10th-12th for a few days learning, networking, and as you see here, some impromptu sight-seeing. CICA 2019This was Spring’s 12th year attending and being involved with the CICA event, and I wanted to share what we view as the key takeaways and over-arching theme of the conference: preparing for the future – captives and otherwise.

It’s true what they say, that you can’t figure out where you’re going if you don’t understand where you’ve been. So before we dive into the future-focused learnings of CICA 2019, we can set the stage with “Captive History: Lessons Learned Through the Years”, where a panel of “Michaels” led the audience on a trip down memory lane. They started with the 1920’s, brought us to the first captive in 1950s, and landed where we are now, with over 6,000 captives in existence worldwide. They covered key lessons learned from factors such as:

  • Corporate globalization
  • Domicile specialization
  • Access to internet

And others.

A number of sessions around regulatory and tax updates help illustrate the current captive landscape, such as “Regulatory Hot Topics”, “Captive Tax Developments – What They Are and What They Mean”, and “Addressing the Extra-Domicile Regulatory and Premium Tax Risks”.

Now that we’ve addressed the past and present, I believe the true emphasis at CICA this year was the future. Here are all the ways in which this theme came into play.

The Next Generation

The captive industry has a range of talent thought leaders and experts, but a fair amount of attention went to making sure the next generation is prepared to take over.

  • In “Shaping the Captive Leaders of the Future”, Courtney Claflin of the University of California and John Prescott of Johnson Lambert highlight the importance of recognizing an aging workforce and reacting accordingly. Among other advice, they recommended campus recruiting, internship programs, emerging leader programs, and data and technology as recruiting methods.
  • During “Succession Planning: Has Your Company Begun?”, a panel offered training and development best practices as well as on-boarding and transition guidelines.
  • “Keys to Succeeding as a Young Professional in the Captive Industry: Mentorship” was another discussion centered around bolstering the younger workforce demographic for not only successful careers, but for a strong industry as well.
  • CICA has always been focused on education, so it’s no surprise that students had a seat at the table at the conference. Specifically, one session spoke to bridging the gap between the classroom and the office environment, while another served as a spotlight on Butler University’s student-run captive.

The Geo-Political Landscape

The captive industry, and the insurance industry at large, are among those that can be most impacted by changes in the political and/or environmental climates. Thus, in speaking about the future, these areas were important to reflect upon.

  • A session led by Jason Flaxbeard, Jim Bulkowski and Eric Bishop spoke to changes in US tax reform, technology, corporate governance, cyber and more to emphasize the dynamics at play. They then speculated whether these new risks can be seen as an advantage, a danger, or both for captives.
  • During “The Political Climate and the Future of Captives”, the audience was led through some “Hotspots of 2019”, such as Brexit, the substance requirement for captives, and Association Health Plans. For each scenario, they outlined key lessons to be taken by captive and risk professionals.

Innovation

If we as an industry can’t continue to innovate as the industries around us do, I don’t need to tell you that the outcome won’t be great. The following topics shed light on how captives can adopt creative strategies for future growth.

  • Spring’s Managing Partner, Karin Landry, led a panel discussion on the opportunities for integrating workers’ compensation and disability through a captive. This is an emerging trend which we see larger employers moving toward, and the session offered strategical advice and case studies revealing tangible results of an integrated approach.
  • One Captives 101 session spoke to captives themselves as vehicles of innovation, stressing their importance for a stable and blossoming organization.
  • Andrew Rennick and Ryan Ralston presented innovative solutions for micro-captives, which have recently taken some press hits. Enterprise Risks, Extended Warranties and Product Recalls were some of the use cases they went through.
  • We can’t talk about the future and captives without mentioning cyber, can we? One session reviewed an AM Best and Guidewire Cyence Report to educate the audience on breach expenses, cyber market growth, and modeled carrier portfolios.
  • Speaking of topics trending in the industry, Steve McElhiney of EWI Re spoke to blockchain technology and its ties to captives through a case study. He listed several potential captive blockchain examples, such as exposure management, medical captives, and RRGs.

 

All in all, the conference was certainly valuable for industry professionals of all types and levels of experience. Myself and the rest of the Spring team are already looking forward to next year’s event, and putting these recent learnings to work!

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.