By DAVE LENCKUS, who has covered the captive insurance industry for many years
Only a couple dozen employers fund long-term disability and life benefits through captive
insurers. Just a single employer has won government approval to finance its retiree medical benefits through its captive. Relatively few employers use their facilities to write their medical stop-loss protection.
More than a decade after the U.S. Department of Labor first approved an employer's plan to fund employee benefits through its captive, the take-up rate among employers has not mushroomed as anticipated.
Benefits experts had anticipated that dozens or even hundreds of employers would follow the lead of Columbia Energy Corp. Ltd., which won labor department approval in late 2000 to fund its employees' long-term disability and life benefits by reinsuring them into its captive.
So far, 24 others have.
Last year, Coca-Cola Co. became the first employer to obtain federal approval to fund retiree medical benefits in its captive. Coca-Cola's process involves using a voluntary employees' beneficiary association to purchase stop-loss policies for retirees and then reinsuring the coverage into one of the company's captives.
Even funding a plan sponsor's medical stop-loss protection though a captive has attracted only a small percentage of employee health benefit plan sponsors, mostly Fortune 500 companies. And that risk financing approach does not even require government approval, since it involves the employer's risk rather than plan participants' benefits.
Those small numbers, however, do not reflect the value that funding benefits in captives offers employers, benefits experts said. But, they acknowledge, the captive insurance approach might not be for everyone for one or more reasons, including:
-- The resulting advantages for the parent company might be insufficient for the time and effort required to set up the funding arrangement.
-- Tax questions stemming from the health insurance reform law could be too vexing for some health plan sponsors, compelling them to wait until those uncertainties are formally resolved before deciding whether to fund employee or retiree health care or the company's own medical stop-loss coverage through their captives.
-- The relationship between a company's risk management and human resources departments might not be strong enough for the two areas to come together on
Despite the totals, the notion of funding long-term disability and life benefits in captives still generates "a lot of excitement" among employers, which "routinely" consider this option, said Karin Landry, managing partner with Spring Consulting Group LLC of Boston.
The appeal is manifold, consultants said. Employers typically can reduce their costs 15 percent to 25 percent by eliminating commercial insurers' profit margin and earning float on their cash flow. The added business balances out the captive's property/casualty risk exposures; captives provide underwriting flexibility and the claims data to use that flexibility soundly. Benefits funding might provide enough third-party business to trigger tax benefits on the reserves of all of the captive's business.
The problem for many employers is that they already are committing much of their energies to employee health care issues, Landry said.
Employers in recent years also have delayed their alternative benefits funding plans while dealing with demands created by the faltering economy, said Nancy Gray, the Burlington, Vt.-based regional managing director-Americas at Aon Global Insurance Managers.
Another key problem for many employers is the commitment required. "The effort involved puts people off because the thought of dealing with the Department of Labor is intimidating," said Gary Osborne, president USA Risk Group, a captive management company. Nor does everyone need third-party business for a tax deduction. "The cost savings are not always that great considering the need to enhance the plan and the effort to notify participants," he said.
Employers should figure on one to three years from the first days of the evaluation period to implementation, said Joseph J. Poplaski senior vice president and chief actuary for group benefits at Liberty Mutual Insurance Co.
That time horizon lengthens if the employer does not have an existing captive, because the labor department wants to see a year of audited financial statements from a captive before the agency will consider a plan sponsor's application, Poplaski said.
And then there is no guarantee that the employer will have "a profitable experience" in the short term, given the costs--such as fronting fees--of setting up the arrangements, Aon's Gray said. However, she stressed, long-term cost savings are likely.
For some employers, funding benefits through captives is not practical, experts said.
For example, smaller companies do not have the economies of scale necessary to make covering long-term disability and life benefits in captives worthwhile, said Kathleen Waslov, senior vice president and senior resource consultant, Captive Consulting and Multinational Employee Benefits for Willis of Massachusetts Inc. of Boston.
Waslov estimated that employers need about 5,000 covered lives to cost-efficiently fund those in captives.
For medical stop-loss coverage, employers need far fewer covered lives, Waslov said. Five hundred would be sufficient. But with that small of a group, the more economical approach is to join a group captive, she said. An employer that insists on funding that risk in its own captive would need enough lives to generate about $1 million of health care expenditures, she said.
Small to middle market companies--those with 500 to 5,000 lives--increasingly are interested in pooling, Waslov said.
Even some companies with 50 to 100 lives are exploring this possibility, she said. "Employers are so desperate for savings, they're saying, 'Why can't I join?'"
Indeed, Waslov expects the real explosion in the use of captives for funding benefits, particularly health care plans, will be ignited by small to midsized employers.
Plan sponsors should be able to count on many other returns from funding benefits in captives, maintained Mitchell Cole, a director in the international consulting group of Towers Watson & Co. in Stamford, Conn.
Otherwise, "it's better to not look at a captive as a solution" Cole said. "If a captive doesn't measure up, then why pursue it?"
For example, a captive should yield access to additional external and internal capacity.
Externally, a captive should expand the number of reinsurers the facility can turn to for medical stop-loss coverage, more than doubling the amount of available capacity.
Internally, a captive that writes medical stop-loss coverage can aid a parent company's subsidiaries that cannot bear as much risk as other affiliates.
A facility also gives its owner flexibility in designing unique coverages. Cole, however, pointedly omitted the prospect of counting benefits as third-party business. By focusing on that, "you're permitting a tax tail to wag the captive," he said.
"Things need to stand on their own financial legs." After the financial considerations, then the possible tax advantage can be mulled, he said. However, he said, the IRS has not definitely articulated the conditions under which it would treat employee benefits coverage as third-party business.
Another stumbling block for employers that are considering using their captives to fund benefits is a provision of the new health care insurance reform law.
In amending Section 162(m)(6) of the Internal Revenue Code, the Patient Protection and Affordability Care Act cut in half the tax deduction that health care insurers can take for executive compensation costs. The provision limits tax deductions to the first $500,000 of compensation. The previous ceiling was $1 million of compensation.
One question that has arisen for employers is whether the provision applies to employers with captives that write medical stop-loss coverage.
"Most people feel it really shouldn't apply but to direct writing health insurance companies," said Landry of Spring Consulting. "But the definition is currently gray, so a lot of people are staying away from it" until the Internal Revenue Service and U.S. Treasury determine whether Congress intended the PPACA to sweep in captives along with commercial insurers.
An even greater danger is that the provision would apply to companies seeking to fund retiree medical benefits through their captive, said Cole of Towers Watson.
"Now, would 162(m) apply to active and retiree medical coverage? That's far less clear," Cole said. "One could argue it does. But was it the intent of the legislation?"
A reasonable conclusion is that the health reform law does not apply to active or retiree health care coverage financed through captives, since a plan sponsor's captive is not designed to insure the general public, and Congress never discussed applying the provision to captives, he said.
Other problems aside, the silo walls between risk management and human resources could pose challenges for employers considering funding benefits through captives.
"Having these two groups come together is sometimes complicated; they have different strategies and priorities," said Michael Cormier, New York-based chief executive officer of the Global Captive Solutions Group at Marsh Inc.
"The human resources manager and the risk manager don't get along," Osborne said. "This is absolutely a real hindrance to these programs-- the human resources manager thinks the risk manager is invading his or her turf or that they will be asked why they didn't suggest this before."
Clear communications with human resources and assurance that its corporate role is not being threatened is critical, said Poplaski of Liberty Mutual.
For human resources, insurance attracts the best employee talent, while risk management views it as a cost of doing business, Poplaski explained.
Human resources departments are sensitive to those different perspectives, because corporate finance departments already question the cost of benefits, he said. "Now, risk management is stepping into the picture."
So human resources departments "feel like they're getting squeezed," he said. They have to be assured that using a captive is a better way to cover benefits costs and that human resources "is not being told which benefits to offer."
Essentially, Poplaski said: "One area of the company has a tool to benefit another area that doesn't understand the tool and questions if it's a threat. A bridge needs to be built between risk management and human resources."
But Marsh's Cormier said he "could see" either human resources or risk management starting the discussion of using a captive as a benefits funding vehicle.
"Sometimes benefits consultants talk to the human resources manager about funding vehicles, and some risk management professionals are looking for third-party business or a consistent financing strategy for property/casualty risks and employee benefits costs," he said.
In any case, he said, "to pull it off, both have to be interested in it."
Poplaski also pointed out that corporate purchasing departments are more involved in procuring insurance, so the lines of communication have to be opened to that group, too.
"It's a more complex buying decision than procurement is usually involved in," because benefits represents "a value buy--you want to make sure employees feel good" about it, he said.
For whatever reasons the approach might seem unappealing, using a captive to fund benefits is the right answer for companies that have a strong commitment to risk management and are financially sound, Poplaski said.
For too many employers that are not considering it, however, the unfortunate reason is a lack of familiarity about this financing mechanism, Towers Watson's Cole said. "Sometimes it's easier dealing with only what you know about rather than venturing into territory that's unusual or different."
March 1, 2011
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