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Employee Benefits in Captives: The Basics

Employee Benefits-SF
May 31, 2017

A small but growing number of employers are tapping their captive insurance companies to fund employee benefit risks.

Captive experts estimate that 70 to 80 employers, including Coca-Cola Co., Google Inc., Hormel Foods Corp., and Microsoft Corp., currently use their captive insurers to fund a variety of employee benefit programs, such as accidental death and dismemberment, group term life insurance, and long-term disability.

The key factor driving employers to tap their captives to fund benefit risks is cost savings.

Benefits experts say that, for certain lines of coverage, like group term life insurance and long-term disability, cost savings often are in the 15–25 percent range compared with buying the coverages in the traditional market.

Those cost savings are possible because the captive—not an outside insurer—can earn the underwriting profit and investment income on premiums its parent pays to the captive.

Another advantage of the approach is that captive benefit funding diversifies a captive's book of business. Adding benefits to a captive's risk portfolio can provide more stable underwriting and may provide additional rationale to justify the deductibility of premiums for income tax purposes. This will also ensure greater cost predictability compared with purchasing coverage in the commercial market, where rates can swing wildly from one year to the next.

In addition, funding benefit risks through their captives gives employers greater flexibility in designing their employee benefits programs. Commercial insurers may impose coverage limits or other terms that an employer may not want.

Still, there are challenges facing employers that want to fund employee benefits through their captives.

One challenge is getting two corporate units—risk management and employee benefits departments—to work together. Indeed, putting together a captive benefit funding program can take a lot longer if an employer's corporate risk management and employee benefits departments do not have strong relationships.

The biggest challenge, though, is winning approval from the US Department of Labor, which is required for captive funding arrangements involving certain benefits, including disability, life insurance, and health insurance.

That approval is necessary because captive benefit funding arrangements generally are considered prohibited transactions under a 1974 federal law: the Employee Retirement Income Security Act (ERISA).

In some cases, regulatory review can be fairly quick. If a captive sponsor can qualify for a regulatory review approach known as EXPRO, the Labor Department is required to respond within 45 days of an employer's filing its captive benefits funding application.  Under EXPRO, the entire review and approval process typically can be completed in under 3 months.

However, to qualify for EXPRO, an applicant has to cite two substantially similar individual exemptions approved by regulators in the last 10 years, or one similar individual exemption approved in the last decade and one approved through EXPRO in the last 5 years.

Without EXPRO, the review process often takes two to three times longer.

To win Labor Department approval for their captive benefit funding programs, employers have to meet certain basic regulatory requirements, including that a commercial insurer be used to issue policies as well as enhance participants' benefits. Numerous insurers, including Metropolitan Life Insurance Co., Minnesota Life Insurance Co., and Prudential Insurance Co. of America, have insured benefits, which are then reinsured—in some cases 100 percent—through employers' captive insurers.

However, there is one type of benefits-related coverage that can be written by captives without Labor Department approval: medical stop loss insurance or reinsurance. This type of insurance is designed for self-insured employers to provide a cap on the amount of losses they incur (either on a per occurrence or aggregate basis) under their health/medical plans for employees. Medical stop loss insurance does not directly cover employees and makes no payments to or on behalf of employees. Instead, it reimburses the employer, which is the insured, for claims the employer pays on behalf of its employees. Since the employer is the insured, and not the employees, ERISA does not apply, and there has been a substantial trend in recent years of captives writing medical stop loss coverage (see "Medical Stop Loss in Captives").

Additionally, Labor Department approval is not required for employers to use their captives to fund benefits offered to employees outside the United States.

In fact, dozens of employers, including Coca-Cola, Deutsche Post DHL, and sporting goods manufacturer Adidas A.G., have tapped their captives to fund benefits offered to employees in numerous countries.

Executives at those organizations cite similar advantages—cost savings and flexibility in benefit plan designs—as their US counterparts in funding benefit risks through their captives.

In addition, captive benefit funding has made it easier and faster for international companies to analyze employee benefit claims information because they do not have to use different insurers in different countries.

Given the cost savings and other advantages, small but steady growth in the number of employers funding employee benefits through their captive insurers is expected in the years to come.

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