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Few companies are using their captive insurers to reinsure medical risks. Here, Mitch Cole, a director at Towers Watson & Co., and Nicole Serfontein, a senior consultant with Towers Watson, explain the use of captives for both active and retiree medical exposures.
Mr. Jack Smith
Vp-Compensation and Benefits
In our recent meeting, you asked why so few companies use their captive insurance companies to reinsure either active medical or retiree medical risks. You asked us to elaborate on our answer in a letter that you can share with your leadership group.
To recap, we said that, indeed, some companies have used their captives for U.S. active medical, retiree medical and stop-loss medical, as well as for non-U.S. medical. We agree, however, that not many companies have pursued this option, especially relative to other captive use. There are three primary reasons for this:
• Vexing U.S. regulations
• Need to clarify captive use for retiree medical
• Perception that using captives for multinational pooling is too complex
But we also think there are some good reasons to use a captive for non-U.S. medical. To start, let's consider the reasons companies have been reluctant to use captives in this way.
1. Vexing U.S. regulations
There is probably no greater area of concern for U.S. human resource and finance leadership in many companies than health care regulations and the cost of claims. Yet doing something about them has proven a challenge even for very creative HR and finance departments. For two reasons, captives are almost never part of the solution except for medical stop-loss insurance:
• Regulatory and cost hurdles of moving from self-insured to insured status
Jack, I'm sure you recall that to use a captive for U.S. benefits, a sponsor would be required to obtain a Department of Labor Prohibited Transaction Exemption. This requires the use of a fronting insurance company, effectively requiring self-insured programs to move to insured status. In addition to regulatory hurdles, this approach can prove costly.
Because the medical program would be fully insured, the fronting company would be required to include state-mandated benefits, and possibly rates, for its insurance. For most employers, this would present an insurmountable hurdle for two reasons: First, most companies with self-insured medical programs are large enough to pay their own claims and, second, self-insurance gives them more design discretion compared to insured products. It is unlikely that state-mandated coverage would be a good fit for these self-insured employers. Yes, they could reinsure the risks into their captive, but the risks insured would very likely be different than what they would have been under the self-insured program.
Second, these self-insured employers are used to paying the net cost of only their own claims and avoiding state premium taxes and insurer margin charges. With a captive arrangement, more money would flow between the company and the captive, resulting in more out-of-pocket cost in fees, premium taxes and the like.
As if this were not enough, there are very little tax savings in using a captive for medical. Nearly all medical claims are paid in the same year in which they are incurred, except those incurred in the last month or so of the year. The incurred but not-yet-paid claims are generally paid in the first two months of the next year. So aside from perhaps an accelerated deduction for medical inflation from one year to the next, there's not much financial benefit to the employer in the way of accelerated tax deductions or deductible reserves.
A sea change in what insurance companies may provide in the future colors employers' thinking on captive use. Health care reform, if it survives, may encourage certain types of employers to drop sponsorship of a medical plan for employees. While an employer exiting sponsorship may be prepared to subsidize a portion of some employees' personal premium costs, it is unlikely that such an employer would want to reassume the burden of actually providing the coverage. In short, in the current U.S. regulatory environment, a self-insured company may not view captive use as a worthwhile option until the status of health care reform stabilizes. Nevertheless, companies that shift employees to private insurance or health insurance exchanges might use a captive to finance their own cost burden, much like stop-loss insurance. In this scenario, the employer would have to consider ways to do this most cost-effectively—especially if a number of subsidiaries are involved.
Notably, captives are increasingly used for medical stop-loss insurance in and outside the U.S. There are generally four reasons: cost, capacity, coverage and control. On capacity, the captive provides direct access to reinsurers, which may in turn provide sharper pricing. For control, a self-insured can use a stop-loss program among its subsidiaries to reflect their own risk and cost tolerance, which almost always is less than the family of companies. For coverage, as multinational corporations expand into markets with insufficient public health benefit programs or where local insurers don't offer sufficient coverage, the captive can be used to close gaps for coverage that insurers are unwilling to carry.
2. Needing to clarify captive use for retiree medical
Most employers with a retiree medical obligation generally do not fund it except as part of collective bargaining. There are three reasons companies most frequently cite not to fund. First, using that money in operations can earn more than placing it in a fund. Second, funding may send an unintended signal to employees that the benefit is guaranteed. And third, the company could withdraw the benefit in the future, especially under health care reform.
Your company has identified a cadre of retirees for whom the benefit would almost never be revoked. By funding the benefit today, you could monetize all of the deferred tax deductions now on your balance sheet, thereby converting nonperforming assets into performing assets. And, by using your captive, any investment earnings in excess of what is needed to pay claims would be profit for use by the captive.
We also understand that your company will give the balance of its post-65 retirees an annual subsidy to buy insurance from an exchange. You will still have to accrue a liability for this future cost, but it will be lower than your current liability for retiree medical. A captive could be a very important vehicle for funding the future liability.
But this may not be the right answer for every company. This isn't an easy captive arrangement to implement, and only one company has done it so far. Yet, as you said, it's worth considering if the gain is worth the effort.
3. Understanding why a captive for multinational pooling isn't complex
Very often, employers believe that using a captive to reinsure multinational benefits that include medical is too complex to undertake. And for employers with very limited resources, that may be the situation. However, we know of employers that successfully use their captive to reinsure multinational benefits for their global operations, despite a perpetually stretched HR staff.
So why can some employers manage it—even with limited resources—and others cannot? We think it comes down to the interested employer (1) recognizing that for many employers the pooling program is just a way to finance claims and that the insurer will be paid back over time; (2) understanding that the nature and cost of non-U.S. benefits is increasingly important to global governance and oversight; and (3) capturing claim data, especially on medical, is a key priority to identify cost drivers and develop interventions that manage cost and improve employee productivity.
We think the ability to capture claim data could be the most important. With health care inflation continuing to climb—and reaching double digits in many countries (see chart)—data have become increasingly important as companies look for ways to slow their annual cost increases and manage the health risks of their employee population. Many companies with operations outside the U.S. have a difficult time getting timely and wholly reliable data from their insurers and cannot be proactive in designing interventions to better manage both costs and employee health.
A captive is not a silver bullet for data collection, but it can help facilitate the process. Because the captive's sponsoring company is the ultimate risk taker, it has a greater say in the type and extent of data to be collected and analyzed. Most data are delivered quarterly to captives, making them far more valuable than 12-month-old data for identifying and responding to employee population health trends and risks. This ability to access and analyze data across the company is increasingly important as companies move to more centralized decision-making about benefit programs and program governance (see chart). A captive can facilitate that process.
Once the direction of U.S. health care reform becomes clearer, we'll gain a clearer understanding of whether using a captive for U.S. health benefit obligations—both active and retiree—makes sense for your company. Until then, using your captive for non-U.S. health benefits is a good option, largely because of the current data it can provide allowing you to understand your claims and providing a platform for HR and finance to join forces to manage what is a growing problem for many multinationals.
Jack, let's talk again once your leadership has had a chance to give you their views on their desired way forward or we have a known outcome on health care reform.
Mitch and Nicole
Mitch Cole is a director of Towers Watson & Co. in its Stamford, Conn., office. He leads the company's work globally in benefits financing solutions, which combines Towers Watson's expertise in employee benefits and pensions with risk expertise and transaction execution capabilities to provide risk management and financial solutions. He can be reached at 203-326-5431 and firstname.lastname@example.org.
Nicole Serfontein is a senior consultant in the Towers Watson Arlington, Va., office. She co-leads global health care within the international consulting group and has consulted on health insurance and related matters for many multinational companies, government and plan trustees. She can be reached at 703-258-8286 and email@example.com