By JACK ROBERTS, who consults with insurance brokers, carriers, risk managers and media companies
For healthcare professional liability risk, captives have become the risk mitigation strategy of choice. Hospitals, medical centers, physician practices and nursing homes rely on risk retention groups and single-parent, "pure" insurance captives to transfer medical malpractice liability risk to their captives.
With the risks associated with the new healthcare reform law, healthcare institutions will rely on captives even more as the industry's most important risk-transfer option. A.M. Best reports, for example, that healthcare-related risks now comprise more than 55 percent of all captive insurance companies in operation.
David Provost, deputy commissioner of the Vermont Department of Banking, Insurance, Securities and Health Care Administration, said that healthcare institutions are probably the fastest growing captive industry sector in Vermont, and that healthcare captives could become the largest individual industry sector among the state's captive population this year.
Healthcare institutions choose a Vermont domicile because of the state's solid regulatory reputation, including its responsive legislature and regulatory environment; its expertise in professional liability and medical malpractice liability; its captive infrastructure and industry; its cost advantages; and, possibly the most important near-term trend, the national political issues that make offshore domiciles less attractive to U.S.-based companies.
Especially as new liability risks for Vermont's healthcare captive community are identified under the federal health reform law, more premium dollars for the medical professional liability coverage will flow through healthcare captives domiciled in Vermont.
"The commitment that we see coming from Vermont is critical to our company," said Timothy J. Padovese, CEO of the Ophthalmic Mutual Insurance Co. (OMIC), a risk retention group for 4,250 ophthalmologists nationwide. OMIC was originally domiciled in Colorado in 1987 but moved its domicile to Vermont in 1991.
Vermont licensed 33 new captives in 2010. Captive formation growth will accelerate, if a hard property-casualty insurance market develops. Historically, captive formations tend to follow the commercial insurance markets. When the market is soft, formations decrease in the face of lower commercial insurance prices and stronger competition from the traditional insurance markets. In hard markets, formations quickly increase because the insurance premiums are high and often coverage isn't available to specialty markets such as medical professional liability.
In 2010, Vermont had 576 active captives, solidifying its position as the largest U.S. domicile for captives. And, last year, Vermont reached its No. 900 captive license since the state began its captive operations. Vermont is known as the home of the very largest captives, although officials estimate that about 25 percent of the state's captives have less than $1 million in gross written premiums. In 2010, Vermont captives had in excess of $17 billion in total gross written premiums. Reflecting its big captive reputation, 42 Fortune 100 companies make Vermont the domicile for their captives.
Vermont's reputation dates back to 1981 when the state licensed its first captive for BFGoodrich. Historically, the Cayman Islands had the reputation as the home to medical and healthcare captives, but today the Caymans has strong competition from domestic domiciles like Vermont. In 2010, Vermont licensed five healthcare captives including EmblemHealth Inc., the Albert Einstein Healthcare Network's captive (see article on Page A-8), a group of Midwestern physician practices, a captive for nursing homes and healthcare agencies, and a group of New Hampshire hospitals.
HEALTHCARE REFORM RISK
"A captive gives you great flexibility to adjust coverages," said Dianne Salter, senior vice president for insurance at Jefferson Health System in Philadelphia. "You can react very quickly and intelligently to changing conditions. This flexibility, I think, will be very important as healthcare reform becomes a reality in the coming years."
Jefferson started its own risk retention group domiciled in Vermont in 2002. It insures the largest healthcare system in the Philadelphia region, which includes hospitals, physicians and other medical professionals and the Jefferson University medical school, for the system's primary layer of general and professional medical liability. The facility last year had about $56 million in gross written premiums.
Salter joined Jefferson in 2002 from Marsh & McLennan, where she worked with clients to help set up captive services. After she joined Jefferson, her initial task was to set up the Vermont captive, which began operation in December 2002. At the time, Jefferson, along with the healthcare industry, was in the middle of the medical malpractice crisis with commercial coverage often not available, especially for very large risks. And even today, especially for excess coverage attaching at less than $10 million, it can be very difficult to get coverage in the commercial markets.
Nancy Gray, regional managing director for Aon Risk Solutions, agreed with the assessment that flexibility is an important asset for healthcare captives. "Healthcare reform is evolving and a captive gives owners more options. Those options are increasingly important as the industry continues to consolidate with healthcare reform. As more hospitals buy physician practices, for example, a captive can make a lot of sense."
Richard Smith, executive director of the Vermont Captive Insurance Association, said the association has targeted healthcare captives as a growing market for membership. And he agrees that healthcare reform may bring the captive community some new opportunities. "Every part of the healthcare industry is grappling with what healthcare reform will mean to them. Certainly with all the aspects to healthcare, there are some very smart people looking at emerging risks," Smith said. And he agreed that the inherent flexibility in the captive structure lends itself to the changing healthcare landscape.
Because of the nature of professional medical liability risks, healthcare companies and groups frequently choose to insure through risk retention groups, in addition to pure captives. A risk retention group is an alternative risk mechanism created by the federal government under the Liability Risk Retention Act of 1986. Risk retention groups currently can insure only liability risks, although there is a proposal to allow property coverage, which should spur opportunities for alternative risk opportunities for hospitals with large property exposures. Regulatory oversight for a risk retention group is the job of the domicile, where the risk retention group is located. Under the federal law, generally risk retention groups don't have to follow the insurance regulatory process of all 50 states, only those of the domicile. Risk retention groups also offer, in many cases, a particular advantage for malpractice risks. Risk retention groups, because they are organized as insurance companies, would qualify for coverage under a state's medical malpractice funds, such as the Pennsylvania MCARE program. Permission is required by the particular state to participate in the program, and generally risk retention groups can obtain that permission because they would qualify as an insurance company. The other option for a pure captive would be to use a "fronting" insurance carrier to access those funds. In effect, the fronting carrier issues the insurance policy and then cedes all or part of the risk to the captive. As Salter said, however, fronting involves expensive costs. "From a cost perspective, the idea of paying $400,000 to $500,000 to a fronting carrier for a risk like ours doesn't make sense," she said. But, the challenge without a front is that you must operate the risk retention group like an insurance company and have the required administrative and professional staff to be a success. Also, with a front you lose important control of the captive itself to the commercial insurance carrier.
The Opthalmic Mutual Company's Padovese said regulatory flexibility is a big advantage for OMIC because it writes coverage in all 50 states. "I have to only file my rates in Vermont. If I had to file every change in rates or policies in all 50 states, I would have to increase my staff and it would probably drive me crazy," he said. With Vermont as its regulator, there are few, if any, objections by other state departments of insurance to Vermont, Padovese said.
Richard Cornelius, legal advisor to two Vermont captives that were created for community hospitals in Indiana and Oklahoma cited another regulatory advantage. "Vermont has a very strong history of long-term stability among its administrators. Other domiciles don't have that stability," he said.
Because of the nature of medical malpractice liability, healthcare institutions are shy about publicity. Malpractice claims, depending upon the state, can be huge. But states that have enacted caps on court judgments for nonmedical damages, such as pain and suffering, have seen rates slow or even decline.
Malpractice liability is probably the catalyst for starting many captives, Cornelius said. "Clearly the malpractice crisis, which affected the availability of coverage for physicians and hospitals, was a strong impetus for captive formations in the 1990s," he said. "Malpractice insurance just wasn't available when the industry was in crisis." A captive at that time was the only option when the large liability insurance carriers exited the market or went out of business.
COSTS AND THE SMELL TEST
Vermont gets some criticism for being an expensive domicile. Gary Osborne, president of USA Risk Group, said the cost difference between Vermont and offshore domiciles is marginal. "The cost structure is really not that much more than going offshore," he said. The real advantage, he said, for healthcare captives is that a domestic captive location, especially Vermont, won't raise any red flags. "What do you do when one of your members calls and finds out that the board is on a three-day meeting in the Caymans?" one captive owner said. Indeed, for pharmaceutical companies and physicians there are now government restrictions on entertaining physicians in expensive locales. "It just doesn't give the right impression," Osborne said.
He said, "There is a geographic advantage to a location in the northeast, like Vermont." The cost of traveling and staying in Vermont, he said, is much less expensive and less time consuming than a trip to the Caymans or the British Virgin Islands.
"There is no objective reason to go offshore" Cornelius said. His members, community hospitals which are often nonprofit and serve conservative Midwestern communities, would find that an offshore location "doesn't have a good smell to our small communities." Once there may have been an advantage because some of the offshore domiciles could write physician liability business, but that's no longer the case.
The other political factor is that offshore domiciles have been under political attack, as federal lawmakers look for ways to tax income from foreign-based companies that do business in the United States. Offshore investment income generally isn't subject to federal tax, until the funds are repatriated to the United States. However, most offshore captives make a decision to be taxed as a U.S. entity, so the issue is one that affects older captives that chose not to make that tax decision. "The issue is mostly one of perception," Provost said.
The offshore captive industry is an easy target. Osborne of USA Risk said that the issue in healthcare is "perception, perception, perception." He knows of cases in which healthcare operations "got major grief in the local press for an offshore location."
For Jefferson's Salter, the ability to fund loss control and risk management programs and initiatives may be the most important advantage to a captive. "I think we have made some real strides using the captive. We continue to identify areas of opportunities and new initiatives," she said. For a hospital, risk management is critical. "At Jefferson, our programs and commitment come from the bottom up and it permeates all our operations."
Strong risk management and loss control at captive sponsors is critical, if only to prevent losses. A captive can realize a significant cost savings with strong risk management, claims administration and loss control.
OMIC's Padovese said, "We pride ourselves in risk management." Because OMIC only insures ophthalmology, it has strong, specialized expertise in both claims handling and risk management. "We do national programs with 500 to 700 doctors in a room at the annual ophthalmology conference. Those sessions are just focused on risk management," he said. In addition, they offer members online seminars and regional conferences.
The result, Padovese said, is that "our loss experience is 30 percent better than the industry." And last year OMIC paid its members a 10 percent dividend, stemming from both its strong loss ratio and higher returns on its investment portfolio. With a 40 percent market share, OMIC last year had $42 million in gross written premiums.
For many healthcare companies, the Cayman Islands have been an easy choice as the captive domicile for a healthcare organization, largely because so many healthcare captives had chosen the Caymans in the early 1980s. Caymans marketed its captive options to the healthcare industry, especially its ability to write physicians' liability. "Caymans is the home to the big healthcare captives, but they don't generally see the smaller ones. They have great medical liability expertise, but now they are expanding into other industries," said Christina Mancini, CEO of Captive.Com. Now, she said, much the same is true of Vermont. "Vermont has the medical expertise," especially the underwriting expertise, Mancini said.
Vermont's Provost acknowledges that healthcare captives were the Caymans' "stock and trade." But he said that Vermont has been the home to healthcare captives since 1989. "We can basically write any professional and general liability for healthcare organizations," Provost said.
Provost said there's a large base of healthcare captives in Vermont and plenty of support and talent in the Vermont captive community. "You can network and learn with lots of other owners and support people who know the professional liability medical market," he said.
VCIA's Smith said his group has targeted healthcare captives. "For years, healthcare was associated with offshore domiciles. It was probably a misperception,'' he said. "Maybe we didn't do as good a job as we could have marketing domestic domiciles to healthcare operations. Now we're marketing to them."
Growth of healthcare captives stands to benefit many in Vermont.
"The captive industry is important to a (small) state like Vermont," said Aon's Gray. Indeed, Vermont's peers and colleagues at other domiciles see the state as a first-class regulator. And it's not just important to the state of Vermont because of the premium tax it generates, she said. "There's a large infrastructure that has built up around the Vermont captive community--auditors, actuaries, captive services managers, lawyers, and so forth,'' Gray said. "That's especially important to Vermont because of the number of jobs it generates and the benefit to the Vermont economy."
May 1, 2011
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