Employee Benefits in Captives: The McGriff Difference

A Journey by Wade Bice and Bob Reynolds

In 1999 we began a two-year journey that ended with the Department of Labor (DOL) issuing a Prohibited Transaction Exemption (PTE) for Columbia Energy Group (CEG) to use their SPC to fund Long-Term Disability (LTD). And it was indeed quite a journey.

Prior to this ruling the placement of benefits in a captive was difficult because the DOL considered it a prohibited transaction. In general, Congress and the DOL thought that certain transactions were so fraught with abuse that they should be prohibited, regardless of the actual intent. So our journey was ultimately a quest to convince the DOL that using a captive was indeed a good thing for all parties involved.

There were many hurdles to clear to create a structure that would be acceptable to the DOL and insurance market. A lot of them had to be cleared more than once. Many days and nights were spent ironing out details and finding solutions to meet legal, compliance, contractual requirements and DOL constraints. Despite the department’s strict placement of guardrails around many of the provisions in the plan and the ultimate approval process of the application, captives are now widely used for a variety of EB risks.

A talented team of individuals from within McGriff, as well as people from other firms, were able to ultimately achieve success. The team included the captive manager, ERISA/DOL attorneys, actuaries, insurance carriers, and many others, including the most important members, the Risk Manager and Chief Financial Officer for CEG.

Certain requirements for DOL approval are a bit more onerous today than the original PTE, but it is still a viable, creative, and financially sound way to place certain EB business. The required enhancements to win DOL approval centered around protections and enhanced benefits for the employee.

If the employer will potentially gain from underwriting profits and investment income, then the employee should be a party to those benefits as well. While these enhancements are generally in the form of plan design, they can also include cost relief. One of the more intriguing requirements was that an offshore captive had to set up a U.S. branch captive. This directive was to ensure that the captive would be subject to U.S. laws and tax codes.

Also, while it took almost two years to convince the DOL to grant the original exemption, the DOL began to allow for an expedited approval process, known as an EXPRO, which can be used to create a much shorter period of application approval. If the new application is materially the same as the one approved for CEG, the decision can be made in as little as 90 days.

In addition, the DOL approval required a commercial insurer to issue policies as well as enhance participant benefits as discussed earlier. Numerous insurers have insured benefits, which are then reinsured—fully, in some cases—through the employers’ captive.

There are many key factors leading employers to expand their captives to fund EB risks. Cost savings and flexibility are certainly two primary considerations, since employers can save from 10% to 50% compared with the traditional use of commercial markets. Those cost savings are possible because the captive, rather than an outside insurer, retains the underwriting profit and investment income on premiums its parent pays to the captive. In good years, the captive can keep any funds not paid out in claims and also hold a portion of the reserves set aside for claims until they’re paid out. Additionally, retaining a large portion of the risk creates flexibility around plan design, administration, and cash flow.

Another often overlooked advantage of this approach is that captive EB funding diversifies a captive’s book of business. Adding benefits to a captive’s risk portfolio can provide more stable underwriting, risk diversification, and cost predictability when compared to P&C risk as well as the commercial marketplace. Ultimately, this approach may provide additional rationale to justify the deductibility of premiums for income tax purposes. If the EB lines of coverage are determined to be third-party business, this deductibility will be very important and profitable to the captive. These EB lines of coverage are typically considered a risk to the employee rather than the corporation so they can be deemed third-party risk.

Likewise, in today’s risk-conscious (and often, risk-averse) commercial marketplace, employers who fund benefit risks through their captives have more flexibility in designing their employee benefit programs. Commercial insurers may impose coverage limits or other terms that an employer may not want.

However, there are other challenges facing employers that want to fund employee benefits through their captives.

One challenge is getting two corporate units, i.e., risk management and employee benefits departments, to work together. Indeed, putting together a captive benefit funding program can take a lot longer if an employer’s corporate risk management and employee benefits departments do not have strong relationships.

But the biggest challenge, as previously discussed, is winning approval from the U.S. Department of Labor for benefits deemed to be ERISA benefits. This is required for captive funding arrangements involving certain ERISA benefits.

The one type of benefits-related coverage that can be written by captives without DOL approval, however, is medical stop loss insurance or reinsurance. This type of insurance is designed to provide a cap for self-insured employers on the number of losses they incur (either on a per occurrence basis, an aggregate basis, or a combination of the two) under their health/medical plans for employees.

Medical stop loss insurance does not directly cover employees and makes no payments to, or on behalf of, employees. Instead, it reimburses the employer, which is the insured, for claims the employer pays on behalf of its employees. Since the employer is the insured, not the employees, in most cases ERISA does not apply. We’ve seen a substantial trend in recent years of captives writing medical stop loss coverage.

Given the many advantages there will likely be a steady growth in the number of employers funding employee benefits through their captive insurers.

Over the last 20+ years, we’ve used SPCs to insure and control costs for:

• Group Life Insurance
• Group Long Term Disability
• Medical Stop Loss
• Voluntary Benefits
• Budget Control

There are many other uses for SPCs that are not mainstream but are innovative and profitable to the captive and the employer. We continue to explore new ideas and ways to use captives for EB.

Our use of captives for the purposes described above is not only good for the captive, your client, and the employees, but it’s good for us as broker/consultants. It separates us from most broker/consultants and provides a close relationship with many of the senior individuals within the company, allowing for long-term relationships.

Keep in mind this article does not cover all topics that need to be discussed before heading down this path. Decisions must be made at the outset regarding several strategies and key partners, including captive manager, state of domicile, actuary, investment advisors, electing a captive board, risk management, HR, and an ERISA attorney.

The captive manager will be important from the beginning since they’ll need to provide a feasibility report or study to determine the appropriate lines of coverage for the captive to entertain. While it is an enjoyable and interesting undertaking, it requires all parties to be completely involved in the process from the beginning.