When a captive health plan works well, employers are able to lower the cost of healthcare — in some cases by 30%-40% — for their employees. Regardless of how many employees or plans they have, all member organizations receive a return at the end of the underwriting year based on their level of participation, rather than their individual loss ratio and its repeatable year over year.
However, as captives have become more popular, they have also become susceptible to mismanagement, poor performance and low or no returns.
To ensure a captive is optimized for excellence, it must meet four imperatives:
1) Size. The obvious reason for choosing to participate in a captive or group purchasing coalition is the buying power and stability that comes with it, which means employee volume is critical. Captives need to meet a minimum number of employees in order to disperse risk effectively, reduce volatility over time and increase stability. A starting threshold is about 1,000 employees. That 1,000 threshold can be achieved by as little as four to five clients. But, as the number of clients increases, predictability and stability do as well.
2) Likeminded members. A single large company purchasing insurance inherently has the safety of numbers. However, it also has insight into its risk and control to improve its performance. It can assess benefits usage over time, identify trends and then take action accordingly, such as implementing claims management, wellness and employee assistance programs; distributing incentivized health surveys; improving environmental factors (air quality, office equipment and furniture) and encouraging work/life balance. In a broad sense, the clients are “ready” for a captive.
In general, greater volume yields lower costs, so when small companies come together to purchase insurance as one, the benefits of bulk buying follow. The challenge and primary risk for a smaller company once it joins a purchasing group is that, while they can control their own employee health and wellbeing initiatives, they can’t control those of their member community. In an attempt to lower costs by increasing purchasing power, they could be adding risk if they are not well-aligned with the group they are joining.
As an easy example, consider smoking. Smoking-related illness in the United States costs more than $300 billion a year, including nearly $170 billion in direct medical care for adults and $156 billion in lost productivity, according to the U.S. Department of Health and Human Services. If one company out of 10 allows its employees to smoke on their property, it increases risk and volatility for everyone else. If nine out of 10 captive members implement smoking cessation programs that are linked to employee plan contributions and other claims management policies and one does not, it puts the entire pool at risk. It is imperative that companies that join together share the same philosophy and practices when it comes to employee health and wellbeing.
Captives or healthcare purchasing coalitions — group purchasing that combine captive insurance techniques with enhanced program offerings and a systematic membership process — that use tools such as feasibility studies, mandated minimum health and wellness program participation and specialty programs like 24/7 independent case management to carefully manage captive membership help ensure members are aligned in theory and practice.
3) Adviser alignment. Similar to member compatibility, adviser alignment is also critical to captive success. This approach works best when there are controlled operating guidelines and a connected “wholesale” adviser community. In the absence of a proven adviser structure, a captive or wholesalers can struggle to thrive.
What should be avoided are scenarios where advisers who are doing the right things, such as using claims controls, managing risk and only offering membership to qualified organizations, can be pooled together with advisers who have minimal experience and are not using appropriate cost controls to ensure proper loss ratios and performance. The result is a frustrated client who does not receive refunds and a great adviser who no longer believes captives are viable, smart options for their clients.
Employee benefits, especially healthcare benefits, vary greatly from region to region and state to state. Local legislation and regulations, climate, cultural influences, demographics and many other geo-relevant factors contribute to a dynamic benefits environment. This phenomenon makes local advisers imperative to navigate the state laws, local providers and local robust plan designs.
However, captives do not share the same boundaries. They can and do span multiple geographies. Any company that has 35 employees or more is a candidate for captive membership, but they need a local representative with market expertise to build optimized plans that align with the needs of their specific employee community and meet the requirements of the captive at the same time.
In turn, one captive can have many different advisers acting on behalf of many companies in a successful way if they are all working with the same mindset.
Is it the chicken or the egg? Captives need the best advisers to be successful, the best advisers need thriving captives to be successful. They both need an engaged, aligned adviser community to be successful. Coalitions or captives that employ a thoughtful approach to their adviser network ensure adviser alignment and foster a productive investment environment that’s primed for growth.
4) Performance-based structure is needed. The health insurance industry is antiquated in its delivery to employers and, consequently, the way independent advisers access captive pools can sometimes be tricky. In most cases, advisers have to work through a “wholesaler” to enable their clients purchase insurance using captive methods. Wholesaler networks allow independent advisers to access “public pools” or “incubators” for a single client alongside of many other independent advisers’ clients to reach the optimal size.
This method has been instrumental in the adoption of the captive model, but has also contributed to the primary issue that has plagued public captives because of the way captive wholesalers are compensated.
Typically, captive wholesalers charge a set percentage of the client’s premium for the services and expenses to run the captive (and the program). Their expense is taken off the top and only the remainder of the client’s premium is placed in the second risk layer (i.e. captive risk or shared premium layer). As an example, if a wholesaler is charging 40% for their services of the program (underwriting, excess layer reinsurance, claims adjudication, captive access, captive premium taxes), it only leaves 60% of the client’s premium to be placed in the second layer to cover the claims that hit layer.
Running a successful loss ratio on only 60% of a client's premium in the second layer can be difficult. As such, captive wholesaler compensation is not correlated to the performance of the pool or could hurt the chances of unused premium being returned to employers.
In a sense, captive wholesalers, also sometimes referred to as managing general underwriters, are compensated based on how big the pool is, rather than how well it performs. As a result, wholesalers and MGUs can be not incentivized to optimize programs or improve performance before they admit them into the pool. This can impact everything from operations to underwriting quality.
When a captive or coalition directly links its compensation — and mandates that wholesalers or advisers also share risk — to the success of the group of clients in the captive, everyone is motivated to provide the highest level of service, attain a deep understanding of each client’s risk, fix problem areas proactively, add cost controls/risk management tools that can help them perform better and, most importantly, save members money.
In addition, performance-structured compensation also ensures that only qualified candidates are recommended for participation in the captive, which facilitates alignment of members and advisers; and prevents individual advisers from using the captive in ways it is not designed to operate.
Curated community, carefully cultivated controls, compelling captives
When designed and operated with care, skill and data, captives are powerful tools for smaller organizations looking to offer their employees better benefits at lower costs. Their success is proven as evidenced by their performance and ability to deliver plans at 40%-50% of the cost of the national average and return millions in surplus assets to members. But, not all captives are the same. When evaluating captive options, organizations should consider the following:
- Are members required to meet specific benchmarks or qualification before they can join? (i.e. health and wellness qualifications, retrospective loss ratios, underwriting requirements)
- What are the captive’s guidelines for risk management and claims and cost controls?
- Are the captive management fees based on performance (i.e. part of shared risk and vary depending on performance) or volume (i.e. size of the overall premium invested)?
- Are wholesalers and/or advisers required to share risk in the second layer?
Are existing members available for informational conversations and ongoing support?
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