Fronting vital for benefits captives

BONITA SPRINGS, Fla.—Selecting a fronting insurer to issue policies and provide services is an essential component of funding employee benefit risks through captive insurance companies, a panel of experts says.

For regulatory reasons, employer requirements include using a fronting insurer, which typically reinsures all or most of the risk with the employer's captive. Under procedures adopted nearly a decade ago, the Labor Department requires the employer to select an insurer with a rating of least A from A.M. Best Co. Inc. to win its approval of their captive benefit funding applications.

Not only is selection of a fronting insurer a regulatory requirement, it also is practical, says Suzanne Gallie, senior risk manager in the corporate risk management department at Sun Microsystems Inc. in Broomfield, Colo. Speaking last week at the 19th annual World Captive Forum in Bonita Springs, Fla., Ms. Gallie said fronting insurers used for benefit captives perform vital functions such as underwriting, collecting data, and administering and paying claims. Sun uses a Vermont branch of its Bermuda captive insurer to fund life insurance risks.

Employers, though, have about a dozen insurers from which to choose in the captive benefits market.

“Recognize that this is not a large pool,” said Jeffrey Fitzgerald, an associate director in the Charleston, S.C., office of captive manager and consultant Strategic Risk Solutions.

A key reason why more insurers have not entered the captive benefits market is that profits are modest. In such arrangements, the captive reaps underwriting profits and investment gains, while the fronting insurer is paid a fee that may be far short of what it could earn by taking on the risk, insurers say.

Still, some of the biggest names in the commercial insurance industry, including units of American International Group Inc., Aetna Inc., CIGNA Corp., Hartford Insurance Group, Liberty Mutual Insurance Co., MetLife Inc., Minnesota Life Insurance Co., Prudential Insurance Co. of America and Unum Group, have fronted captive benefit funding programs.

While the profits may be modest, insurers are attracted because the business can build a long-term relationship with an employer that can lead to the insurer providing coverage in other lines, said David Brooker, vp-advanced markets in Prudential's Silver Spring, Md., office.

Just as few insurers front captive benefit programs, only about 15 employers are using captives to fund benefit risks of their U.S. employees.

One reason more employers are not using captives to fund benefit risks is a lack of understanding by corporate benefit and human resources departments of how captives operate.

“It takes time to educate HR on captives. Many don't understand captives and it will take awhile for HR to develop a comfort level,” Ms. Gallie said.

“There is a fear of loss of control on the part of HR. Unless risk management steps in and takes the lead,” captive benefits funding “will not happen,” said Bill Fitzpatrick, vp-corporate risk benefits, insurance and risk management in London with DHL GBS Ltd., a unit of Germany-based delivery giant Deutsche Post A.G.

DHL has been funding benefits of tens of thousands of non-U.S. employees through captives for about a decade and received Labor Department approval last year to fund long-term disability coverage for U.S. employees.

At times, HR managers will argue that there are no funds to pay for a captive benefits funding feasibility study. Ms. Gallie suggests a simple solution: Have the captive pay for the study.

Overcoming those hurdles can be worth it. Funding benefits through captives can generate annual savings between 5% and 15% a year compared with buying coverage from commercial insurers, said Kathleen Waslov, a consultant with Towers Perrin in Boston.

There are other savings as well, said Jim Long, worldwide multinational director with Alico Global Benefits Network in New York.

For example, because the Internal Revenue Service under a 1992 ruling considers employee benefits risks to be unrelated business, a captive could have enough third-party business for the parent to be allowed take a tax deduction for the property/casualty insurance premiums paid to the captive.

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