Understanding Captive Insurance Arrangements

Understanding Captive Insurance Arrangements
September 7, 2022 Lisa Winter

If you’re familiar with self-funded health care benefits, you already understand the advantages they offer. Self-funding is an attractive solution for employee benefits because it helps employers save on the cost of health care.

Why an employer may choose self-funding

With self-funding, employers assume the responsibility and related financial risk for paying employees’ claims. With this comes a certain amount of freedom through improved financial and administrative control. Employers who choose to self-fund can realize cash flow advantages, as they only pay employee claims as they are incurred. The company can then invest and receive returns on unused claims funds (rather than the insurer). It also provides flexibility in plan design, as well as access to plan insights and reporting. According to a study by the Kaiser Family Foundation, more than 80 percent of employers with at least 1,000 employees choose to self-fund their health plan. The same survey found that nearly half of employers with 200 to 999 employees self-fund their health plan1. However, when looking at smaller employers, those with less than 200 lives, many do not opt to self-fund. For them, the issue is they are financially unprepared for higher than expected claims. If a company faces one or more catastrophic employee claims, the employer has to cover the cost. However, the possibility to self-fund is not out of reach.

Stop loss protects risk

Stop loss insurance is the solution to help mitigate these concerns, by putting a ceiling on financial risk. Employers can choose the stop loss coverage that works best for their needs. Specific stop loss protects a company against claims above a specified amount on a per-participant or per-family basis. Aggregated stop loss protects a company against accumulated claims that exceed a specified ceiling for the entire group combined. The stop loss carrier is then responsible for any claims above this ceiling. This works well to protect groups against financial risk.

Captives pool stop loss

By opting for a captive solution, employers can have a “shock absorber” for large claims.  Captives are essentially a pooled fund created by a group of like-minded employers that acts as its own insurance company. They allow the participants to spread financial risk between them, and provide an added layer of funds for protection against high-dollar and catastrophic claims that rise above the stop loss ceiling. Pooled funds in a captive are available to every member of the captive; however, each individual company retains control of their individual employee benefits plan. The captive is owned by the groups who contribute to it, but managed by an independent outside vendor. If the funds exceed claims, premiums can be refunded to the participant companies—they are not retained by an insurance company.

Advantages of a captive

Why would a group consider joining a captive? Aside from offering small-to-midsize groups reduced financial risk to self-fund, they also provide several other advantages. They can help reduce and stabilize the fluctuation employers often see with year-over-year rate increases. With reduced risk comes the added benefit of a long-term strategy for financing employee health care benefits. Captive managers partner with brokers to fill in gaps in coverage for the plan sponsor. Working together, they provide one valuable solution, delivered in one consistent voice. The captive manager’s four main functions (underwriting, claims handling, record keeping, and compliance) allow them to add value by working in conjunction with the broker to bring forward the best-fit administration for plan sponsors. Something to consider for fully-insured employers is their plan costs are fixed. If they have low claims, the insurer keeps the profit and if they have high claims, their renewal will increase. Using captives, employers will see their fixed costs fall as low as 20 percent to 35 percent of their total health care spend, while depending on their size variable claim payments make up the remaining 65 percent to 80 percent . In other words, employers have the opportunity to retain up to 80 cents of every dollar.

Who might consider a captive?

Any group interested in switching to a self-funded plan is a great candidate for a captive insurance arrangement. A captive provides a bridge to self-funding that helps groups avoid spikes in stop loss and the impact of catastrophic claims—financial situations that may currently be giving them pause. Currently, captives make up 10 percent of the self-funded market and this number is growing.

Choosing a TPA to work with you and a captive

It’s important to work with a seasoned TPA to handle your claims. The right TPA should have a robust claims system, enhanced reporting and stellar quality control.

1 https://www.kff.org