Using a captive insurer to fund certain types of employee benefits can offer significant savings to some employers, while at the same time increasing the employee benefits available to workers. This kind of a “win win” scenario makes sense in a lot of different situations, but it is important that an interested employer work with the right technical and legal expertise to achieve the best proper result and garner the necessary regulatory approvals.
Working with experts in the employee benefits captive field is proving to be even more important currently as some of the rules for funding employee benefits in captives are under review. Employee benefit captives will continue to be formed even as new requirements are implemented for the approval of certain types of captive transactions by the Department of Labor (DOL).
The process to fund certain employee benefits in a captive has historically allowed companies the option to choose one of several vetted and approved routes. Many of these routes require certain applications to be approved by the U.S. Department of Labor (DOL). To determine whether an application needs approval, companies need to ask themselves these questions:
- Are the benefits subject to Employee Retirement Income Security Act of 1974 (ERISA)?
- Is the captive a “party in interest” (for example, a captive more than 50% owned by a Plan Sponsor) with respect to the employee benefits plan?
- If a party in interest, will the captive furnish services or use plan assets in such a way that the prohibited transaction rules of ERISA apply?
If the answer is yes to any one of these questions, the Plan Sponsor (employer) must file for a Prohibited Transaction Exemption (PTE) as defined under ERISA. In other words, because the captive offers benefits to the plan sponsor, and because the law prohibits the plan sponsor and others from using the plan to benefit them, the DOL must review the arrangement and determine that it is also in the best interests of the plan participants (the employees) to grant an exemption.
Generally, there have been three approaches to PTEs to receive DOL approval. Plan sponsors can follow one of the following paths:
- Statutory Exemption– Under ERISA, the Act provides a 5% exemption for typically commercial insurers that insure their own benefits. No DOL application or additional approval is required, because the law itself creates the exemption.
- Class Exemption – PTE 79-41, created by the DOL, provides an exemption if the captive has 50% or more of unrelated business, and can write the benefits program directly. No specific DOL application or additional approval is required, because DOL has “preapproved” any transaction meeting the conditions in the class exemption.
- Individual Exemption – Individual exemptions require the plan to apply to the DOL for approval. They fall into two categories:
- Standard process – Each application is individually reviewed based on its individual features and provisions, and DOL decides whether to approve it. About 25% of the recent DOL applications for captive benefits granted have followed the individual exemptions process.
- ExPro process – This is an expedited version of the standard process and this is what is currently under review. To achieve ExPro approval, the transaction described in the application has to be substantially the same as two previously granted exemptions. About 75% of recent DOL applications for captive benefits granted have followed this process.
Under the current “ExPro” process, an exemption application receives final authorization from the DOL to proceed within 78 days from the acknowledgement of receipt by the DOL. The rules and special application process for ExPro are governed by the conditions of PTE 96-62. This class exemption defining the rules of the expedited process (ExPro) requires an application either to (1) cite at least two substantially similar transactions which were the subject of individual exemptions within a 5 year period, or (2) one substantially similar individual exemption granted by the DOL within 10 years, and one substantially similar transaction authorized through ExPro within 5 years. The ExPro application must also explain why any differences should not be considered material.
The DOL has quietly let it be known that it is reviewing the captive insurer exemption requirements and processes. During that review period, the ExPro process will be unavailable to captive applicants (it will still be used for noncaptive insurer matters). While some have voiced concern that this temporary suspension of the DOL ExPro process has no fixed end-date, this does not mean the Department has ceased to review and process applications for captive insurers. In fact, they are actively doing so, and are asking that applicants use the standard process. Even in the standard process, applicants are well advised to continue explaining how their transactions are substantially similar to those for which exemptions were previously granted.
Using the standard process, the requirement to rule in 78 days is eliminated, sometimes leading to a longer approval process. While some have voiced concerns over this temporary suspension of the ExPro process, our view, based on a number of discussions with the DOL, is that the outcome of the review is likely to produce a more defined and streamlined process for accelerated approval. We also believe that this review was necessary in any event, because as the attached chart illustrates, some of the important captive exemptions are about to reach their five or 10 year anniversaries, making application of the ExPro process more difficult as fewer exemptions meet the time requirements or are very different from the typical ExPro filing.
In the meantime, employers are continuing to form employee benefits captives using the other routes available to them.
The chart above illustrates the Individual Prohibited Transaction Exemptions that can be referenced when submitting an application under the ExPro process. In early 2013, Archer Daniels Midland will drop off the list for citation. Therefore, the ExPro process will have fewer substantially similar exemptions to be referenced based on the guidelines the DOL originally outlined under the PTE 96- 62.
In addition, while the existing ExPro process offers consistent outcomes, it does not provide a standardized approach that adjusts to or satisfies current market conditions. In shutting down the ExPro route for now, DOL has the opportunity to take into account the fact that Archer Daniels Midland will sunset, approve new exemptions allowing greater variability in benefits enhancements and independent fiduciary reports, and to provide consistency around the evaluation of these areas.
Recent applicants submitting individual exemptions under the standard process were asked to provide answers to a dozen questions that are focused around benefit enhancement criteria, such as:
- What percentage of plan participants can utilize the enhancement? If less than 100 percent, please explain the reason.
- Does the enhancement affect the total premium rate paid by participants? If so, what is the rate increase, expressed as a percentage of the total premiums before the enhancement?
- Please explain how the enhancement will be useful to plan participants and protective of the plan?
The timing of the DOL return to the ExPro process is unknown. In the meantime, the DOL, along with industry experts, are addressing these issues as individual exemptions move forward, structuring a new process that could be beneficial for the DOL and companies exploring their funding options with regards to their employee benefit programs. Engaging the DOL now with well-crafted individual exemption applications can form the basis for a new and improved Ex-Pro process, benefiting everyone… especially plan participants.
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