Employers are looking for new ways to reduce the cost of employee benefits. One approach increasingly gaining traction is the use of captives to fund a wide range of benefits including health, disability, and life insurance. In addition to the cost savings employers can gain, captives offer them the ability to be more flexible in terms of plan design. A captive is a licensed insurance carrier controlled by a parent corporation (the “parent,”) and whose business consists primarily of insuring or reinsuring the risk exposures of the parent, the parent’s affiliates, and/or other entities having an especially close business relationship to the parent (such as the parent’s customers or vendors).
Employers can cut the costs of benefits through a captive because they are taking on the risk in lieu of paying what could be an expensive premium to an outside insurer. With the cost savings, employers can the have the opportunity to accumulate cash and earn investment income. If an organization’s underwriting experience is good, funding benefits can be very advantageous for the employer.
Moreover, if a company already has a captive for its property-casualty risks, expanding into benefits provides an avenue to diversify the captive’s book of business – offering an offset if other lines of coverage funded through the captives incur major losses. In addition, because the Internal Revenue Service considers benefits risks to be third-party business, funding benefits through a captive can increase the likelihood a captive will have enough outside business for the parent to take a tax deduction for the property-casualty premiums paid to the captive. Under IRS rules issued in 2002, a parent can take a tax deduction for property-casualty premiums paid to its captive if at least 50% of the captive’s business is unrelated to the parent.
Of course, for a captive to work effectively, risk management and employee benefits need to be in concert prior to moving ahead. Also, employers must secure the approval of regulators at the U.S. Department of Labor to expand their captive insurers’ book of business to cover corporate employee benefits risks. The Labor Department provides a regulatory roadmap to follow in structuring a captive benefits funding arrangement for employees that includes among the requirements the following:
- The captive must be licensed in a U.S. state or be licensed in a state as a branch of a captive domiciled in another jurisdiction.
- A highly rated — no less than “A” by A.M. Best Co. Inc. — commercial insurer must be used to issue the policies. There is no requirement that the fronting insurer take on any of the risk. In many cases, the front is simply that — an insurer just issuing the policies, for which the employer pays a fee. In other cases, the fronting insurer has taken on a significant portion of the benefits risks funded through the captive at the employer’s request.
- The employer must enhance in an objective way the benefits provided to plan participants affected by the captive benefits funding arrangement.
- An independent fiduciary must be used to monitor the transaction and be authorized to take any action necessary to protect the interests of participants.
There are other requirements that must be adhered to as well.
Caitlin Morgan specializes in offering captive insurance solutions and can provide assistance in determining whether a captive is right for your client. There are many factors to assess when setting up a captive, or when choosing to diversify the book of business if a captive is already established. Give us a call at 877.226.1027 to speak with our captive specialists about creating a custom program for your client.