Captive stop-loss: a smarter way to cover employee medical plans

As captives have made that leap, they have increasingly been used to manage nontraditional risks, including those covering their employees—for many businesses, their most important asset.

In addition to writing employee benefits via their captive insurers, employers are increasingly using their captives to secure medical stop-loss insurance, through which they can protect against potential catastrophic medical expenses.

Growing medical expenses

The pandemic has put a spotlight on the health and wellbeing of employees—and the associated costs for employers. But the growth in stop-loss premiums has not been driven by COVID-19 specifically, but rather by the long-term rise in the potential frequency and severity of catastrophic medical claims since passage of the Affordable Care Act (ACA) a decade ago.

Many of the ACA’s provisions took effect in 2014, including the elimination of lifetime limits in employee-sponsored group health programmes—good for individuals, but not for businesses, which lost a powerful means for controlling costs. Those costs can quickly become damaging for businesses, for one of the following reasons:

To manage potentially spiralling medical costs, many self-insured employers purchase medical stop-loss insurance, which transfers to an insurer liability for losses above a certain amount. Employers can use stop-loss coverage to protect against losses attributable to a specific individual, in addition to managing their aggregate losses across employee medical plans.

A smarter way

Stop-loss coverage can be expensive, however. Pricing continues to escalate at a rate commensurate with inflation. Moreover, the benefit of favourable loss experience in a given year accrues largely to stop-loss insurers, not self-insured employers. Stop-loss insurers can opt to exclude claims for specific individuals covered by employee-sponsored health plans if they are expected to generate large claims—a process known as “lasering”.

For these reasons, many employers are turning to captives as another option. Instead of purchasing stop-loss coverage from an insurer, a business can use a captive to pool large medical claim risk with other corporate risks. A captive can provide stop-loss insurance to a parent’s self-insured employee medical plan, thereby allowing the captive to retain a layer of relatively predictable risk and cede the unwanted or volatile risk to an external party via a reinsurance contract.

This approach has proved highly popular with employers across several industries. While some important lines of coverage, such as directors and officers liability (D&O) and cyber, are increasingly becoming captive staples, medical stop-loss has been an especially strong growth driver for captives: Net premiums written for medical stop-loss increased more than 80 percent in 2020, according to Marsh data.

Although purchasing reinsurance can present the same risk of lasering, the cost of medical stop-loss reinsurance is often lower than that of primary stop-loss coverage—something that is not true for many other forms of property and casualty insurance. For a self-insured employer, running stop-loss through a captive can potentially generate savings of seven figures in a given year when compared to the cost of securing coverage from the commercial insurance market.

Working with HR

Running stop-loss coverage through a captive may not be the right solution for every self-insured employer. Before choosing this approach, an employer should analyse its historical premiums and losses. A company that has been spending, for example, $2 million or more per year on medical stop-loss coverage, with a loss ratio of less than 60 percent over that period, may benefit from using a captive.

If there is a savings opportunity, an employer can work with a captive advisor to structure a captive to maximise that opportunity. With an understanding of the likely sources of its catastrophic claims and after modelling potential losses, an employer can structure a captive to fund a layer of risk without taking on more than it would have by purchasing insurance from the commercial marketplace.

This can be an easy sell for financial executives; it’s just another way of securing coverage with potentially sizable savings and limited additional risk if constructed in a proper manner. Convincing human resources (HR) teams, however, may be a bigger hurdle. Oftentimes, in asking whether their organisations can benefit from using captives to manage stop-loss risk, risk professionals will run up against HR staff who may not recognise the potential benefits and may be protective of existing relationships and processes.

Importantly, moving stop-loss to a captive often means taking the procurement process out of the hands of HR. Instead of being managed in a silo with little involvement from risk management, medical stop-loss is suddenly subject to the same scrutiny and processes as other major risk areas, including property, workers’ compensation, D&O, and cyber. And why shouldn’t it be, given that self-insured employee medical plans are often among the largest exposures for employers?

In many ways, this more rigorous approach can be seen as a positive. But it may take some effort by risk and finance departments to demonstrate to HR teams—who may be protective of existing processes and relationships, including their benefits brokers—that captives can offer a better way to protect organisations from the costs of catastrophic claims or the accumulation of losses.

Ultimately, captives can help HR teams fulfil their primary responsibility to manage employees and employment-related issues by stabilising health plan budgets in a smarter, more cost-effective way. And with HR’s support and cooperation—including their insight into existing medical cost management processes and pain points—captive advisors can gain reinsurers’ confidence and secure favourable terms and pricing, which can maximise potential savings.

As novel as it may seem, managing medical stop-loss risk in a captive is no different from any other line of business that benefits from the control and oversight of qualified risk management and finance professionals. In fact, the short-tail nature of medical stop-loss can complement longer-tail property and casualty risks and, in many ways, is easier to manage in a captive. And with captive balance sheets growing stronger, medical stop-loss can typically be added to a captive without any additional capital.

It comes down to an employer’s desire: do you want to realise more control over and financial efficiency for a key risk to your organisation? If the answer is yes, take a closer look at running medical stop-loss through your captive.

Mike Serricchio is a managing director in the Captive Solutions Group at Marsh. He can be contacted at:  michael.serricchio@marsh.com