By Travis Sartain, Senior Benefits Advisor
The cost of funding employee benefits risks continues to rise, driven by new taxes and fees under the Affordable Healthcare Act and higher medical claims resulting from the declining health of U.S. workers. Even a modest increase in employer costs can have a detrimental impact on small and mid-size businesses (SMBs), where limited cash flows and tight budget constraints mandate strategic cost containment. For these organizations, a group employee benefits captive can offer a number of advantages.
A captive is an alternative funding solution for employers to enter into an agreement where they become their own insurance company. This arrangement allows SMBs to leverage volume to achieve better pricing through economies of scale. In addition to cost savings, participants in a benefits captive have more control over the design of the benefits offered to employees, and reap the financial rewards of underwriting profits and investment income earned on premiums. In short, a benefits captive enables businesses to save money on their coverage, as well as make money by pocketing the profits that normally go to the insurer.
Group Captives vs. Mutual Insurance CompaniesGroup benefits captives are similar to mutual insurance companies in many ways; however, noteworthy differences exist between the two approaches. A captive is typically exclusive to a particular industry, geographical region or employer size, and is geared toward companies looking for coverage options outside of the traditional market. Captive insureds put their own capital at risk, and the participating businesses benefit from the underwriting profits. In contrast, mutual insurance companies are commercially sold, and although policyholders benefit from revenues in excess of expectations through dividend payments or reduced premiums, the policyholder has not invested any assets into the insurer. When the insurance ceases, so does the policyholder’s ownership status.
In a group benefits captive, participants have the opportunity to act as their own insurance carrier by assuming the financial risk associated with employee claims, in exchange for which they can also reap the benefits if the captive generates a surplus. In this alternative funding arrangement, the participants are taking risk, but they also have the reward for good performance—for example, by managing healthcare claims, adding a wellness program, along with a health management or disease management program, and keeping people in a better state of health.
By incorporating caps for catastrophic claims, captive insurers can also mitigate the risk associated with high-dollar liabilities. For example, claims in excess of $250,000 would go to an insurance policy, while everyone shares in the funding of claims that exceed each participant’s individual self-insured retention level.
Control and Cost Savings
Captive insurers offer a number of advantages to businesses of all sizes, and especially to SMBs. In addition to arranging coverage that may not be available in the traditional insurance market, captive participants have greater control over the benefits programs and can achieve better pricing due to greater autonomy and economies of scale.
Standard insurance companies are subject to what’s taking place in the economy—they are affected by stock prices, internal corporate objectives, and other factors that ultimately trickle down to their policyholders. When you’re in a captive, you and the other participants are in charge, along with the captive manager, who administers the insurance company.
In addition, although all participating members have the advantage of economies of scale, giving the captive as a whole greater purchasing power, each company sits in its own independent silo. This means that organizations that are performing better can have reduced costs, underneath the umbrella of the captive insurer, and also set their own pricing. As part of the collective, they have the opportunity to retain profits that typically would go to an insurance company, and individually, each participating business can customize its benefits program based on the company’s needs, risk tolerance, and benefits cost.
Expense components associated with traditional insurance are generally about 40 percent of premiums taken in, while these costs represent only 15 to 30 percent of premiums for captive insurers. This means that benefits captive members have improved cash flows, which can be further augmented by participants cutting claims administration costs and effectively controlling losses by focusing on wellness and safety programs. Benefits captive members can realize financial stability on a multi-year basis that outperforms traditional insurance carrier arrangements because of the ability to implement customized cost control solutions, such as offering health and wellness assessments, providing opportunities to consult with medical professionals, and engaging employees to better manage and improve existing medical conditions.
Single Parent vs. Rental Captives
Larger employers may find it beneficial to create a single parent captive, because the company has the needed volume to leverage better pricing. For small and mid-size firms, however, a rental captive arrangement (also called a rent-a-captive) can be a smarter option. A type of sponsored captive, rental captives are owned and controlled by unrelated parties who come together to create a larger employee population and negotiate more favorable pricing. Instead of directly participating in the captive insurance company’s ownership, insureds “rent” the insurer to gain the benefits of the captive arrangement. The captive insurer contributes the core capital and charges a fee for operating the plan. Participants are not required to commit funds for capitalization, and administrative costs often are lower than owned captives. A seasoned broker consultant can seek out and identify the type of benefits captive that ultimately benefits the client, depending on factors such as industry or geographical location, the captive’s length of operation or performance, or even upon the captive manager.By stepping outside of the traditional insurance market and being willing to put their own capital at risk, organizations that participate in a benefits captive can exercise greater control over their employee benefits offerings, improve cash flows, and achieve more favorable pricing through economies of scale. Rather than accommodating the limitations of standard carriers, companies engaged in a benefits captive have more flexibility to structure coverage that meets their unique needs, and ultimately realize a profit for their efforts.
This document is not intended to be taken as advice regarding any individual situation and should not be relied upon as such. Marsh & McLennan Agency LLC shall have no obligation to update this publication and shall have no liability to you or any other party arising out of this publication or any matter contained herein. Any statements concerning actuarial, tax, accounting or legal matters are based solely on our experience as consultants and are not to be relied upon as actuarial, accounting, tax or legal advice, for which you should consult your own professional advisors. Any modeling analytics or projections are subject to inherent uncertainty and the analysis could be materially affective if any underlying assumptions, conditions, information or factors are inaccurate or incomplete or should change.
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