Should you consider an employee benefits captive?

Commentary: Historically, we haven’t talked about captives when it comes to employee health benefits, but we’re starting to. As employers grapple with how best to provide quality benefits for employees and comply with the Affordable Care Act, they’re seeking out new strategies. Captives are an interesting approach that can work for some plan sponsors.

 The advantages of self-funding include the opportunity for cost savings and plan flexibility. Companies that self-insure are, ostensibly, betting on themselves. They are willing to gamble that their claims will be less than what they’re insured for, which in turn will give them a dividend for their strong performance. Participating in an employee benefits captive is doubling down on that bet.

Also see: “Betting on self-funding can have a big payoff.”

How captives work

An employee benefits captive is made up of a group of employers that come together to insure the risks of its owners. A captive is a separate risk-assuming legal entity with profits and losses shared among multiple participating companies. Its risk commences at a low, pre-determined individual stop-loss (ISL) level and extends up to a high per-individual cap where a stop-loss carrier then assumes the risk.

If the members of a captive don’t have as many losses as anticipated, they will receive a return premium in the form of a dividend. In a standard insurance program, that money would not be returned and the insurance company would retain this premium as profit. 

The captive group pays a third-party administrator to run it; this is a fixed expense. The captive members pay “policy premiums,” which cover all liability over the ISL limit. This is also a fixed expense and includes stop-loss premiums, paid to a third layer stop-loss carrier and captive layer premiums to the captive.  

Participating companies are required to fund shortages that may occur in the captive. Similarly, if there’s a surplus, the members share in the dividends.

Pros and cons

To date, captives have not been very popular in the world of employee health benefits because of the volatility of insuring people. It’s one thing to have property and casualty insurance on a building, but it’s very different to insure human beings, who have a tendency to have unpredictable health emergencies. When an employer joins a captive, it isn’t just placing a bet on the health of its employees; it’s also betting on the health of employees at other members of the captive. If one of your co-captive companies has a catastrophic loss, you have to share it. 

Also see: “There can be freedom in captivity.”

This could be a significant downside, and it’s why captives for employee benefits remain relatively rare. For a lot of employers that self-insure, betting on themselves is enough. They don’t need to add to the uncertainty by betting on other employers as well.

However, for the right organization, there are some intriguing advantages. The first is the opportunity for improved cash flow, as the employer pays only for the claims incurred under the captive. And captive members also enjoy lower premium taxes, avoid the health care reform insurance fee and have lower carrier fees. They also enjoy greater flexibility in designing the plan, and don’t have to be concerned with state-mandated benefits.

Who should consider a captive?

For some employers, an employee benefits captive is an interesting consideration. Specifically, consider a mid-sized company that wants to gain more control of its health insurance spending, but can’t take on all the risk themselves. Importantly, organizations considering an employee benefits captive have to think long term; a captive is not something you can try for one year. In fact, most captives require at least a three-year commitment.

Normally the captive is comprised of like-minded companies. For example, all members must participate in robust wellness programs. Or they might all be from one industry. 

Also see: “The ACA: Top 10 predictions for 2016.”

Typically, employers that choose a captive are already familiar with how they work because they’re part of a property and casualty captive. As such, they typically are thinking about the long term and have a higher risk tolerance and a desire for transparency than other employers. Organizations that are ready for captives also have strong cash flow, and typically have a track record of minimal claims and a robust wellness program.

In this day and age, employers should consider every possible approach to providing health insurance to their employees. When contemplating joining a captive, it isn’t always easy to thread the needle, but it’s an idea that is picking up steam and will make sense for some employers.

Stephanie Ward is senior regional vice president at Corporate Synergies, where she supervises employee benefits renewal activities, carrier and vendor performance, rate negotiations, funding analysis and claims analysis for employer-clients. She also provides her expertise in the development and management of a complete benefits strategy.