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The Evolving Role of Captives: Within the New Health Care Reality

The Symposium on Captive Insurance in ConnecticutOctober 2, 2013

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Content Current State The Healthcare Environment is Ripe for Change Captives 201 Creation of a Captive Case Studies

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Current State

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Healthcare Cost Escalation

Average Annual Premiums for Single and Family Coverage, 1999-2012

Source: Kaiser/HRET Survey of Employer-Sponsored Health Benefits, 1999-2012. * Estimate is statistically different from estimate for the previous year shown (p<.05).

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

$15,745

$15,073

$13,770

$13,375

$12,680

$12,106

$11,480

$10,880

$9,950

$9,068

$8,003

$7,061

$6,438

$5,615

$5,429

$5,049

$4,824

$4,704

$4,479

$4,242

$4,024

$3,695

$3,383

$3,083

$2,689

$2,471

Single CoverageFamily Coverage

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The Affordable Care Act and ACOs Established in 2010 to:

Promote accountability for patient population Encourage investment in infrastructure Increase quality and efficiency of service delivery through

redesigned care processes Coordinate services under Medicare part A and B Rewards ACOs if their overall costs per registered patient

are less than average Medicare beneficiary in geographic area in a given year

Value Based versus Volume Based Purchasing Model

Goals: Better Health, Lower Costs, Outcomes Based Shared Savings

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ACOs and Captives Many looking at ACO risk as part of captive programs

Allow providers to share in cost savings generated by ACO’s per-capita costs limit― Captive would also be responsible for equitable distribution of

savings to ACO’s providers― Captive stop loss for providers

Help manage the financial risk like the medical malpractice risk exposure by providing collaboration in defending medical malpractice allegations

Provide controls to help reduce medical error and support single focus

Increasing use of captives to manage risk!

Starting with Employee Population

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A Trend Toward Self-Insurance

Control medical cost inflation Avoid Impacts of ACA

additional taxes and fees: Health Insurance Industry Fee of 2-2.5% in 2014 and 4% in 2015 on fully-insured groups

“…groups between 51 and 100 employees are more likely to self-

fund in greater numbers when they become subject to the small group

market reform rules in 2016”RWJ - Factors Affecting Self-Funding by Small Employers; April 2013

“82 percent of employers have experienced a growing level of interest in self-funding their group health insurance plans over the past 12 months, 32 percent stating that interest has increased ‘significantly’”

Munich RE: Business Wire, April 15, 2013

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

52%

54% 54%55% 55% 55%

57%

59%60% 60%

Growth of Self-funded Plans(All Employers)

Source: Kaiser/HRET Survey of Employer-Sponsored Health Benefits, 2012.

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Stop Loss in a Captive

Captive

Reinsurer

The captive provides a secure way to self insure health risks

The captive protects itself from excess claims by buying cover from an outside reinsurer for individual

claims and total claims that could exceed 125% of expected

The captive holds reserves for the employer

to pay individual claims over each member’s

retained risk SIR

125% of Expected Claims

Employer Self Insured

Retention

(SIR) Level

Individual Claims

Agg

rega

te C

laim

s

$250,000

Employer retains some risk to reduce their

overall costs

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The Healthcare Environment is Ripe for Change

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Reasons Captives are on the Rise

Growth of employee benefits captive a result of: Insurance needs Health care reform and other legislative changes Business, financial and tax considerations Lack of confidence in traditional insurance companies Increase in specialist consultants with turnkey solutions Brokers see captives as a way of retaining clients and

increasing margins by participating in the risk More domiciles with more flexible captive legislation

Market pressures will continue to force employers of all sizes to search for creative alternatives to traditional insurance products.

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Trends in Captive Use for Benefits New captive formations and expansion of

existing captives Greater domicile choice Increased funding of unrelated / 3rd party risk

Truly unrelated Employee benefits a major investment for many

companies Post-retirement costs in Europe and US are

becoming critical issues where captives are a solution Pensions Retiree medical Stop loss

Expanded rent-a-captive or segregated cell captive use Employee benefits are now a major investment for many companies Companies are now seriously looking at captives as a funding vehicle for

benefits as blue chip organizations take the lead

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Then vs. Now: What has changed?

Captives were rarely used: Perceived obstacles

Reinsurance restrictions Territorial restrictions, (i.e. US

only) Relatively few employee benefits

reinsured by captives Limited HR familiarity with captives Insurer reluctance Alleged marginal economics

More people involved: HR, Finance and Risk agendas Everyone knows about it

Consolidation of risk financing Network restructuring and changes

not aligned with growing market Viewed as the next step in cost savings

and control Active management increasing:

Communications Formal guidelines Annual review and changes Quarterly claims management

What does this mean? Captives represent an emerging growth area!

Ten Years Ago Now

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Case for self insurance is stronger Generally, stop loss coverage allows:

― More flexibility of plan design (ERISA vs. state laws)― Control medical cost inflation― Access to data not available with fully insured plans which

translates into the ability to make targeted changes PPACA provides even more incentives:

― Avoid Impacts of ACA additional taxes and fees

Consider how your risk pool may change due to PPACA. Fully insured groups need to spread costs.

The Environment is Ripe for Change

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Captives 201

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Captives are Generally Established to Insure or Reinsure Risk

Direct Insurance

Parent

Captive

Parent pays premiums to

captive

Captive insures parent exposure and pays

claims

Reinsurance

Parent

Captive

Parent pays premiums to the

front

Front insures the captive’s parent exposure and pays

out claims

Insurance Company

The front reinsures the program with the

captive

The captive pays fronting fees and

claims

Structure is important. Stop loss within a captive is not first dollar

coverage.

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Types of Captives Single Parent (Pure) Group

Risk Retention Groups Association

Agency (Broker Owned Captive) Rent-a-captive or cell facilities

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Who Should Consider a Captive?

Companies with. . . Good risk management Long term commitment Financially sound Driven by an interest in

financing assumed risk positions

Reasonably predictable insurance risk

Should not consider, if . . . Poor risk management /

high loss ratios Short term outlook or

price driven Financially weak Highly volatile or

catastrophic exposures without the support of stable lines

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U.S. Employee Benefit Offerings

Retirement Health Security Time Off

Voluntary

VacationFinancialProductsHolidaySTD1

DrugsDefinedContribution

Sick Leave

Mortgages

Investment Funds

Fringe

Training, Education Assistance

Transportation

FSA3

Legal, Financial Planning

Dental

Other Leave

Health & Welfare

Pension

Post-Ret Life

Post-Ret Medical

Medical(Stop Loss)

Life Ins.

LTD2

Workers’ Compensation

Auto/homeowners Insurance

Life Long Term Care

1 Short Term Disability2 Long Term Disability3 Flexible Spending Accounts4 Employee Assistance Programs (mental health, legal assistance, etc.)

Multinational Pooling, Expatriate Global Assistance

Prevention, Disease Mgmt

Critical Illness

EAP 4, Work/Life

Executive Benefits

Typical Non-ERISA

Typical ERISA Plans

= Typical Captive Programs

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Employee Benefit Cost Savings Using CaptivesProgram Estimated Savings* Frictional Costs

Active medical stop loss 10% - 12% Cost of stop loss

Term life insurance 10% - 15% Commercial insurance

Retiree medical 3% - 15% Accumulated Post-Retirement Benefit Obligation

Long-term disability 15% - 25%

Commercial insuranceOn self-insurance, accelerated deduction of claims cost and tax effective investment accumulation on reserves

Multinational pooling 10% - 15% Commercial insuranceExecutive benefits – Deferred compensation COLI Split dollar replacement

10 + % Net cost resulting in higher yield on investments

* These are typical savings that our clients have experienced in the past; actual performance may vary

Other advantages are similar to property/casualty captive funding e.g., broader coverage, stability against market fluctuations, improved service, direct access to

reinsurers, and increased control

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Reinsurance (Stop-Loss)

LOSS FUNDSRetained by Captive

Expected Paid Loss

Retained by Business Unit

ExpectedLoss

$ Max Determined

Paid to Reinsurer

Risk Transfer for Aggregate Loss

Protection

Loss Funding -good loss

experience stays with captive,

PR

EM

IU

MS

Loss Funds into

Captive

Long-Term Strategies: 1. Grow LOSS FUNDS by retaining and managing more risk in the captive, lessen dependency on other insurance over-time2. Accrue value in the captive

Operating Costs

How Stop Loss Captives WorkHow Losses Are Paid OutWhere Premium Goes

LossFunding

Expected losses paid by Captive

DeductibleLoss Fund for SI Layer

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Why are Organizations Interested in Stop-Loss Captives? Existing P&C captives and can be extended to

other employee benefits Could improve tax efficiency of existing captives May be used when multiple employer welfare

arrangement (MEWAs) and other group stop loss structures are prohibited or require more capitalization

Allows heterogeneous entities or smaller organizations to pool coverage

The costs of forming a captive are able to be spread out among all of the participants

The risk per participant is lower New lower cost captive structures plus current

approval precedents make access easier

Medical stop-loss captives allow self-

funded employers to pool excess medical claim costs with other companies to facilitate the purchase of stop loss coverage with higher attachment points, thus

effectively lowering the cost of coverage and effectively

controlling their health

cost expenditure

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Key Considerations When Forming a CaptiveCaptive Type

• Pure• Group• Fronted• Direct• Cell• Rental

Captive Legal Structure

• Stock• Mutual• Reciprocal

Domicile

• Capital and Surplus

• Financial ratios• Minimum

attachment points

Tax Issues

• Deductible premiums

• Insurance accounting

• Deposit accounting

• Accelerated deduction

Regulatory Compliance

• Financial metrics• Record keeping

Human Resources Same carriers and networks Access to transparent data Expert support for health

data/trends, health reform and legal issues

Employees No noticeable change Minor and seamless transition

of services Improved employee support

services

Staff Impact

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Control• Premium

volatility reduced via claims pooling

and large scale

PROGRAM STRUCTURE• 5-8 custom health plans

• Best in class health management and wellness• 1-2 carriers

• Full data analysis for management/benchmarking

• Active member involvement in decision-making and design

One Central Point of Contact

• Enrollment• Billing

• Employee interface• Employer data

Transparency• Financial and performance data• No hidden costs

Buying Power• Creates cost

savings that increase as the group expands

Flexibility• Select plans

• Select employee contribution

• Maintain existing broker relationships

Choice• Members can

choose to self insure some of

their own risk to save cost

Group Captive Program Development

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Health & Productivity Management

Funding

Group Captive Program Development

Founder

Employer

Group

Additional

Participants

Health Insurance Funding

Improved Risk Mgmt Bulk Purchasing

Other Risks – Life

Disability

Retiree Health

Pensions Life

Performance

Measurement

Healthier, More Productive Employees

Improved Benefits Value and Cost Management

ROI MeasurementContinuous ImprovementTighter Controls and Risk Management

Health Management

Initiatives

Wider Health and WellnessInitiatives

In House Primary

Care

Health and Disability

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Creation of a Captive

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The Fundamentals must be Sound

Effective Captive Program

Understanding of Risk

Profitability over Time

A Sound Business Plan

Access to the Right Insurance

Markets

Good Analytics

Expert Management

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How to Establish a Captive Conduct a feasibility study

Loss history Risk/reward discussion (potential benefits) Minimums: solvency, capital requirements, premiums Ownership options Financial analysis Legal: DOL requirements, taxation, and incorporation

Actuarial review Select partners Incorporation Captive licensure Capitalization Reinsurance / insurance contracts Service provider agreements Seek DOL approval if necessary; but it may not be necessary

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Case Studies

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Case Study 1: Group Captive Feasibility Study

• 25 employers with approximately 9,000 total employees spend $110M per annum on health insurance

Organizations

• By funding their stop loss health insurance through a captive, the group will conservatively save over $6M

Situation

• 5 year net present value savings exceed $30M• Additional savings are anticipated from:

• Better health management• Reduced reinsurance costs • Further savings on administration

Anticipated Results

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Case Study 1: Group Financial Projection

Representative Sample

25 employers9,800 employees

Full population60 employers

100,000 employees

Spending $110Mon health insurance

Spending $1.2B

Conservative 2011 savings 4% - 9%

depending on group

Savings of $180M -$250M per year -

improved with volume

Projection

Impact of Captive

Impact of Captive

Results are pending first year review in 2014!

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Case Study 2: Pure Captive

• Global food distributor with 60,000+ employees

Organization

• Offshore property/casualty captive already in place• Opportunity to fund its otherwise unfunded liability• Interested in integrating disability and workers’ compensation• Leveraged current stop loss program to incorporate additional premium volume;

considered direct and fronting placement

Situation

• Reduced reinsurance costs• Further savings on administration• Capture investment income

Anticipated Results

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Case Study 2: ResultsLine of Coverage Captive Savings ($$)

Retiree Medical 22% of the liability over ten years

Long Term Disability Stop Loss 21% of the existing premium

Medical, Dental and Vision Stop Loss 8% of the existing premiums

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Questions and Contact Information

Karin LandryPartnerSpring Consulting Group, LLCPhone: 617-589-0930Karin.Landry@springgroup.com

Teri WeberPartner and Senior ConsultantSpring Consulting Group, LLCPhone: 617-818-3148Teri.Weber@springgroup.com