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Medical Stop-Loss Group Captives

Donald Riggin | February 1, 2012

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Using captives to cover employee benefits is nothing new in 2012. The first instance of note occurred in 2000, and roughly 28 large, mostly multinational companies have placed at least one of their Employee Retirement Income Security Act (ERISA) employee benefits into their single-parent captives. Using a captive to insure medical stop loss, however, is receiving quite a bit of attention these days, due in part to two provisions in the 2010 Accountable Care Act (ACA).

As of January of last year, insurers and self-insurers were prohibited from imposing lifetime benefit caps. As of January 1, 2013, annual benefit caps will also be prohibited. These changes will have an impact on medium-sized employers that self-insure their medical obligations. Medical stop-loss insurance covers claims in excess of a company's per occurrence, and sometimes aggregate, self-insured losses.

Almost all medium to jumbo companies in the United States self-insure their employees' health insurance obligations. But only their health insurance, otherwise known as medical cost insurance, is routinely self-insured. The other employee benefits, such as insurance for short-term disability and life insurance, are usually purchased in the commercial insurance markets.

Employers that self-insure their medical costs have the option to purchase a stop-loss insurance contract. Medical stop-loss insurance is not actually considered health insurance, and as such, it is not governed by ERISA. Unlike most lines of property and casualty insurance, with the possible exception of workers compensation, health insurance costs can be extremely predictable based on the characteristics of the group ("group" in this case means a company's employees, not a group of companies) and its size. When groups approach 3,000 lives (employees), actuaries can often project future loss experience with scary accuracy. In this environment, many companies forego the purchase of stop-loss cover.

This was before the passage of the ACA. The lifetime and annual benefit extensions noted above mean that self-insurers can no longer limit their liability without purchasing a form of medical stop-loss insurance. Smaller companies, those with between 300 and 1,500 employees, also very often self-insure their medical costs, mainly because of the ever-increasing cost of medical insurance. These companies, however, often find themselves between a rock and a hard place when it comes to limiting their exposure to loss. The first problem is that small to mid-sized employers usually don't have enough actuarial credibility in their loss data to comfortably self-insure without stop-loss coverage; there is too much volatility.

The second problem is that, in order to contain the volatility in any meaningful way, the stop-loss attachment point(s) must be low enough to make a difference, which can be very expensive. Conversely, when the attachment point(s) is high enough to be affordable, much of the volatility remains with the employer. Here is where a group medical stop-loss captive can create significant value for its members.

Designing a Stop-Loss Captive Program

There are many ways in which a group stop-loss captive can be structured, but the fundamental argument is the same regardless of the captive's ownership, etc. We begin with a group of, say, 15 employers, each with between 300 and 1,000 employees. For each employer, we determine, based on loss experience, its optimal level of self-insurance. For example, an employer with 600 employees might retain $75,000 per occurrence, with a multiple of this as the annual aggregate.

For this employer, the captive's attachment point would be $75,000 per occurrence and the annual aggregate. Another employer's optimal retention may be $150,000 per occurrence, so the captive would attach at that level.

Let's further assume that the captive's limit of liability is $100,000 per occurrence with an appropriate annual aggregate. Finally, one or more medical stop-loss insurers provide coverage excess of the captive's retention. The captive provides several benefits.

First, because premiums and losses are shared among the group, the captive's premiums may be considered tax deductible. Second, the stop-loss insurer's premium reflects the fact that its attachment point is at least $100,000 (the captive's limit). In practice, however, the stop-loss attachment point would be equal to each member's individual retention, plus the captive's limit. Of course, the stop-loss insurer may impose a minimum attachment point for all members, but this can be managed in most cases.

Third, as the captive's losses would, by design, be relatively minimal, the members would be able to recoup some of their captive premiums in the form of dividends.

Fourth, the captive solves the volatility problem by capturing it in a self-insured, highly cost-effective structure. Given the volatility created by the ACA, a group captive for medical stop loss is a creative and interesting alternative to commercial insurance alone.

Companies with around 2,500 covered lives (health insurance lingo for employees) and higher are able to rely, to one degree or another, on their own loss history to establish actuarially credible expected losses.

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