The "benefits" of captive ownership

A group captive can help small and mid-sized employers achieve
affordable health coverage

By Michael J. Moody, MBA, ARM

One of the major reasons for an organization(s) forming a captive is the flexibility that it can bring to a corporation’s risk-financing program. Certainly a properly formed captive can reduce expenses for its parent. Lower operating costs, elimination of agents’ commissions and profit for the insurance company, as well as direct access to reinsurance have all proven to mitigate the cost of coverage.

Add to this the fact that the captive can invest its reserves, and it is easy to see why comparable coverage in the traditional market typically has a higher premium. Another advantage is the fact that the captive may be able to offer coverage that is difficult to obtain, or unavailable in the open market; and it is easy to see the benefit of captive ownership.

Over the past few years, due in large part to the crisis in the financial service sector, many captive owners have been searching for ways to maximize the value of their captives. One of the topics that is frequently discussed with regard to captive expansion is employee benefits. Adding employee benefits to the captive’s portfolio of risks offers a number of advantages, and increasing numbers of captive owners have been investigating this idea. In fact, the number of employers moving a portion of their employee benefits to a captive has been growing in recent years.

It is easy to see why employers would be interested in the potential savings available from including benefit programs in a captive. Thanks to double-digit annual inflation over the past 20 years, health insurance has become one of the most costly expenses corporations incur. However, the current administration’s effort to reform the health insurance industry has caused some organizations to push this topic to the back burner. But now, the logjam in Congress has once again put meaningful health reform in jeopardy. As a result, employers who had taken a wait-and-see attitude with regard to putting their employee benefits in a captive are again taking a serious look at this possibility.

”Benefiting” from early adopters

For years, employers that wanted to consider including employee benefits within their captives had a pretty steep regulatory mountain to climb. Since many U.S. employee benefit plans come under the authority of the Employee Retirement Income Security Act (ERISA), they are subject to a number of federal standards. Most of these standards greatly limit the ability of an employer with regard to funding the benefits, and they typically require an exemption from the U.S. Department of Labor (DoL) to deviate from them. Employers had been aware of the major advantages of including benefits in their captives:

• Cost savings—for example, it has widely been publicized that recently approved DHL Corp. will save about 25% over their traditionally purchased long-term disability (LTD) coverage

• Diversity of risks

• Potential tax advantages from third-party business

However, few employers were willing to invest the necessary time and money involved in securing the exemption.

One of the first organizations (CSX Corp.) that unsuccessfully attempted to secure a DoL exemption spent years trying to gain acceptance and ultimately gave up. Several other corporations, however, had better success; and in 2000, Columbia Energy became the first to gain DoL approval to include employee benefits in its captive. Archer Daniels Midland (ADM) also obtained approval some two years later. Both organizations elected to reinsure their group term life and AD&D coverages via their existing captives.

The significance of the approval of ADM’s plan was that it triggered an internal DoL procedure known as EXPRO that requires that the Department must respond to an application within months, not years, as long as the risk-financing plans are similar to previous approvals. So when the second approval was completed, many experts believed that this would open up the floodgates for other corporations to begin using the expedited approval process. However, for a host of reasons, this never happened, and today there are still fewer than two dozen companies that have taken advantage of DoL’s EXPRO process. Many industry experts have indicated that a number of captive owners are still contemplating adding employee benefits into their captives.

A road less traveled

In addition to what has become the norm (those programs that can avail themselves of the EXPRO process), there have been attempts by a number of employers to expand usage beyond the group life and long-term disability coverages. Employee health coverage is one area where there has been a growing interest in utilizing captives. In the past, corporations typically have shied away from using a captive for health insurance coverages. The primary reason for this is that since the timing of the premium payments and claims payments is so short, there is little opportunity for holding reserves and thus earning investment income. The captive concept typically works best in situations where there is a longer payout period available.

The recent interest in using captives for group health coverage is being driven by small to mid-sized employers (50 to 1,000 employees) which are seeing the highest percentage rate increases from the traditional market and have the fewest alternatives to reduce overall costs. For the most part, this interest centers on group captives that can assist in lowering costs.

The concept of group health solutions is not new to this market; employers previously have been able to utilize funding options such as Multiple Employer Welfare Arrangements (MEWA) to form coalitions to purchase coverage. The primary benefit of the MEWA has been the use of the purchasing power of the group to lower the costs. The use of the group captive can provide similar advantages without as much administrative involvement.

Another recent example shows the extent of innovation in this market. The December 22, 2009, issue of the Federal Register made note of the fact that The Coca-Cola Co. had received tentative authorization to use their captive for funding retiree health care benefits. Coca-Cola had been working for more than a year to win authorization for its unique funding approach. In essence, Coca-Cola wanted to utilize its South Carolina captive, Red Re, to take the assets already held in a Voluntary Employees Beneficiary Association (VEBA) trust and purchase medical stop loss insurance. The captive would then be able to pay claims over the expected lifetimes of about 4,000 retirees and dependents. Prudential, the fronting carrier involved with the transaction, would reinsure the retiree health risk directly to Red Re.

This approach was designed to offer Coca-Cola greater financial flexibility by being able to release the assets from under the more restrictive VEBA. The company established the VEBA in 2006 and has contributed more than $216 million to the trust. Freeing the funds held by the VEBA will let Coca-Cola reduce the overall cost of the program as well as offer additional benefits to the retirees. At this point, a number of benefits experts note that there are significant financial advantages to Coca-Cola’s innovative approach.

Conclusion

Congress has been working for more than a year to pass some form of the president’s signature legislation, the overhaul of the nation’s health insurance programs. While hopes were initially high a year ago, today with the Democratic Party’s loss of its “super majority” in the Senate, progress has slowed and the final resolution is very much in doubt.

Despite the effort that Congress and the administration have expended on this matter, employers continue to see escalating employee benefit costs. As a result, many employers are once again investigating the feasibility of expanding the use of their captives. Additionally, a number of innovative approaches for other benefit plans, such as retiree health and pensions, are moving forward rapidly. As a result, a number of employee benefit experts are predicting significant growth in the use of captives.

From a strategic planning standpoint, the use of a captive in the employee benefits arena represents one of the biggest growth opportunities for agents and brokers. This opportunity can be a real door opener for prospective accounts or a great value-added service for existing business.