Employee Benefits in Captives - Spring Consulting Group · Advantages of Placing Employee Benefits in Captives There are several advantages to funding employee benefits in a captive

EmployeeBenefitsinCaptivesWhatRiskManagersNeedtoKnow

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TableofContents

CaptiveInsurance.....................................................................................3WhatisaCaptive?............................................................................................................3HistoryandGrowthofCaptives.................................................................................3EmployeeBenefits...................................................................................4DevelopmentsinEmployeeBenefits.......................................................................4UsingaCaptivetoFundEmployeeBenefits.........................................................4AdvantagesofPlacingEmployeeBenefitsinCaptives.....................................7EmployeeBenefitFundingOpportunities.............................................................8UsingaCaptivetoFundRetireeMedicalObligations..............................11

UsingaCaptivetoFundPensions...........................................................12CriticalStepsintheCaptiveDevelopmentProcess.................................13EstablishingaCaptiveforEmployeeBenefits...................................................13Feasibility...........................................................................................................................14Design..................................................................................................................................15Implementation...............................................................................................................16OngoingDevelopment..................................................................................................17

CaseStudy1:FundingEmployeeBenefitsinaCaptive...........................18CaseStudy2:FundingRetireeMedicalandOtherBenefitLiabilities.......19AboutSpring..........................................................................................21

What’sNext?.........................................................................................23


CaptiveInsurance

WhatisaCaptive?Acaptiveisaninsuranceorreinsurancecompany,establishedspecificallytoinsureorreinsuretherisksofitsowner,alsoknownasitsparentcompanyorcompanies.Insomecases,captivesarealsousedtoinsuretherisksofthirdparties,similartocommercial insurers. However, as the name implies, a true captive is one thatexclusivelyinsuresitsparentcompanies’shareholders’risks.

HistoryandGrowthofCaptivesCaptives developed in the late 1800s when a group of New England textilemanufacturerswerelookingforawaytohelpmitigaterisingfireinsurancerates.1Then in the 1900s, companies began looking for better tax advantages and fewerrestrictions,leadingtothefirstoffshorecaptives.Inthe1960s,mutualassociationsdeveloped,allowingorganizationstofundrisksbypoolingwithsimilarcompanies.2Captiveinsurancegrowthsurgedinthe1970sand1980s,whentheproperty&casualtymarkethardened, leadingto increasedcosts.The total number of captive insurance companies grew from100 in the 1960s to1,000inthe1980s.3Thenumberofcaptiveinsurancecompaniescontinuestorise.In2010,therewere5,617captivesworldwide,4upfrom5,525in2009.About80%oftheStandardandPoor500(S&P500)companiesownoneormorecaptiveinsurancecompanies.5Throughout the United States, captive domiciles are revising andmodifying theirlegislation tobetteraccommodateemployers’ evolvingneeds. Forexample,manydomiciles are refining their requirements for establishing cell captives, andmanyareopeninguptonewlinesofcoverage,suchasemployeebenefits.Today,over30statesallowtheestablishmentofcaptiveinsurancecompanies.

1RosemaryM.McAndrew,“Captives:HeretoStay,”TheJohnLinerReview14(2000)2RogerCrombie,“TheBermudaMarketat60,”BermudaRe/insurance,November2007:9-143McAndrew4“BusinessInsurancerankscaptivedomicilesworldwide,”BusinessInsurance,March14,20115“OffshoreCorporation,”OffshoreCaptiveInsuranceCompanyFormation,http://www.offshorecorporation.com/captive-insurance


EmployeeBenefits

DevelopmentsinEmployeeBenefitsFormostcompanies,employeebenefitsrepresentasignificantfinancialinvestment.As every human resources director knows, the costs of employee benefits, healthinsuranceinparticular,havedramaticallyincreasedoverthelastdecade.Employeebenefitcostscancompriseasmuchas40%ofacompany’stotalpayroll.Captives canprovideeffective, long-termsolutions to the risingcostsof fundingavarietyofemployeebenefits,aswellaspensionandretireemedicalobligations.

UsingaCaptivetoFundEmployeeBenefitsAlternativemarketmechanisms (captives) account for about30% ($98billion) ofthetotalannualcommercialriskprotectionmarket($326.9billion).6Fifteen years ago, captives were not commonly used for financing employeebenefits, as regulatory obstacles and reinsurance restrictions limited eligibility toonlythelargestofcaptives.TheDOLmustapprovetheplacementofERISAbenefits intopure-parentcaptives.Many well-known organizations have obtained funding approval, including ADM,AlconLabs,Alcoa,AGLResources,AstraZeneca,BannerHealth,InternationalPaper,Memorial Sloan-Kettering Cancer Center, Sun Microsystems, and UnitedTechnologies.Many more companies have used captives to fund other non-ERISA employeebenefits that do not require DOL approval. Moreover, employer groups andassociations are establishing captives to fund employee benefits, thus offering analternative to the commercial insurance markets and providing an incentive formembershipgrowth.Forcompanieswithproperty&casualtycaptives,certainemployeebenefitsmaybe“unrelated business,” i.e., insurance business unrelated to the captive’s parent.Adding unrelated business to a single-parent captive can improve the captive’soverall financial efficiency; satisfy the need for third party business allowing theparenttodeductitscaptivepremiumsfromitsU.S.federalincometaxes;andcreateadditionalcostsavings.6Conning;MarketStanceanalysis;InsuranceInformationInstitute


Regulatorychangeshaveledtoincreasedemployeebenefitcaptivefunding. Someofthesechangesincludethefollowing:n InternalRevenueServiceclarifiesriskshifting/distributionandunrelatedbusiness

requirementsIn1993, the IRSruled7thatcertainemployeebenefits insurancewritten inapurecaptiveisunrelatedbusiness(tothecaptive’sparent)sinceitbenefitstheemployeeandnot theemployer. In2002, the IRS issued threerevenuerulingsclarifying thequalification of captives as insurance companies for federal income tax purposes,including discussions of third party business, brother-sister arrangements andgroupcaptives.8n TheDOLreviewprocessprovidesaroadmaptofundingIftheproposedtransactionissubjecttoERISA,theDOLhasastreamlinedprocessforapproval.n GASB45andFASB158requirementsraiseawarenessofpost-retirementliabilitiesAccountingrulessuchasGASB45andASC715(formerlyFAS87/106andamendedby FAS 158) require that organizations account for retiree medical and pensionobligations.These requirementsencourageemployers tonotonlyaccount for theliabilities, but also to seek efficient funding methodologies. In addition, GASBstatements 74 and 75 are increasing the required disclosures for public retireemedicalobligations.n CourtrulingsclarifytheparametersforfundingretireemedicalprogramsInWells Fargo&Co. v. Commissioner224F.3d874 (8thCir. 2000), the tax courtclarifiedtheamountthatcanbesetasidetofundretireemedicalbenefits,expandingthepotentialfundingallowedtoemployers.n RevenueRuling2014-15clarifiesfundingopportunitiesforretireemedical

programsIn2014,theIRSruledinRevenueRuling2014-15thatNon-cancellableAccidentandHealth Insurance policies will receive life insurance tax treatment as long as thefollowingfactsandcircumstancesaremet:

- TheCompanymaintainsaVEBATrustthatsatisfiestherequirementsof501(c)(9)

- The Company purchases a Non-cancellable Accident and Health policyfromaninsurancecompanyandreinsuresthepolicythroughthecaptive

- Both the Company and the VEBA retain the right to cancel the retireehealthcoverageatanytime

7IRSRevenueRuling92-938IRSRevenueRulings2002-89,2002-90and2002-91


As a result, insuringnon-collectivelybargained retireemedical benefits throughacaptiveallowsfortax-freegrowthofreserveswithouttheneedforaPrivateLetterRuling.


AdvantagesofPlacingEmployeeBenefitsinCaptivesThere are several advantages to funding employee benefits in a captive. Theseincludecostsavings,increasedcontrol,improvedriskmanagement,andenhancingapreviouslyestablishedcaptive.n Improvedcostsavings

l Controlemployeebenefitpremiumcosts― Estimated potential savings for employee benefits in captives vs.

commercialinsurance9areasfollows:n Long-TermDisability(5%-20%)n GroupTermLifeInsurance(15%-20%)n AccidentalDeath&Dismemberment(5%-10%)n ActiveMedicalStop-Loss(5%-15%)n Retiree Medical (5% - 15% of the accumulated post-retirement

benefitobligation)n MultinationalPooling(10%-20%)

l Reduce frictional costs (commissions, taxes, risk charges, insurer profit,administration)andunderwritingsavings

l Captureinvestmentreturnsl Improvecashflowandcentralizeinvestmentofreservesl Improvemanagementreportingandunderstandingofrisks

n Increaseadministrativecontrol

l Designcoverageandprovisionsofbenefitsl Improvedatamanagementandlosscostmanagement

n Improveriskmanagement

l Manageacentralizedriskpooll Purchasestop-lossreinsurancetomanageexposuretocatastrophiclossl Quantify the financial benefits of wellness initiatives and specific loss

preventionprogramsn Enhanceaproperty&casualtycaptive

l Increasereservesandreducedependenceoncommercialmarketsl Improvespreadofrisk;portfoliodiversityl Add third party insurance business potentially creating tax-deductible

captivepremiums

9SavingsareestimatedfromCICA2009InternationalConference


EmployeeBenefitFundingOpportunitiesAwiderangeofemployeebenefitsmaybefundedthroughacaptive.Benefitsthatpayoutovermultipleyears(e.g. long-termdisabilityandretireemedical),providecashflowstabilityandlosspredictability.Linessuchasgrouplifeinsurance,whichcan be very profitable for commercial insurers, offer the captive the same profitpotential. The chart below shows all employee benefit options, and gives anexampleofthosethatatypicalemployermaywishtofundthroughacaptive.

Captive solutions can be used to fund benefits covered by ERISA federal law, orthose not covered by ERISA. ERISA benefits are primarily the benefit planssponsored by and contributed to by employers, such as retirement, group lifeinsurance,health, andwelfareplans.Theseplansare subject to federaloversight,undertheauspicesoftheDOL.Non-ERISAbenefitsareoftenbenefitplanstargetedtoaspecificpopulation,suchassupplementalretirementplansforexecutives.TheseplansmaynotreceivethetaxbenefitsgrantedtoplanscoveredbyERISA,nordotheyrequireDOLapproval forcaptivefunding.

Retirement

Health Security TimeOff

Voluntary

Pension

Medical LifeIns. Vacation

Auto/HomeownersInsurance

FinancialProducts

HolidaySTD1Drugs

DefinedContribution

Post-RetLife

Post-RetMedical LTD2 SickLeave

Mortgages

InvestmentFunds

Life

Fringe

Training,EducationAssistance

Transportation

FSA3

EAP4,Work/Life

Prevention,DiseaseMgmt

LongTermCare

Legal,FinancialPlanning

Dental

OtherLeave

Health&Welfare

Workers’Compensation

P

P

P

P P

P

P

P

P P

PTypicalCaptiveOpportunities1 ShortTermDisability2 LongTermDisability3 FlexibleSpendingAccounts4 EmployeeAssistancePrograms(mentalhealth, legalassistance, etc.)

P

P

P

P

PP

P

P

CriticalIllness

P

P

ExecutiveBenefits PMultinationalPooling,ExpatriateGlobalAssistance P

Typical Non-ERISA

Typical ERISAPlans


Funding employee benefits in a captive has no direct impact on the plans’beneficiarieswiththeexceptionofaNoticetoInterestedPersons letterexplainingthe transaction and the benefit enhancements that may be required by the DOL.HumanResourcesstaffneednotworryaboutsignificantadditionaladministrativeresponsibilities,orthepossibilitythattheplans’benefitswillbechangedotherthanthepositiveeffectofthebenefitenhancements.TypicallyifitisanERISAbenefittheemployercancontinuetoworkwithitsexistinginsurer. As a result of this process, the insurer’s role is changed. In a captivearrangement, the insurer continues to insure the employer’s risks, but itimmediatelyreinsurestherisksintotheemployer’scaptive.Inthisrole,theinsurerbecomes a fronting insurer. This arrangement allows the fronting insurer tocontinue to administer the program. The employee pays the fronting insurer anannual fee, allowing the captive to retain investment income and underwritingprofit(ifany).Thefollowing illustratesthetypicalERISAtransactionbetweenthecaptiveowner,thecaptive,thefrontinginsurer,andthecaptiveowner’semployees.

Long-tailbenefitssuchasgroupuniversallifeinsuranceandlong-termdisabilityareidealcaptivecandidates,butinsomecasesmedicalinsurancemaybeplacedintoacaptive. Companies large enough to fund aportionof their insurable risks into acaptivealmostalwaysself-insuretheiremployees’medicalbenefits.

CompanyABCFrontingInsurance

Company(Front)

CompanyABCEmployees CompanyABC

Captive

CompanyABCpurchasesinsurancecoveragefrom

theFront

ThecaptivereimbursestheFrontforbenefitspaidtoCompanyABCemployees

Reinsures thepolicywith

Company’scaptive,remittingpremiums

forCompany’sshareoftherisk

TheFrontpaysCompanyABCtoadministerthe

benefit


Fundingfirst-dollarmedicalbenefitsdoesnotusuallymakeeconomicsense,asthecaptivemay add expensesnot found in a traditional self-insured approach. SincethePatientProtectionandAffordableCareAct(PPACA)prohibitsinsurersandself-insurersfromplacinglimitsonemployeebenefits,manyself-insuredemployersfindthemselves assuming additional liabilities because medical coverage is now anunlimited liability. A captive is an ideal vehicle inwhich an employer creates anannual aggregate limit, known as stop-loss coverage, and purchases excess(unlimited) coverage from the commercialmarkets above the captive’s aggregateretention.


UsingaCaptivetoFundRetireeMedicalObligationsU.S. GAAP(Generally Accepted Accounting Principles) requires all employers toaccrue the estimated amount of total retiree medical and other benefits like lifepayable to current employees throughout their lifetimes on their balancesheets. This requirement forces employers not to fund these obligations, just torecognize them. Recognition, of course, creates a liability without an offsettingasset,andalwaysraisesthequestion,“howarewegoingtopayforthesebenefits?”Employers thatoffer retireemedicalbenefitsoftenrespond to theabovequestionby restricting eligibility requirements, closing the plan to employees who retireafteracertaindate,increasingtheretirees’portionofthepremiums,increasingco-insurance payments and deductibles, transitioning to a Defined Contributionarrangement,andmodifyingorreducingplanbenefits.Employersthatchoosetofundaportion(orall)oftheirretireemedicalobligationsare able to offset the liability, but traditional funding options can be problematic.Oneof themostcommonfundingoptions,aVEBA(VoluntaryEmployeeBeneficialAssociation) trust, is subject to Unrelated Business Income Tax (UBIT) oninvestmentearningsonfundssupportingnon-collectivelybargainedbenefits.An alternative is to have the VEBA purchase an insurance policy, such as TrustOwned Life Insurance (TOLI), or Trust OwnedHealth Insurance (TOHI),which isthenreinsured into theemployer’s captive. Thisarrangementcreatesadegreeofflexibility,well-matched payments for the cash flow requirements of the trust, aswellaspotentialtaxefficiencies.Otherbenefitsinclude,butarenotlimitedto:

• Potentialtaxdeductiblepremiums• Tax-freeassetaccumulation• Tax-freedistributionformedicalexpenses• Improvedbalancesheetperformance• Long-termcostsavingsascomparedwithmostpay-as-you-gomethods• Increasedoperating income through reductionof retiree life insuranceand

medicalcosts• Enhancedemployee/retireesecurity• Positive impact on public relations - prefunding demonstrates financial

commitmenttoretirees’welfare


UsingaCaptivetoFundPensionsIRS regulations require that a plan sponsor fund up to 100% of its pensionobligations over several years. Today’s low interest rates and wildly fluctuatingportfoliovaluesmake100%fundingdifficult toachieve.Moreover,onceaplan isfullyfunded,excessfundsreturnedtothesponsoraretaxedatthesponsor’sordinaryincometaxrate,plusa50%excisetax,creatinganeffectivetaxrate on excess funding of 85%. Thus if the sponsor can achieve full funding, themarketcandrop,requiringadditionalcontributions,orthemarketcanrise,withoutacashbenefit to theplansponsor,creatinga “headsyou lose, tailsyoudon’twin”situation.Plan sponsors considermany options for dealingwith the volatility inherent in apensionplan.Theseincludeassetliabilitymatching(choosingplanassetsintendedtogoupinvaluewhenthepensionliabilitiesgoupandviceversa)andterminatingthepensionplanentirely,whichcanbeanexpensiveanddifficultprocess.Asolutionthatreducespensionplanriskwhileretainingassetswithinthecorporatefamilyisapensionbuy-insolution.Apensionplanbuysanannuitymatchingallorpart of its liabilities. The annuity is held as a plan asset. The annuity can bestructured to match all or part of the payment stream from the plan, so thatmovementsinthevalueofthepensionobligationarematchedbymovementsintheannuity asset. This approach reduces the plan’s cash flowvolatility. The annuitycan thenbe reinsured toa captiveownedbyorotherwiseaffiliatedwith theplansponsor. The sponsor could then avoid paying the high fees associated withpurchasingannuitiesfromcommercialcarriers,andprovidestabilitytothepensionplanandtheplanparticipants.


CriticalStepsintheCaptiveDevelopmentProcess

EstablishingaCaptiveforEmployeeBenefitsWhilecompanieswithexistingcaptivesmayusethemtocoveremployeebenefits,companies without captives cannot establish new pure captives specifically forfundingERISAemployeebenefits. TheDOLrequiresthat theemployer include itscaptive’slatestauditedfinancialstatementintheapplicationfiling. Thismeans,ofcourse, that theemployermustalreadyhaveacaptive tosatisfy this requirement.Mostemployers initially formproperty&casualty captives, andafterayearor sotheypetitiontheDOLtopermittheplacementofcertainemployeebenefits.The decision to form a new captive involves a range of considerations. Theemployermustcontributecapitalequaltotheminimumsolvencyratioofthechosendomicile,(basedonexpectedfirst-yearpremiums).Likemostcaptiveinitiatives,theemployer must be prepared to make a multiyear commitment to the program.Althoughsomebenefitsmaybereceivedyearone,fullbenefitswillonlyaccrueoncethecaptivehasbeenoperationalforafewyearsandtherisksarestabilized.Awell-establishedbenefitscaptivecanprovideongoingcostsavingsascomparedtopurchasinginsuranceinthecommercialmarkets,andprovidecosttransparencyasthecaptive’sfinancialperformanceisauditedeachyearbylaw.Captivesmaynotberightforsomeorganizations,thusafeasibilitystudyenablespotentialownerstoevaluatetheeconomicimpactbeforedecidingtoproceed.The diagram below illustrates the stages and timing of a typical captivedevelopment process. At the conclusion of each phase, employers have anopportunitytomakeadecisionwhethertoproceedtothenextphase.

Feasibility Design Implementation OngoingDevelopment

Timing

Process

4- 5weeks 8+weeks 14+weeks Ongoing

DecisionPoint

DecisionPoint


FeasibilityAcomprehensivefeasibilitystudyprovidestherationaleuponwhichthedecisiontoformacaptive(orplaceemployeebenefitsintoacaptive)isbased.Thefirstpartofthefeasibilitystudyprocessisdedicatedtoinformationgathering.Typically,informationregardingplandesignsandhistoricallossexperiencefortheappropriatelinesofinsuranceandfinancialinformationabouttheparentcompanyisgathered.Thisdataisusedtoidentifythebestcaptivestructureforeachorganizationanditsparticularaccountingpoliciesandemployeebenefitsrisks.Thereareseveralviablecaptivestructures,includingparticipatinginacellcaptive,whichisownedbyathirdparty.

Alternatively,asingleparent(owned)captiveprovidesgreatercontrolandflexibilitythancellcaptives.

Thechosencaptivestructureisthebasisuponwhichcostsavingscanbedeterminedforeachemployeebenefitsplan.Somebenefitplanscannotproducesavingssufficienttowarrantplacementinacaptive.Oftencompanieslookatcellcaptivesifthisisthecase.

Parent

Captive

Parentpayspremiumstocaptive

Captiveinsuresparentexposureandpaysclaims


Thecaptivefeasibilitystudyalsoprovidesananalysisofcaptivedomicilesandarecommendationthatmeetstheemployer’srequirements.ThereareoverthirtycaptivedomicilesintheU.S.,andregulationschangeperiodically,socarefulevaluationofdomicileoptionsisimportant.TheDOLrequiresthatERISAbenefitsbefundedinacaptivesubjecttotheU.S.courts.InordertofollowtheDOLexpeditedprocess(discussedbelow),mostcompaniesuseaU.S.-basedcaptive,orformabranchofaforeigndomiciledcaptive.Thefeasibilityanalysisprovidestheinformationtomakeaninformeddecisionastowhethertoformthecaptive,aswellasprovidingthebasisforthedomicileregulator’sapproval.Briefly,thefeasibilitystudytypicallycoversthefollowing:

• Captivelegalstructure• Optimalretentionlevelsforeacheligiblelineofinsurance• Areviewofappropriatedomicilesandapreferredoption• Thecaptive’seconomicimpactontheparentcompany• Thespecificcoveragethatbelongs(andthosethatdonotbelong)inacaptive• Fiveyearproformas• Costsavingsthroughimprovedcashflowsandexpensereductions• Theimpactofvarioustaxandaccountingtreatments,andanin-depth

discussionoftheIRStestsfortaxdeductiblepremiumsandlossreserves• Discussiononplanoptionsandbenefitintegrationthatmaycreatefurther

savings• Timetableandcostsforimplementingthecaptivesolution

DesignIf the employer decides to form a captive, the feasibility study becomes part of adetailed captive application submitted to the domicile regulator. For employeebenefits captives covering ERISA plans, DOL approval is also required. Ifappropriate,theDOL’sEXPROor“fasttrack”applicationprocesstypicallyrequiresbetween78to90daysfromthedateoftheapplicationtotheultimatedecision.The domicile regulator (and the DOL) requires a business plan with a detaileddescriptionofthecaptivestructure, itsowners,andthefundedbenefitplans. Theapplication alsomust include information on the captive’s board of directors andkeycommitteemembers. Thecaptive’spremiumratesareoftencalculatedbytheemployer’sactuarial consultantsworking inconjunctionwith the fronting insurer.Five year financial statements are required to demonstrate that the risks aresufficientlyprotectedbylossreserves,capital&surplus,andreinsurance.


Thebusinessplanmustincludethecaptive’sserviceproviders.Theseinclude:

• Thirdpartybenefitadministration,oftenprovidedbythefrontinginsurer• Stop-lossinsuranceand,ifappropriate,reinsuranceprovider• Legalservices• Taxandaccountingservices• Auditingandbanking• Captiveconsultingandactuarialservices• Captivemanagement

ImplementationThereareafewstepsinvolvedintheprocesstoimplementemployeebenefitplansinacaptive.n DomicileapprovalA well-conceived and executed application covers all the domicile regulator’srequirementsandshouldgenerate fewqueries. However, it isnotuncommon forthe regulator to require clarifications or additional information. Most domicilesutilize the services of a third party actuary to review the captive’s actuarialcalculationsandfinancialprojections.Asthecaptivematuresandgeneratesexcesssurplus,theboardmaydecidetodeclareadividendoremploytheexcesssurplusintheformofreducedpremiumrates.n DOLapprovalOncethedomicileregulatorapprovesthebusinessplan,ifthebenefitsaresubjecttoERISA,theDOLfilingmustbecreatedandsubmittedtotheDOL.Likethedomicileregulators, theDOLmayaskquestionsregardingtheapplication. Thesequestionswill need to be answered as part of the process. If the application has beensubmittedaspartoftheEXPROprocess,theDOLhas45daystotentativelyapproveorrejecttheapplication.Aftertentativeauthorizationisissued,noticesaresenttoparticipatingemployees. Within78daysormore, thefinalauthorizationis issuedforthecaptive.n UnderwritingtheemployeebenefitsinthecaptiveOnce the DOL issues final authorization, the captive begins the implementationprocess. Vendor contracts are finalized, the new employee benefit plans arecommunicatedtoemployees,andenrollmentcantakeplace.


OngoingDevelopmentEstablishingacaptivetofundemployeebenefitsriskscreatesalong-termfinancialsolution that manages employee benefit costs and stabilizes this element of acompany’sbalancesheet.Ontheotherhand,theemployeesnowownaninsurancecompany that requires prudent governance and formal reporting to the captiveregulatortoremainincompliance.n GovernanceCaptive boards and shareholders meet annually and usually within the domicile.The finance committee tracks the captive’s financial performance through theservices of accounting and captive management advisors. The underwritingcommittee manages the insurance placements advised by the captive’s outsideactuariesandconsultants.n Re-pricingandnewmemberadditionsThe actuarywill calculate the ongoing impact of cost, utilization trends, changingdemographics,andparticipationlevelsinthevariousinsuranceprograms,andwillmakerateadjustmentsonanannualbasistoensurethatthecaptivecancontinuetofulfill its financial obligations in conjunction with the fronting insurer. Thesechangesmaynecessitategoingback to themarket toconsideralternativevendorswhere necessary. The captive structure allows a great deal of flexibility to buildcustomizedprogramsandadjustplandesignsonemployee contribution levels, toreflectthechangingneedsoftheemployerovertime.n AdditionalinsurancelinesHavinginvestedinthecaptivestructure,itisrelativelyeasytoagreeonadjustmentin the business planwith the domicile regulator and to add additional insurancelines toawell-establishedprogram. Thoseemployerswhomaystartoff coveringgrouplifeanddisabilitycoveragethroughtheircaptivemayconsideraddingretireemedicalormedicalstop-losslinesatalaterdate.n BenefitintegrationThe captive enables employee benefit plans and property & casualty plans to befundedthroughessentiallythesamecaptiveprogram.Thisprovidesspreadofriskandoverall stability. Thepotential tocoordinateandconsolidatedataalsoallowsforbenefit integrationthatcangenerateadditionalsavingsasbenefitoverlapsareeliminated and administrative and risk efficiencies are introduced. This oftenresults in a better employee experience along with continued savings. Workers’compensation, disability and medical plans particularly lend themselves tointegration.


CaseStudy1:FundingEmployeeBenefitsinaCaptiveA healthcare organization with 10,000 employees wanted to implement captivefundingforsomeoftheiremployeebenefitswithouttoomuchchangeorimpactontheircurrentprocesses.ChallengesTheorganizationwantedtoexpandtheuseof theirVermontcaptiveto fund long-termdisabilityandgrouplife/AD&Dcoveragetoreducetheoverallcostsofriskandenhance cash flows to the parent company. Additional objectives includedimprovingoperationalperformanceoftheirbenefitsprogramsthroughintegrationof coverage frombotha fundingandprocessperspective, andbuildingupcaptiveassets for a better return on investment. The client wanted to use its existingcarriersinordertominimizeanyimpactonhumanresources.Moreover,theclientsconsidered the impact on existing carrier relationships, renewal dates, andemployeeprocesses,andalsoacknowledgedthatthehumanresourcesdepartmenthadanumberofprograminitiativesunderway.ProcessSpring conducted a feasibility study to determine if the objectives could be met.Workingcloselywithhumanresourcesandriskmanagement,wehelpedstructurethe program, obtaining DOL and captive domicile approval. We were able toimplementthenewstructurewithexistingcarrierswithinasixmonthtimeframe.Spring’sSolutionsAfter determining that funding long-term disability and group life coverage in acaptivewouldmeettheirobjectives,wetransitionedtheexistingcarriersfromfullyinsuredtofrontedcontracts,andconfirmedthattheclaimsandoperationalprocessfor human resources and employees did not change. Additionally,we negotiatedprogram savings that could eventually be passed on to employees, leading to asavings in the HR budget and creating financial reports to better manage theprogram.ResultsThesavingsascomparedtothefullyinsuredarrangementswereover$7millioninthe first year. The organization was able to maintain the same operational andclaims processes for human resources and employees, but with improvedinformationflowresultingfromthenewreportingformats.


CaseStudy2:FundingRetireeMedicalandOtherBenefitLiabilitiesA group of utility companies wanted to evaluate options for funding employeebenefitsliabilities,retireemedical,andpensions.ChallengesThese utilities were required to fund their retiree medical benefits for theiremployeesandretirees.Theregulatorswererequiringthemtofundinadvance,forbenefitsthatwouldbepaiddecadesinthefuture.Theseassetswouldbetiedupformany years, and theutilitieswanted to be certain that theyperformed aswell aspossible.Theseclientsfoundthatthetraditionalmethodsoffundingdidnotsuittheirneeds.Theavailableoptionseitherhadonerousrestrictions,highfees,orhightaxes.ProcessSpring helped these utilities form a group captive. This captive issued long-termTrustOwnedHealthInsurance(TOHI)policies.Thisenabledtheutilitiestomakeatax-deductible contribution to the trust. The trust could then purchase TOHIpoliciesthatwouldprovidenon-taxablereimbursementforaportionoftheclaimspaid.Thepolicies invest inmarketable securities,withexcess returnspaidout intheformofenhancedTOHIbenefitstothetrust.Spring’sSolutionsAcaptivestop-lossarrangementwasrecommendedtomeettherisksoftheutilitycompanies.ResultsThecaptiveproducedover$100millioninsavings,ascomparedwithanon-captiveapproach,over the first10years. Springcontinues toplayarole in thisprogram,including annual policy pricing, claims processing, reserve calculations, quarterlyconferencecalls,andannualmeetingswiththeboardofdirectors,policyapplicationsupport,andpolicyissuancesupport.ConclusionCaptives are useful and versatile risk financing tools, especially for employeebenefits. Theyprovidesignificantlybettercashmanagementthancanbeprovidedthrough a trust and can produce impressive cost savings as compared to fullyinsuredguaranteedcostplans.


Whilethebenefitsofcaptivesarenumerous,employersmustunderstandthattheyare insurance companies, and therefore subject to the same tax and accountingoversight applied to everyU.S. domiciled commercial insurer. Captives representlong-term organizational and financial commitments, as their facility to createsignificantvaluecannotberealizedintheshort-term.Captivesareformedforavarietyofreasons,butthemostimportantreasonisthis:to reduce the employer’s long-term cost of risk. While captive premium taxdeductibilitycanbequitevaluableovertime,thecaptivemusthaveasound,non-taxbusinesspurpose.Fortunately,thecostsavings,investmentincome,andfavorabletaxenvironmentallcontributetoreducingtheemployer’s long-termcostofrisk,whichisthebusinesspurposecitedbymostcaptiveowners.


AboutSpringSpring, provides a full range of strategic consulting services to institutions in theinsurance and financial services industry; broad consulting and brokeragecapabilitiestoemployers;andfundingsolutionsforbenefitprograms,includingtheuseofcaptiveinsurancefacilitiesandtheday-to-daymanagementthereof.Spring was formed in March 2004, through a management buyout of the USinsuranceandfinancialservicesstrategyconsultingpracticeofWatsonWyatt,LLP. OURUNIQUEEXPERTISE Spring has works with employers of all sizes to design, implement, fund andimprovetheiremployeebenefitprograms.Spring brings our clients unmatched expertise in the area of employee benefitsdesign, alternative funding and captive management. The Spring team has beenproviding a full range of employee benefit and captive program administrationservices, including underwriting, pricing, reserving, claims processing, financialmanagement and administrative services to employee benefits captives for morethan10years.Tohelpensurethesuccessofourconsultingengagements,Springhasunderitsroofafullarsenalofresources,toolsandstrengthstobenefitourclients.Theseinclude:n Award-Winning Broker-Agents. We have been developing innovative, cost-

saving employee benefit solutions for clients of all sizes for decades and havebeenrecognizedbesomeoftheindustry’stoppublicationsandorganizationsforourwork

n CaptiveSpecialists.Wehaveexpertiseindevelopingcaptiveinsurancestrategiesin employee benefits for our clients that seek cutting edge alternative riskfinancing solutions. With our precedent-setting captive strategies, we havehelped shape the employee benefits captiveworld in the United States as weknowittoday

n Recognized Experts. You want the best in the business— people who haveworked with FORTUNE 500 to small business clients to solve problemscreatively.Ourconsultantsarerecognized leaders in thedesignand fundingofcaptive insurance solutions, and can bring to bear their collective knowledge,insightandindustryconnectionsforthisproject


n StrategicSolutions. Youneedanswersthatwillbelong-termsolutions—onesthattakeintoaccountnot justtheproblemoftoday,buttoanticipateandplanforthechallengesyourorganizationwillfacetomorrow

n EffectiveTeamwork.Youneedacommitted,proactiveteamwiththeabilityandresourcestodeliverservice.Youwantexpertswhocantransfertheirknowledgeofcomplexissuestotheyourteameasilyandeffectively

n Predictability. You need straightforward advice tailored to your specificbusinessissues.Youwantnosurprisesinbothourworkingrelationshipandtheresultsweprovideyou

n FocusonBusinessObjectives.Youneedateamwhounderstandsyourbusinesswellandisdedicatedtodeliveringservicesthataddvaluetoyourbusiness—afirm that understands the complexities of issues ranging from financialforecasting toactuarial fundingand its impactonshort- and long-termbudgetandfinancialplans


What’sNext?Springisarecognizedleaderinbenefitcaptiveconsulting.Thereisnootherfirmouttherethat isexperienced indeveloping innovativebenefit fundingprogramsusingcaptives. Our team of consultants, legal experts and actuaries can help youdetermineifacaptiveistherightplacetofundyourcompany’sbenefits.If you’d like to explore benefit captive funding further, the next step is a quickdiscovery discussionwith a Spring consultant to find outmore about your needsanddetermineifacaptivefeasibilitystudyiswarranted.Contactustodaytosetupafreeconsultation. CONTACTINFORMATION SpringConsultingGroupLLC30FederalStreet,4thFloor,Boston,MA02110Phone:(617)589-0930;Fax:(617)[email protected]:spring-consulting-group-llcTwitter:@SpringsInsightYouTube:SpringConsultingGroupSlideShare:SpringConsultingGroup

Documents

Employee Benefits in Captives - Spring Consulting Group · Advantages of Placing Employee Benefits in Captives There are several advantages to funding employee benefits in a captive