Some of the nation’s largest employers have for years formed captive insurance companies to reduce the risk and cost of employee health benefits. Now that strategy is becoming more popular among smaller and medium-size.
“People don’t realize just how big this business is,” said George O’Donnell, technical director of the health and employee benefits risk management unit at Aon Risk Solutions in New York.
It’s big enough that there are more than 6,000 captives worldwide, up from 1,000 in 1981. The Self Insurance Institute of America held a panel discussion on the topic at its recent national conference in Chicago.
“Their growth has been exponential,” said Andrew Cavanaugh, chairman of the Alternative Risk Transfer Committee of the SIIA. “Small and midsize companies are looking for ways to manage cost and risk.
”A captive is an insurance company formed by a company to cover its own risks. In other words, it’s a form of self-insurance.Bigger companies, like Coca-Cola, have used captives since the 1970s to cut the risks of providing health benefits in the U.S. and to workers in other countries. A few big companies, including Coke, GE and GM, also reinsure their life insurance and dismemberment insurance benefits through captives. Using captives for that purpose requires approval from the Department of Labor. The latest company to win such approval was Intel. Last year, Google and Microsoft were among those that received the Labor Department’s blessing.
Big companies own their own captives, like Coke’s South Carolina-based Red Re, while most companies need to band with others to form joint captives.“Captives act as a shock absorber” against costs, said Cavanaugh, who helps companies form and manage captives as CEO of Pareto Captive Services, based in Philadelphia.
Changes in the health insurance market, including the passage of the Patient Protection and Affordable Care Act, have accelerated the use of captives.
“U.S. health care costs are out whack compared to the rest of the world,” so captives look increasingly attractive to employers, said O’Donnell.
Captives allow companies to lower costs by retaining risk that normally would be placed in the commercial insurance market. A common way captives are used for employee benefits is to provide stop-loss insurance for health benefits. That type of policy pays off when an individual’s medical claims reach a certain level, usually because of catastrophic illness or injury.
The costs of stop-loss insurance have climbed along with health care costs over the years. Smaller companies, those with fewer than 5,000 employees, typically aren’t in the financial position to former their own captives. Instead, they must find other companies to share the costs and benefits.
Inside the U.S., Vermont was the first state to allow captives inside its borders. Hawaii, Utah and South Carolina, among others, are most active in the marketplace.
The amount a company can save on health insurance varies, but most estimates are in the 15 percent to 20 percent range. Companies also come out ahead financially if the premiums they pay their captives are larger in a given year than are claims. The excess money is retained by the captive and can be used for future claims. Premiums paid to a traditional insurer are lost.
All of this shifting of risk takes place behind the scenes.
“Employees generally don’t see any change to benefits,” Cavanaugh said.
David Provost, deputy commissioner of the Captive Insurance Division of the Vermont Department of Financial Regulation, noted that companies that self-insure do so outside of the scrutiny of regulators.
But forming a captive means overcoming regulatory hurdles.
When Intel, based in Santa Clara, Calif., petitioned the Department of Labor to allow it to use its Hawaii captive to reinsure its life insurance and accidental death and dismemberment insurance, it became one of only about two-dozen companies to seek such permission.
That aspect of the business was first tested by Columbia Energy Corp. in 2000. The Labor Department required the company to satisfy four requirements to get its OK: it had to employ an independent fiduciary; the captive insurer had to be a licensed in at least one U.S. state; the company had to improve long-term disability insurance offered to its employees; the fronting insurer had to have a rating of “A” or better from A.M. Best Co.
Columbia satisfied those requirements and others followed. The Labor Department has since created a streamlined process that can give the OK in about two and a half months.
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