Seven highway construction companies are funding their group health care benefits programs in an innovative way that utilizes tax-free trusts and a Vermont-domiciled risk retention group owned by the companies.

The arrangement, believed to be the first of its kind, involves the interplay of voluntary employee beneficiary associations set up by each company and the RRG, ACBG Risk Retention Group L.L.C.

Under the arrangement, each company sets up and funds a VEBA, which is a special tax-free trust authorized under federal law. Employers receive an immediate tax deduction for their VEBA contributions, while VEBA assets earn tax-free interest. In turn, VEBA assets must be used to pay for benefit-related expenses, such as health care claims.

In the case of the contractors' arrangement, when claims payments cause VEBA assets to fall below a certain level, the contractors make new contributions to their VEBAs.

Then, the contractors are reimbursed through policies issued by the RRG. The RRG, in turn, is reinsured by a unit of Allianz Group.

While thousands of VEBAs and a couple of hundred of RRGs now operate, the contractors' program is believed the first time that the two entities have been joined together to fund benefit risks.

Program organizers say the arrangement offers several advantages to members compared with other designs. For example, by banding together, members have a lot more leverage in negotiating with vendors, such as third-party claims administrators and wellness program providers, said Steve Heussner, the RRG's president in Dallas.

Additionally, since employees' health insurance policies are not issued by a commercial insurance company, the policies do not have to provide coverage in line with state laws that require certain benefits be offered, which can drive up costs and complicate administration, said Randal Schultz, a shareholder in the Kansas City, Mo.-based law firm Shughart, Thomson & Kilroy P.C., which assisted in the development of the program.

Other approaches also were not practical. Some contractors, for example, felt they were too small--with just a few hundred employees--to individually self-fund all their health care risks. Additionally, Internal Revenue Service regulations do not allow different employers spread across the country to set up one VEBA.

On the other hand, while risk retention groups cannot be used to fund employee benefit risks, federal law allows RRGs to provide coverage for contractual liability, in this case an employer's obligation to fund VEBAs when costs exceed specified limits.

"It is a blending of employee benefits and risk financing," said Mr. Schultz.

Additionally, the program has tax advantages. Members receive immediate tax deductions on their VEBA contributions and premiums paid to the RRG.

Furthermore, the RRG, unlike other types of captive insurance companies, can issue policies to members in any state after meeting the licensing requirements of one state. Currently, the program has members in seven states.

Members say their positive experience in a group-owned offshore captive insurance company--American Contractors Insurance Group in Bermuda, which funds various casualty risks--was a driver for their participation in the health care benefits funding program.

"The concept of captive insurance works for property/casualty risks. Let's see what it does for health benefits," said Linda Clarkson, vp of Total Risk Management Inc., the insurance and risk management subsidiary of Clarkson Construction Co. in Kansas City, Mo., one of the contractors involved.

Outside observers say the joining together of VEBAs and an RRG is an appealing one. "It is a way of pooling your risks and for each company to have much less volatility," said Karin Landry, a managing partner with Boston-based Spring Consulting Group L.L.C., a captive insurance consultant, who first wrote about the concept several years ago.

By banding together, "policyholders are going to get a lot more bells and whistles," Ms. Landry said.

"I think it is a very viable idea," said Jon Harkavy, vp and general counsel with Risk Services L.L.C., a captive and RRG manager in Arlington, Va. "My guess is that this will be replicated," he added.

Still, putting together such a program has its obstacles, observers say. "You need a group of employers that is willing to work together," which can be challenging, Ms. Landry said.

At the same time, some employers might shy away from participation out of concern that they would subsidize the claims costs of others with less favorable experience, said Henry Saveth, an attorney with Mercer Human Resource Consulting in New York.