Weighing up multinational pooling and employee benefit captives
While multinational pooling has been around since the 1950s with thousands of arrangements set up, the use of captives to finance employee benefit (EB) risk is a lot newer.
This is according to Mark Cook, director at Willis Towers Watson, who suggests that captives used for global EB risk have only been around for the last 20 years, with an uptake particularly in the last five years.
A Willis Towers Watson research report, 2016/2017 Multinational Pooling and Benefit Captives, showed that the number of EB captives has doubled in the last five years, to approximately 85.
In fact, Willis Tower Watson has helped implement 15 in the last two years alone, and now sees captives as an established part of the EB landscape.
But this is only a recent thing, suggests Cook, who points out that there wasn’t much common ground between the finance and risk folk when they started cropping up 20 years ago.
“The knowledge, the experience, and the understanding [of] the term of captive – if you talk to an HR person now they actually know what it means. Ten years ago they had no idea what a captive was,” says Cook. “And vice versa if you talk to a risk manager and you talk about medical insurance or [EB], they have no idea what the risk profile is or what we're talking about.”
Cook believes this familiarity has improved in the last 10 years, and many companies now have their HR groups and their finance groups – including risk and insurance – working together.
When it comes to choosing the right financing model for EBs, Cook says the real question companies need to be asking is whether their current pooling arrangement is fit for purpose.
While there are other coordinated financing models for EBs in existence, multinational pooling and captives are the most common.
“Pooling has been done for a long time, captives more recently – from our perspective everybody is asking whether what they are doing right is right. Should they be doing something different? It’s not for everybody. But everybody is asking the question.”
So what are the benefits and why should a company pick either?
Cook suggests that pooling and captives actually share many of the same advantages, but to different degrees.
One of the key advantages shared between them is the economic value and cost savings that arise when they are well managed.
The Willis Towers Watson study – which looks at pooling and captive data from over 1,500 annual reports submitted by more than 200 multinational companies – found that well-managed pools can achieve savings of 15 percent or more, and that well-managed captives can achieve savings of 25 percent or more, but the latter may incur additional costs to maintain.
Cook suggests the savings can be on all sort of things, including premiums, cash flow and on investments.
“You are moving from a commercial underwriting set up, with fully insured commercial premium to a premium that technically should be less under a coordinated approach, because you are starting to strip out some of the frictional costs and layers that are added in in a commercial rate,” says Cook.
“No company would put this in place if it’s going to cost more for them to do it. That business case always has to stack up, whatever method they're using – pooling or captives”
He explains that both approaches spread risk across multiple locations and across multiple headcounts, just as one would for property/casualty. When the risk is spread, cost volatility is reduced.
Cost savings in captives
While successful pooling and captives can offer financial savings, Cook suggests there is great value in captives from eliminating insurer risk charges and underwriting profits.
In an EB context, Willis Towers Watson said that the captive usually acts as a reinsurer.
Local insurers – which front the EBs for the captive — will issue policies and pay claims as they arise, with the captive settling balances on a quarterly or other basis.
Cook suggests that many of the frictional costs are stripped out with a captive.
“With a captive state you are going down to the pure cost of the risk and potentially admin fees, depending on how your captive underwrites,” he says.
Furthermore, things like profit sharing locally and broker costs are also taken out, Cook suggests.
“There are no risk charges, there are no underwriting margins. A captive goes down further in streamlining the financial aspect.”
Furthermore, the study suggests there are cash-flow advantages, for example paying premiums at the beginning of the year under annual in-advance or precession models, with claims paid out after they occur each quarter.
And finally, Cook says that the financial benefits also come in the form of improve control of claims and claims management, as well as enhanced control over pricing and rate settings.
While one of the main advantages of using multinational pooling or EB captives is to deliver cost savings to companies, having a greater degree of control over the arrangement can help achieve these goals and optimise the programme.
The Willis Towers Watson report suggested that managing key ongoing aspects can help to optimise the financing strategy, and there is more control over benefit design and policy terms.
This comes in the form of including or excluding specific risks, as well as the ability to monitor and manage the overall results and the claims experience.
The non-financial benefits also include the flexibility to make ex gratia payments that commercial insurers would decline to accept, and access to better financial and claim data to help design and carry out demand-side initiatives.
Both approaches – pooling and captives – can look at using a preferred provider insurance company that may provide better terms of contract locally or globally, according to Cook.
“If you are using the same provider across multiple countries you're going to get the same report. There is an element of control that is given back to the company, because it has the data that can help makes interventions and changes.”
Cook says there are more enhanced risk management and claims management techniques because the company has that data. “So the data becomes timelier, it becomes quarterly rather than annual,” he says.
More effort in captives
While there is greater value in captives – from both a financial and non-financial perspective – they do require considerably more effort than multinational pooling, says Cook.
Firstly, the captive requires the appropriate stakeholders to take a role in governing the programme.
“Pooling is still relatively easy; you're still very much in the insurance world, you've just got this accounting mechanism that gives you a profit share,” he explains. “The captive involves using your insurance company to self-finance your own EB risk. It needs more rigor, it needs more effort from within the company.”
Another area that requires more effort is the process of actually setting up the captive.
This includes solvency requirements, such as making sure the captives has enough money to support the EB line in its particular jurisdiction.
There may also be collateral requirements from the fronting carrier, Cook suggests. He asks: “Does the insurance company need something to guarantee that the EB lines will continue to be paid by the company if anything happens to the captive?”
And finally there are management concerns, which Cook believes are not talked about enough in this space.
“There needs to be a team or person within the company that manages the EB captive programme and takes ownership,” he adds.
When setting up a captive to cover EB risk, Cook stresses that it’s not one size fits all.
“Some captives work on a profit. Some captives work on breaking even – that is a very different philosophy. That manifests into different underwriting guidelines and thoughts into how we price the EB risk - do we take what the local insurers says, or do we make our own price? What do we do if we get a profit in the captive? Are we a profit making model or non-profit making one? This dictates how the programmes work.”
As an example, Cook says some captives can be larger than some insurance captives, and some can be an EB-only captive, and there are very different considerations for either.
As a final point, Cook says it is the harder-to-do captives that generate more cash and savings, but are ultimately more rewarding.