Group Stop-Loss Captives (Re-Imagined as a Single Company)Michael P. Madden

2 Artex

Group Stop-Loss Captives (Re-Imagined as a Single Company)

Property and casualty group captives provide mid-sized employers with access to risk financing vehicles typically only accessed by larger, Fortune 1,000 companies. By banding together in a group captive, mid-sized employers can replicate the risk profile of larger employers. I’ve always thought of group captives as being a large company re-imagined. I also see these larger employers gaining significant advantages for their employer-sponsored healthcare plans; managing cost drivers and achieving a 2%–3% annual medical cost trend increase that is more in line with general U.S. inflation, as compared to the more typical and unsustainable 10% average for medical cost trend. How do they do it?

Healthy cooking for high performance If I were the CFO of a company of 6,000 employees, I would do the following to best manage the costs of providing healthcare benefits to my employees and follow a successful recipe:

� Self-fund my healthcare program since this is the most efficient delivery vehicle

� Buy as little true insurance as possible — that is, buy medical stop-loss with a very high deductible (above $500,000 or $750,000 per individual)

� Proactively manage health cost drivers with a comprehensive wellness and population health risk management program

How would I change things if our 6,000-employee company, instead of having two or three divisions, had 30 distinct operating units averaging 200 employees each?

While my company is a conglomerate with different operating divisions, I wouldn’t want to extend carte blanche to my divisional managers thus sacrificing our biggest advantage; buying power and a credible sized employee population. Starting with the basic recipe above, I would add a few seasoning modifications to further enhance the recipe.

First, I would create a profit and loss (P&L) incentive so that each of my divisions had a direct responsibility for controlling cost drivers, thus directly impacting a portion of the P&L for each division according to some portion of its actual medical costs.

I would not, however, want to adversely penalize any one division because they had a large claim, which would be fairly unpredictable because of their size. The working layers of healthcare claims can be volatile as nearly two-thirds of next year’s high-cost claimants come from this year’s low-cost segment. A heart attack or cancer diagnosis could account for 10%–15% of total costs for a 200-employee division. With our more credible population of 6,000 employees, these events are less than one half of one percent of costs and actuarially expected based upon population size. In order to not adversely impact any specific division due to a single large claim, I would create a stabilizing fund or “pool” across my divisions. Each division would contribute to the pool annually so that it was adequately funded.

Risk management maximizedI would want my divisional managers to remain engaged in the corporate risk management program to control long- term cost drivers. Making sure that divisional leadership was not sacrificing long-term cost containment for small short-term gains, I would incorporate P&L incentives for “toeing the company line” in regards to risk management. Risk management is a corporate investment, and engagement from divisional managers and employees is required in order to realize a return on this investment. Further, each divisional manager benefits when all of the managers engage their employees and promote risk management as the total contributions to the stabilizing

Group Stop-Loss Captives (Re-Imagined as a Single Company) 3

fund would increase at a lower rate when we control claims drivers. I would review the available metrics which we use to gauge long-term cost containment to help determine the indicators used to ascertain each operating division’s annual contributions to the stabilizing fund — participation in the health risk management program, employee engagement level, and claims activity.

The group captive continuum In a group captive program, we build the same risk financing structure from the bottom up. That is, 30 employers averaging 200 employees create the same credible population — our re-imagined large company with 6,000 employees. A stop-loss group captive program allows each employer (in our large company analogy, a division) to control costs by:

� Self-funding their health plan risk

� Buying stop-loss at a higher level around the captive than they could on their own — that is, they purchase less insurance (transfer less risk), recouping insurance company profits

� Promoting progressive risk management programs — creating a culture of health and wellness for their employees, with other like-minded employers, i.e., toeing the same line

� Maintaining an individual incentive to control medical costs in their self-funded layer (under the stop-loss)

� Managing long-term costs by participating in a stabilizing fund (the first portion of stop-loss risk) and having a larger portion of cost increases dependent on the performance of the group captive and not the overall industry

Continuing with our re-imagined company analogy, how should each employer fund the captive stabilizing fund (the risk sharing layer) on an annual basis? The methodology employed is what gives each group captive its unique personality.

It is tempting to set annual allocations in the captive (stabilizing fund) strictly according to loss performance. While this placates the member who has a good year, we should remember that there can be a lot of volatility in medical stop-loss claims for mid-sized employers; this allocation methodology may not align with the goal of the group captive to reduce long-term insurance costs. To what extent would the captive be rewarding luck instead of risk management initiatives that impact year-over-year trend increases? This structure also mirrors how the traditional stop-loss market operates. For mid-sized employers, buying traditional stop-loss is akin to providing carte blanche to divisional managers. In any given year, an employer (in our large company analogy, a division) may perform well, typically receiving trend increases negotiated down from the average industry leveraged trend, but when one of the unpredictable claims happens, as cited above, the employer can experience a significant increase in their healthcare costs. The net long-term increases equal leveraged trend plus carrier profits. A reaction is to drive down stop-loss cost increases by assuming higher deductibles; however, by doing so employers assume more risk and ultimately realize significant increases in overall costs.

Within a group captive that is underwriting traditional stop-loss renewals, employers might recuperate a portion of stop-loss premiums—occasionally rewarding luck more than good risk management—but also adversely penalizing employers when they have had a bad year. The net effect may be a slight decrease in stop-loss costs at the expense of higher overall medical costs. The goal of the group captive program should not be to simply recuperate stop-loss costs, but to impact—stabilize and reduce—overall medical costs.

4 Artex

Division Senior Vice President — Benefit Captives

Mr. Madden leads Artex’s Benefit Captives Practice and has significant experience structuring Stop-Loss as well P&C Group Captive programs. You can reach him via email, at: Mike_Madden@artexrisk.com

Mike Madden

Moving from dividend eligible stop-loss to a better way to finance stop-loss.When running properly, the group stop-loss captive should target the reduction of long-term cost drivers, not just stop-loss premium increases. Long-term costs in the captive will outperform the stop-loss industry when expenses are in check, risk management programs are effective and the group’s claim performance outperforms industry averages.

A process of banding renewal increases based upon a captive’s unique recipe of metrics that focuses on long-term cost containment and recognizes that large claims will happen, and they will eventually happen to everyone, is, in theory, a better way to manage long-term healthcare costs for the group captive and the individual employer. If group stop-loss captives are viewed as a re-imagined large company, then this goes beyond theory and follows the best financing models available. A path blazed by larger employers to achieve annual healthcare cost increases in line with U.S., not medical, inflation.

Some food for thought.Leveraged Trend is the effect that medical inflation has on stop-loss reimbursement. If healthcare costs increase by 10% next year, a greater portion of a similar large claim would be covered by next year’s stop-loss policy. Stop-loss carriers pass on average industry trend resulting in stop-loss increases of 15% to 30% per year. When a large employer’s overall medical trend is less than 10%, they would experience a similar decrease in their own leveraged trend.

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