The Challenge

A mid-sized (over $1B in annual revenue) architecture, engineering, construction and consulting firm was utilizing an industry group captive to underwrite their workers’ compensation, general liability, automobile coverages and subcontractor default risks. The organization requested Spring to help assess whether the group captive solution was still optimal and to help shape their risk management strategy. As part of this review, we assisted them in considering the pros and cons of exiting the group captive program to form their own single parent captive. To support this decision, we helped them understand both the financial implications and qualitative factors they should contemplate and the implications of this change.

The Process

Spring began by undertaking a total cost of risk assessment at the line of business level for workers’ compensation, general liability, excess general liability, professional liability, subcontractor default, and medical stop-loss insurance lines. The purpose of the study was to explore the universe of options available to the client and included a high-level review of potential risk structures, retention levels, domicile options and reinsurance/fronting options. In addition, Spring commented on the competitiveness of the existing framework, generating a robust view of the advantages and disadvantages of the different solutions, and provided recommendations as to how best to move forward.

Spring’s Solutions

Spring implemented a multi-step approach that included the following:

• The Quantitative Analysis: Creating a total cost of risk comparison between the previous group captive and proposed single parent captive structures for each line to understand program cost savings. The key steps include:
  • Analyzing loss and exposure data
  • Developing expected claims at various retentions
  • Defining operating cost assumptions (other than retained loss)
  • Modeling captive company Proforma balance sheet and income statement
  • Estimating captive capital requirements
  • Obtaining brokerage quotes at the analyzed client retention levels to determine optimal retention level and the anticipated market savings that go with it
• The Qualitative Analysis: Evaluating non-financial factors such as risk distribution, domicile, regulations, administrative requirements and the positives and negatives for each captive solution. The key steps included:
  • Evaluating the required structure to meet appropriate insurance tests, like risk shifting and risk distribution
  • Evaluating differences between the home state and other potential domiciles
  • Conducting a deep dive into the various service provider functions and requirements
  • Completing a policy review to outline potential changes to coverage terms with a single parent captive
  • Providing a pros and cons analysis for a single parent captive versus the current group captive structure. Some of the benefits of each are as follows:
    • A single parent captive model allows additional flexibility in coverage option including medical stop-loss, more control over funding structure and selected services and risk control programs, and the ability to take full advantage of a favorable long-term loss profile
    • The original group captive structure offers favorable pricing over commercial markets for certain lines in the near term due to large, self-insured retentions and economies of scale by mixing in the risk of other large insureds with similar risk profiles. It also allows access to certain safety management and other services (if desired)
• Reporting of Results: Preparing and presenting a report highlighting the financial and non-financial differences to enable the client to make a fully-informed decision to either move forward with implementation or stay with the existing captive.
• The Client Decision: After thorough fact finding, analysis and comparisons, and communication with the client, the decision was made to form a Vermont-based single parent captive. To move the process forward, we created an actuarial captive feasibility study, a captive business plan, policy forms and other documents to be submitted to the Vermont regulators. There was initial uncertainty over whether the client would still receive required risk distribution, as there was a change in the third-party risk profile with a single parent captive. However, the accounting and tax team concluded that the new entity, based on the selected coverage structure and underlying insured exposures, still qualifies for risk distribution and can be treated as an insurance company
• Next Steps: Spring began quarterbacking the client through the implementation process once they decided to form their Vermont single parent captive, which involved the following:
  • Preparing an actuarial captive feasibility study and worked with the selected captive manager on the application material for submission to the Vermont department of insurance
  • Assisting in the selection of service providers for the captive
  • Providing ongoing actuarial and consulting services to the parent company and their captive to ensure that they are aware of all possible insurance solutions available and are informed in their insurance choices

Ongoing Success

In the current challenging market conditions, a captive solution is a powerful tool to have during renewal negotiations. Even if it isn’t implemented immediately, having the captive option available provides a competing solution to traditional carriers. Even for coverages not insured through the captive, the client will have increased bargaining power and may receive better offers from traditional insurers. Most importantly, moving from a group captive to a single parent captive has provided the organization the opportunity to use a captive solution to support other aspects of their business. For instance, by adding medical stop-loss to the captive, they will be able to generate additional savings for the HR teams, allowing increased support for employee wellbeing and resources to implement additional wellness initiatives.
In summary, the client chose the solution that provides them flexibility, over maintaining the status quo of their group captive, and enables the parent company a recoup of profits, particularly as it builds surplus over time, that would otherwise go to the group captive and excess carriers. As the captive matures, the client is also expected to receive captive profits back as dividends and be able to further increase self-insured retentions. We will continue to provide insurance consulting (both captive-related and beyond) to the parent company and lead them through the initial year of single parent captive strategies.

Whether or not we have seen the worst of The Great Resignation, savvy employers are not new to adjusting their benefits and “perks” programs to better align with workforce desires. At the Disability Management Employer Coalition (DMEC) Annual Conference last week in Denver, I spoke specifically on whether Flexible Time Off (FTO) has taken over as the frontrunner, versus the more traditional Paid Time Off (PTO) approach. I thought you might be curious to know the answer, at least in my opinion, so I’m jotting down the key points from my presentation here.

Background

As with so many things in business and in life, in order to clearly understand the current state of PTO, it’s critical to look back at the history of the concept. In 1910, President Taft proposed 2-3 months of required vacation, “in order to continue his work next year with the energy and effectiveness which it ought to have.” Countries like Germany, Sweden, and others were no strangers to this idea, and set forth on setting global standards regarding minimum levels of vacation. Today, the U.S. is one of only six countries in the world – and the only industrialized nation – without a national paid leave policy. So, what gives?

At least on paper, Americans seem to prefer work over vacation. You may be laughing or rolling your eyes, but it is a fact that significant time off goes unused at the end of the year (people choose to lose it rather than use it). In some cases, this may be the result of a corporate culture that, while they may document PTO programs, do not actually encourage the use of that time. If you’re expected to work while on vacation, you may not feel it worthwhile to take said vacation.

PTO

Over the years additional policies popped up to fill some of these gaps, such as leave related to COVID-19, sick leave, disability, parental leave, and family leave. Many organizations arrived at a PTO program in which an allocated number of days account for different types of leave which vary by employer, but might include vacation, bereavement, sick and personal leave. While this creates efficiency and reduces unscheduled absences, this design (perhaps inadvertently) encourages working while sick, as employees do not want to use days within their bucket when they have a cold, since those same days could be used on a tropical vacation or, on a less happy note, in the case of a personal or family emergency. This flaw went from acceptable to unacceptable in light of the pandemic, and turned some organizations off of PTO and on to FTO.

FTO

Flexible Time Off (FTO) allows for ultimate flexibility in the volume of “vacation” time taken. With the expectation that employees do their jobs, meet deadlines and achieve their individual and corporate goals, time for rest is scheduled at the discretion of managers. FTO however is not to be confused with unlimited vacation days. While a nice idea, some challenges exist around FTO, including:

• FTO plans are unlikely to meet the needs for vacation plans and sick/safe plans, and are not recommended to fulfill all of these requirements given federal and state law complexities
• Performance management and manager training is critical with this design
  • Be careful about creating guidelines around the number of acceptable days off, because it can quickly morph into a PTO plan with wage liability
• Participation in FTO plans for non-exempt employees is not recommended as it will result in payroll obstacles and litigation susceptibility

Given these factors, however, FTO plans can be a powerful organizational tool. If you’re considering FTO, I recommend first answering the following questions:

• Which population should be considered for FTO?
• What approach will ensure managers are managing workload instead of time off?
• What scheduling and approval processes will be implemented?
• How will you ensure employees have the opportunity to leverage their FTO?
• Are you accounting for sick/safe requirements through another policy/program?
• How will you answer to the stigma that FTO is designed to decrease utilization and save you (the employer) from PTO liability?

The Big Reveal

FTO can bring a lot to the table for an organization: it is unlikely to result in more time off (than before), it is financially savvy, a good recruiting tool, and relatively easy to implement. On the flip side, however, I noted some real challenges. In the end, and if you read this article for the clickbait title, my investigative answer is no: FTO is not the new PTO. It should however be considered as one tool within the absence management toolbox, and assessed according to your individual employer needs and priorities.

After a short hiatus, The Disability Management Employer Coalition (DMEC) was able to host their 2022 Annual Conference in-person for the first time since the pandemic started. DMEC is one of the leading organizations in the paid leave industry and their annual conference brings together employers, vendors, government officials, lawyers and more to network and discuss leading trends in the business. This year also marked the 30^th anniversary of the creation of DMEC, furthermore solidifying itself as a staple in the world of disability management. It was great seeing so many familiar faces from the industry and learning more about what’s keeping industry professionals up at night. This year’s conference took place in Denver, CO and Spring had the pleasure of both exhibiting and presenting.

Although this year’s conference covered a wide range of topics, I noticed the following three key themes.

1) FMLA & ADA Challenges

Although compliance is often a hot button topic at DMEC, this year there was a specific emphasis on maneuvering around FMLA & ADA challenges. Presenters tackled FMLA & ADA challenges from a range of angles including changes in guidance, a Q&A with federal agency leaders, and a mock trial where the attendees acted as the jury. Some of the of the FMLA & ADA related presentations this year included:

• Helen Applewhaite, Director of the FMLA Division at the Department of Labor (DOL) was interviewed on employer challenges under these laws and key DOL and EEOC priorities in a session titled “A View from the Top: Current FMLA and ADA Challenges”.
• In a session titled “Recent ADA and FMLA Trials: Employer Wins and Losses,” experts included interactive polls where attendees could predict jury outcomes from previous FMLA & ADA trials.
• Lastly, compliance experts from ReedGroup and an Absence Management expert from The Guardian conducted a mock trial titled “Law & Order: DMEC Edition,” where presenters took roles of the judge, plaintiff, defense and plaintiff’s attorneys, and the attendees acted as the jury responding to employers breaking FMLA & ADA regulations.

2) Support for Caregivers and Healthcare Workers

Although COVID has settled a bit in severity, caregivers and healthcare workers are still facing high rates of burnout and overworking, without receiving much federal support. Also, in the past 50 years we have seen the highest rates of children and elderly parents in the home, often requiring some type of care, most often unpaid care by a family member. During this year’s conference, presenters tackled the issue of mental health for employees assuming the role of a caregiver and how employers can offer needed support. Below are some of the groundbreaking presentations tackling this issue.

• Experts from the Lincoln Financial Group explored solutions employers can adopt to support employees who act as caregivers in their “Caring for the Caregivers: A Key to Employee Retention” session.
• The Standard’s Dan Jolivet looked at common stressors healthcare workers face that lead to fatigue and turnover in the healthcare industry and brainstormed possible solutions in his “Costs of Care: The Impact of Stress and Compassion Fatigue on Healthcare Workers” presentation.

3) The Future of Leave

As we tentatively look beyond the COVID-19 era, there was a huge emphasis this year on what we can expect from the disability and leave management industry moving forward. During the pandemic many employers adjusted to remote/hybrid leave policies, introduced new mental health resources and navigated changing COVID regulations. But as we slowly move into a post-COVID world, many speakers, such as those noted below, looked at new-age alternative leave policies and what we can expect for the future of leave.

• Representatives from Unum explained how previous leave programs are not working for today’s workforce and a one-size fits all approach is not suitable for most employees in their “Leave Is Changing: Are You Changing With It?” presentation.
• Spring’s SVP, Teri Weber evaluated whether flexible time off policies could be a viable replacement for traditional PTO policies in her “Is FTO the New PTO?” session.
• Leave specialists from Brown & Brown, FINEOS, New York Life Group Benefit Solutions and Spring looked at “How [Employers Can] Harness Market Forces to Meet Future Absence Management Challenges.” Some of these market forces discussed included Instagram, the gig economy and federal paid leave policies.

a) Utilizing Tech & Data

When looking at the future of leave management, we are seeing a giant increase in leave related tech and software, which allows employers to better understand leave trends and preferences within their workforce. Although tech and data collection software are not new in the industry, we are seeing constant updates and an influx of new software that help measure different facets of absence management policies. Below are a few tech & data related sessions we wanted to spotlight.

• AbsenceSoft’s CSO and CCO showcased how data is key in managing eligibility, entitlement, workflow process and more, as well as common mistakes to avoid when designing a data strategy.
• One panel  presented on “Improving the Employee Leave Experience through Technology”, in which they reviewed how tech can expedite the collection of medical documents, identify opportunities for wellness programs and more.
• When it comes to implementing Absence Software, it can be tricky selecting the right program. A discussion including CVS Health and CommonSpirit Health spoke on best practices when selecting and implementing a software-based solution.

b) Moving Past COVID-19

As many organizations slowly move back into the office, employers have been developing and reassessing return-to-work programs and reevaluating leave policies to keep their workforce happy. On a national level, we are seeing changes in COVID-related compliance and a big push to retain talented employees through enhanced benefits packages. Here are some noteworthy sessions related to adjusting to a post-COVID world.

• In a presentation titled “Life Beyond COVID: New Focuses for Absence & Disability Compliance”, representatives from Jackson Lewis review the long-lasting effects of new leave legislation.
• Experts from Voya Financial and FullscopeRMS’s Claims Director, Katie Hunt shared recent research to help enhance leave management and return-to-work programs.
• Another panel including DMEC’s CEO, Terri Rhodes tackled feedback and questions from the audience on challenges for absence management teams, return-to-work programs and ADA accommodation processes.

All in all, being back at the DMEC Annual Conference in-person was a powerful experience! This year I saw so many young and enthusiastic faces which is a good sign for the future of the industry. DMEC never fails to provide innovative insights into the absence and disability management landscape while providing a fun and interactive experience, and I am already looking forward to their next event.

Cell Captive Overview

A protected cell company (PCC) is a legal entity that can be considered as a condo of insurance. A PCC facilitates a turnkey solution for companies by offering clients an individually protected cell that is insulated from the risk of other cells within the PCC; each condo operates as its own captive (with certain restrictions) and does not share risk or rewards with the other condos in the building (PCC). PCCs can vary in type and operational structures. The underlying principle of a PCC is that they are established by a sponsor that funds the capital required by the core. The sponsor is also responsible for ensuring other captives operate within the business plan parameters of the PCC. Clients benefit from a PCC as they spend less time and resources on the operational and establishment activities for the program.

When cell captives were first introduced to the market, they were largely in the form of unincorporated cells, where participation and service provider agreements worked to protect the sponsor’s investment rather than through structural protections.

The model for cell captives has evolved to allow more control for cells with the establishment of incorporated cells. Incorporated cells allow cells to even have their own Board of Directors at the cell level.

Regardless of the type, any cell captive structure allows constituents to benefit from pooled administration, but not from pooled risk, as each cell is independent. Sometimes a company will own multiple cells within the PCC, which are all treated individually.

Cell captives are attractive risk funding vehicles because they offer:

• Easy entry. Cell captives are turnkey and can be established quicker and in a more efficient manner compared to standalone captives.
• Economies of scale. Administrative savings are generated as the costs are pooled across cells.
• Professional captive management. Typically, cell owners can be fairly hands-off with built-in program management.

In addition to being a great solution for small and mid-sized companies, cell captives align with a range of other use cases and can be flexible in structure and purpose, for example:

• A captive owner may want to reform a pure captive into a cell captive to allow different Joint Ventures of the parent company to be insured through cells jointly.
• An organization can use a cell captive to separate higher risk areas of the business, without impacting the rest of the captive. For example, each business unit could head up an individual cell. For instance, an organization may view it advantageous for senior management of each of its subsidiaries to own cells that insure the subsidiaries they manage. In this case, each entity, whose risk profiles may vary greatly, would have its own cell that is run independently but still in favor of the parent organization.

Cell captives were once most commonly leveraged by mid-sized companies entering captive funding for the first time and seeking lower barriers to entry and extra assistance. While still a great fit for mid-sized companies, market conditions are driving more and different types of organizations toward cell captives.

The Surge in Cell Captive Demand

In more recent years, we have increasingly seen large multinational organizations entering the cell captive space, in establishing and owning the entire structure as part of their enterprise risk management strategy. In addition to the basic cell captive advantages listed above, other driving factors that may be of interest include:

• A lower required upfront capital investment, as compared to a standalone captive
• Greater ability to meet different business objectives at once, as well as to adapt
  • It is simpler to add a cell to an existing program than it is to set up a new single parent captive for a different line of coverage. On the other hand, it is also relatively easy to “phase out” a cell that was insuring a critical risk two years ago, but that risk or the level of need is no longer there today.
• While all captives offer flexibility over commercial market solutions, cell captives are unique in that each individual cell can be in the form of a reciprocal, a risk retention group (RRG), a limited liability company (LLC), a non-profit, and other types without the need to match each other
• The ability to write third-party risk while leveraging capital and surplus from an additional captive program

Hard insurance market conditions as well as the landscape for emerging risks are making cell captives even more attractive. While often a good fit for more traditional lines, more and more cell captives today are being used for risks like voluntary benefits, cyber insurance, and excess liability. Further, more domiciles have passed cell captive legislation in recent years, opening doors to many.

As with any assessment regarding alternative risk financing, always start with a feasibility study. While cell captives are growing in popularity and advantageous for many, a thorough analysis of the pros, cons, and other contributing factors specific to your organization, its risk and its objectives, is necessary before any decision is made.

A critical starting point in setting up a captive is the captive feasibility study. Captive feasibility studies come in many forms, and there are no industry standard report formats. As a result, many captive owners do not know what to expect as a final deliverable, and we see many feasibility reports that are severely lacking.

The feasibility study forms the cornerstone for the establishment of a captive and is usually one of the first documents that would be requested for in the event of an audit by the IRS.

Every captive actuarial study should include both qualitative and quantitative aspects. Not only should it clearly map out expected financial results, but it should also highlight important insurance considerations that ensure an appropriate and compliant captive structure.

To help provide a framework, here are five key questions that captive owners should be able to answer based on their captive feasibility study.

1. Do you have appropriate data?

As part of the captive feasibility study process, captive owners should work closely with their current insurance carriers to gather as much high-quality data as possible. The study should reflect at least the following for all proposed lines of coverage:

• All Plan Documents or Summary Plan Descriptions
• Current rates, volumes, exposures, and premiums
• At least 6 years’ worth of prior experience reports, which will show paid premiums, constant premiums, paid claims, and reserves by incurred year
• Large claim, premium rate, and plan change histories

This data will be used to develop future loss estimates once the coverage is placed in the captive. All of it should be readily available, and organizations should be reviewing this data regularly, regardless of whether it is undertaking a captive feasibility study. 

2. Has an actuary reviewed your loss experience?

Once you’ve gathered the necessary experience data, it is important that an experienced actuary review it. All experience reports are different in layout and content, and an actuary will know best how to interpret the data, develop the best estimate of future losses, and ask the right questions of the carrier.  A captive feasibility study should always include a robust actuarial analysis.

A good actuary will ensure that plan changes, rate changes, and overall population changes have been properly reflected in the experience report.  If they aren’t, the actuary can make the necessary adjustments.

The actuary should also review the claim reserves that the carrier is reporting.  In our experience, carriers typically overstate reserves due to conservative assumptions, inflating the loss ratio. A good actuary will independently calculate reserves to compute a more accurate estimate of historical loss ratios and future losses.

3. Do you have a clear sense for the expected administrative expenses – at the start of the program and ongoing?

Administrative expenses related to operating an employee benefits captive include actuarial, captive management, legal, audit, letter of credit (if used for collateral), carrier fronting fees, premium taxes, captive domicile fees, taxes, and state procurement taxes (if domiciled outside of home state).

These fees play a large role in determining whether the captive will be profitable at fully-insured market rates.  If your captive charges rates higher than market rates to turn a profit, then the fees are too high. Carrier fronting fees are typically the largest expense and the most important to get right. Captive owners need to understand how these fees were determined in the captive feasibility study and if they are market competitive and realistic.

We always recommend that a company placing employee benefits in their captive conduct an RFP process to select vendors, and that includes competitive fee arrangements.

4. Is the party that conducted your feasibility study independent, or could there be a conflict of interest?

We have seen many captive feasibility studies completed by non-qualified entities or by organizations that have a vested interest. For instance, many insurance brokers will conduct a high-level analysis to conclude a captive program is not feasible. It is essential to understand the interests of all stakeholders and to work with organizations that have the appropriate credentials to help you make an informed decision.

Find an independent party who can provide an objective, transparent, and unbiased recommendation.

5. Will the coverage qualify as insurance?

Every captive feasibility study must comment in detail on the qualitative aspects of captive insurance including what it means to qualify as insurance. This is an important consideration from a captive owner’s perspective and must be fully understood. There are many case laws that have commented on the lack of understanding of insurance company operations.

For instance, an important aspect of any insurance transaction is that it must achieve risk transfer and risk distribution. There are a few industry-accepted risk transfer tests that will demonstrate that the coverage adequately transfers risk from the insured to the captive.  The “10-10 Test” is the most common, determining whether there is a 10% chance of a 10% loss.  Alternatively, there is the Expected Reinsurance Deficit (ERD) Test where the threshold is an ERD ratio of at least 1%.

Risk distribution requires that the captive distribute its risk among several insureds.  Typical risk distribution tests are meant to ensure that no more than 30%-50% of the risk is from the same insured, and if the captive is a brother-sister insurance company, there must be at least 12 participating entities, each having no more than 15% of the risk.

We also recommend the Coefficient of Variation test to better understand the impact of the law of large numbers.  As the number of independent exposures increases the less volatile actual loss experience will become and therefore more predictable.

Employee benefits or not, all captive feasibility studies should address whether there will be adequate risk transfer and risk distribution.

To summarize, a captive feasibility study is one of the most salient parts of placing employee benefits in a captive.  Captive owners should aim for feasibility or refeasibility studies that are transparent, objective, highly robust, and consider all aspects of the captive transactions.

Our Managing Partner, Karin Landry was in a Q&A with Financer Worldwide, in which she discussed some of the leading healthcare risks and what changes we can expect to see in the insurance market. Check out the full discussion here.

Our Senior Vice President, Teri Weber spoke in a panel discussion hosted by the Boston Business Journal. She discussed the importance of mental health resources during the pandemic. Check out the article here.

Our Senior Vice President, Teri Weber published an article in the Boston Business Journal explaining how organizations can better support employees who also act as caregivers. Check out the full article here.

In Risk & Insurance’s March 2021 magazine, they spotlight research conducted by Spring and quote our Managing Partner, Karin Landry. Check out the magazine here.