Most mid-sized and large employers have taken the step to self-insure their medical insurance plans, which removes margin and profits on these programs. But about two dozen companies in the United States have taken this to the next level by self-funding employee benefit plans through single company captive insurance companies.
A captive insurance company is an entity formed to self-finance insurance risk. “Premiums” are paid to the captive, reserves are held, administrative expenses and claims are paid. However, unlike an insurance company, it is designed solely for the risks of the sponsoring company. A captive makes actuarially based reserves tax-deductible and provides a level cash flow to fund claims that can be variable from year to year. By contrast under a traditional self-insured arrangement, reserves are not deductible and there can be wide fluctuation in cash flows.
Some companies have used captives to fund life and long term disability claims since these are relatively predictable loss programs and the wide year over year variations can be softened by reinsurance agreements. For example, the captive company can assume the first $2,000 per month of long term disability benefit or the first $50,000 of a life insurance claim.
So why aren’t more employers using captives? One answer is that the Department of Labor, which governs and approves captives funding employee benefit plans under ERISA, doesn’t make it easy. Although they have developed a shortened approval timeline, the process is arduous at best. Another reason is that it seems there is no bottom to fully insured life and disability rates. Insurance companies are willing to put long guarantees on these programs. This makes staying insured far more appealing particularly when considering the costs and effort required to get a captive entity off the ground.
But there is a growing trend that I find very attractive as we face spiraling healthcare costs in the era of PPACA: using captives as a layer in a medical stop loss program. Many clients are concerned with predictability and stability of healthcare costs and in response, we have recommended lower levels of stop loss insurance to reduce year over year volatility.
These lower levels come at a cost. Premiums for low threshold stop loss can be significant because they are relatively predictable and have greater frequency. Coverage at high levels where the claims aren’t seen often is relatively inexpensive.
So to reduce the cost of buying this insurance, it makes sense to consider using the captive to fund claims, for example, from $75,000 to $150,000. Companies can then buy traditional stop loss for claims exceeding $150,000. As captive reserves build, the retained limit can be increased and potentially eliminated.
Make no mistake, this strategy is not for everyone — but for the trailblazers, it may be worth the effort.