Expert Commentary

Employee Benefits in Captives: An Update

The subject of writing employee benefits in a captive has been hashed and rehashed for quite some time. For the larger players that must deal with the Employee Retirement Income Security Act (ERISA), there has been a noticeable uptick in formations, but that has not helped the small and medium-sized employers.

April 2012

In the past couple of years, more employers have investigated setting up self-insured plans and then writing excess aggregate in a captive. There are several reasons for that, and those reasons have spawned a quick negative reaction from the regulators, the Internal Revenue Service (IRS), and the National Association of Insurance Commissioners (NAIC).

Driving most of this interest has been the Patient Protection and Affordable Care Act (PPACA) and its many undefined and unresolved issues. Businesses demand certainty from their regulators, and they are not presently getting it. But, what has been noticed is that the PPACA has ignored captives. This fact has sparked the renewed interest by small and midsized employers and their advisers, as it has from regulators.

The central issue seems to be that, while self-insured plans must conform to the PPACA, captives are presently not required to do so. This allows the captive owner to customize coverage in the captive to achieve specific long-term goals that might otherwise not be met. For instance, some coverage can be added to benefit a small, select group, or coverage can be eliminated to reduce costs. For example, the owners/executives could add some coverage for themselves and exclude the other employees. This can't be done under ERISA or PPACA.

A current issue involving birth control coverage could be addressed by offering it in the self-insured plan at a low level, say $50,000, and then eliminating it at the captive excess layer. This could be driven by financial or moral goals, or both.

Attachment Points

Recognition of this flexibility has caused the regulatory trade association, NAIC, to redraft its Model Act for self-insured plans to attempt to prevent captives from attaching at low levels, thereby eliminating the employer's ability to craft coverage that best suits its purposes. At this point, no state has adopted the Model Act, but there is mounting pressure to do so.

Adding to the fun is the IRS. The service has also noticed this development and is attempting similar moves to those of the NAIC. Its motives are a bit different as it is primarily interested in finding more money through taxes. As captives can be structured to have great tax advantages, the IRS would like to discourage a proliferation of these formations. Its approach to doing so is also to attack the low attachment points.

As usual when a new application of captives becomes popular, there are abuses. These abuses have drawn the attention of the regulators. Attaching at, say, $5,000 is probably an egregiously obvious move that will cause a lot of inspection and argument. Clearly, this is not good for the owner that is trying more conventional attachments in the six or seven figures.

This situation will likely put a lot of pressure on actuaries, who will be asked to justify low attachment points in the face of numbers that do not support them. If an actuary does support low attachment points, then the pressure turns to the regulator. Captive regulators generally have more latitude to make decisions when their laws are vague or nonexistent. But, with the proliferation of new domiciles, the likelihood of approval grows.

New captive domiciles have the tendency to want to quickly license new formations in order to justify their decision to become a captive domicile and to raise funds for their department or general fund. Historically, this has led to an increase in failures.

Self-Insurance/Excess Captive

In my view, it is still worthwhile to consider a self-insured captive excess plan to address costs and coverage. As always, the cautious and prudent owner/manager will want to take steps to forego future attacks. This is done by working with the actuary to craft an obviously reasonable plan and working with the manager to obtain some degree of certainty that the regulator will accept the plan and application.

One current attraction to this approach is the uncertainty of the Supreme Court's decision on "Obamacare." Should it be tossed entirely or rewritten, there will be chaos in the marketplace. Insured plans will have to undergo many changes and gyrations, which will affect costs and coverage. The downside of potential regulatory challenge to attachment points can be addressed; the Supreme Court decision cannot. Thus, the path to commercial certainty in running your business would tend toward the self-insured/excess captive route.

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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