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Captive insurers help employers cut voluntary benefits costs

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Captive insurers help employers cut voluntary benefits costs

For more than a decade, a small but growing number of employers have been using an unusual but cost-effective way to fund parts of their employee benefits programs.

Those employers, which include large and well-known companies such as Alcoa Inc., Archer Daniels Midland Co., Coca-Cola Co., Google Inc., Microsoft Corp. and United Technologies Corp., are using their captive insurance companies to fund a variety of benefits plans, including accidental death and dismemberment, life insurance and long-term disability coverage.

Employers taking this approach have several business objectives. One is to cut benefits costs by using their captives, rather than having an outside insurer take on some or all of the risk by paying what could be an expensive premium. A good rule of thumb is that over the long run, employers taking this approach can cut benefits coverage costs funded through their captives by 5% to 15%.

“There is a value in this. There are cost savings, the ability to accumulate cash and the earning of investment income,” said John Dobson, who was director of health and welfare benefits for United Technologies until retiring last year, and now is a part-time contract employee for the aerospace giant.

If an organization's underwriting experience is good, funding benefits “can be a real home run for a captive,” said Terry Richardson, a principal with PricewaterhouseCoopers L.L.P. in Dallas.

In addition, expanding a company's captive beyond traditional property/casualty risks diversifies the captive's book of business, providing an offset if other lines of coverage funded through the captives incur major losses.

“It can be beneficial to spread risk and diversify the risk portfolio,” said John Wilson, president of Three Rivers Insurance Co., Alcoa's Vermont-based captive insurance subsidiary, which Alcoa has used since 2006 to fund employees' life insurance coverage.

There are other attractions as well. Because the Internal Revenue Service considers benefits risks to be third-party business, funding benefits through a captive can increase the likelihood a captive will have enough outside business for the parent to take a tax deduction for the property/casualty premiums paid to the captive. Under IRS rules issued in 2002, a parent can take

a tax deduction for property/casualty premiums paid to its captive if at least 50% of the captive's business is unrelated to the parent.

“There are some very good financial reasons for risk diversification,” Mr. Richardson said.

But if the advantages of funding employee benefits risks are numerous, so are the obstacles.

One potential big obstacle is getting the two corporate departments — employee benefits and risk management, which typically is in charge of captives — to work together.

“Risk management and employee benefits need to be on the same page before moving forward. It can take a fair amount of time to get that cooperation,” said Debbie Liebeskind, a senior actuarial consultant with Towers Watson & Co. in Parsippany, N.J.

Some employers, while aware of that potential issue, say they didn't face it when moving ahead to fund benefits risks through their captives.

“It can be difficult to get two different corporate departments to work together. Fortunately, our corporate culture encourages that kind of interdisciplinary cooperation,” Three Rivers' Mr. Wilson said.

Still, the employee benefits and risk management departments' cooperation “varies, company by company. Benefits are a different language than risk management,” said George O'Donnell, technical director for global risk consulting with Aon Risk Solutions in Somerset, N.J.

Securing the approval of regulators at the U.S. Department of Labor is a hurdle for all employers that want to expand their captive insurers' book of business to cover corporate employee benefits risks.

Fortunately, through Labor Department rulings and guidance, employers have a regulatory roadmap to follow in structuring a captive benefits funding arrangement.

The requirements that must be met include:

• The captive must be licensed in a U.S. state or be licensed in a state as a branch of a captive domiciled in another jurisdiction, such as Bermuda.

A majority of captive benefits funding applications have been filed by employers with Vermont-licensed captives. But other domiciles are well-represented, with the Labor Department approving applications involving captives licensed in Arizona, Hawaii, South Carolina, District of Columbia, as well as various state branches of corporate captives licensed in Bermuda, the Cayman Islands and, in one case

Ireland.

• A highly rated — no less than A by A.M. Best Co. Inc. — commercial insurer must be used to issue the policies. Commercial insurers selected by employers

and approved by the Labor Department to issue policies reinsured through their

captives include: AIG Life Insurance Co.; Cigna Corp.; units of Liberty Mutual Insurance Co.; MetLife Inc.; Minnesota Life Insurance Co.; and Prudential Insurance Co. of America.

There is no requirement that the fronting insurer take on any of the risk. In many cases, the front is simply that — an insurer just issuing the policies, for which the employer pays a fee.

In other cases, the fronting insurer has taken on a significant portion of the benefits risks funded through the captive at the employer's request.

“We went half and half. We wanted to be an equal partner with the issuing company,” Mr. Wilson of Three Rivers said.

• The employer must enhance in an objective way the benefits provided to plan participants affected by the captive benefits funding arrangement.

For example, ADM, one of the captive benefits funding pioneers, sweetened benefits in several ways back in 2002, when it filed for regulatory approval to fund life insurance risks through its Vermont captive. Under the company-paid basic life insurance plan for salaried employees, the maximum benefit was increased to one multiple of base salary up to $1 million, from one multiple of base salary up to $100,000.

In addition, under the supplemental life insurance benefit plan for salaried employees, which is employee-paid, the maximum benefit was increased to as much as five times salary with a $2 million cap, from as much as four times salary with a $1 million cap.

• An independent fiduciary must be used to monitor the transaction and be authorized to take any action necessary to protect the interests of participants.

For about a decade, employers meeting these requirements qualified for rapid Labor Department review of their captive benefits funding applications under a regulatory procedure known as ExPro.

Under ExPro, the Labor Department must act within 45 days on a request for an exemption for arrangements that normally would be considered a prohibited transaction under the Employee Retirement Income Security Act. Including a comment period for plan participants, the entire regulatory process under ExPro takes about 2½ months, less than half the time often needed for exemptions that do not qualify for ExPro.

ExPro generally was available to captive benefits funding applicants that could cite two substantially similar individual exemptions granted in the past 10 years, or one substantially similar exemption and one approved through ExPro within the past five years.

In mid-2012, though, the Labor Department suspended the use of ExPro captive benefits funding arrangements while regulators reviewed the criteria employers had to satisfy.

While the regulatory review was going on, employers could and did seek individual exemptions for their captive benefits funding arrangements.

Coca-Cola, for example, secured final approval of an individual exemption to use its South Carolina captive, Red Re Inc., to reinsure group term life insurance and accidental death and dismemberment and disability policies written by MetLife.

Then in November, the Labor Department proposed an individual exemption to allow Santa Clara, Calif.-based computer chip manufacturer Intel Corp. to use its Hawaii captive, Technology Assurance Ltd., to reinsure life insurance and accidental death and dismemberment and disability policies written by Minnesota Life.

At the same time, the Labor Department signaled its review of ExPro was ending, noting that employers seeking ExPro for captive benefits funding arrangements should review the criteria used in the individual exemption given to Coca-Cola and the one proposed for Intel.

Benefits experts say the conditions are not really new, but that certain requirements, such as enhancement of benefits for plan participants, will receive greater regulatory analysis and that the benefits enhancements be lasting.

In fact, once Intel's application receives final approval, which should be very soon, the door will be wide open again for employers to utilize ExPro.

Having that certainty of knowing how long it will take federal regulators to act on an application is important for employers.

“You know the timeline,” said Karin Landry, a managing partner with Boston-based Spring Consulting Group L.L.C., which submitted Intel's application.

And, experts say, it won't be very long before more employers seek regulatory approval to fund benefits risks through their captives.

“The level of interest has never been higher. The word has sunk in. This is no longer an exotic issue. The market is far better educated” on this approach, Mr. O'Donnell of Aon Risk Solutions said.

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