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As medical costs continue to rise and regulatory uncertainties threaten the amount of control employers are able to maintain within more conventional insurance structures, interest in self-funding and medical stop loss captives will continue to grow, says Phillip Giles of QBE North America.
Self-funding has long proved to be the most efficient form of financing most lines of insurance coverage. Self-funding of healthcare insurance is no exception: more than 80 million individuals—60 percent of all workers under the age of 65—are covered by self-insured employer health plans.
Given the continually rising cost of healthcare and the increasingly uncertain regulatory environment, more employers will explore self-funding as an option to assuage the cost of healthcare delivery to employees. With this sustained growth, the strategic use of medical stop loss (MSL) captives to augment traditional self-funding will also expand.
Most employers large enough to have an existing single parent captive are already self-funding their employee healthcare benefits. Prior to the passage of the Affordable Care Act (ACA) in 2010, many employers of this size did not purchase medical stop loss; however, following the inception of ACA and its mandate of unlimited lifetime benefit maximums within a health plan, they now purchase high (unlimited) levels of MSL coverage and convert lower layers of retained risk into MSL layer funding within their existing captive.
Captive participation in this form of excess coverage further amplifies the potential financial benefits associated with self-funding. Medical stop loss by itself would not typically generate enough premium to justify forming a captive solely for this coverage; however, it can be used to effectively expand the use and enhance the efficiency of an existing captive.
Setting sights on the bigger picture
The captive should not be regarded simply as a tool to reduce the cost of medical stop loss coverage itself but rather as a component of a much larger strategy for reducing the ultimate costs associated with delivering healthcare insurance to employees, hopefully on a long-term basis. Key objectives that might be achieved with a medical stop loss captive include:
Accumulate and deploy surplus to reduce costs
Funding layers of medical stop loss coverage through a captive, as opposed to simply paying claims within the same layers from general assets, allows the employer to more easily recognise and deploy surplus attributable to underwriting profit and investment returns attributable to the funding of these layers.
Adding medical stop loss to a captive enables an employer to capture underwriting profit when losses are less than projected, accrue investment income on premium reserves, and stabilise rates and the cost of risk over time.
Surplus derived from the underwriting and investment return from the captive can be returned to the employer more efficiently in the form of dividend distributions or strategically deployed to offset future costs or expand benefits to employees or retained within the captive to smooth financial volatility associated with other lines of coverage.
Enhanced cash flow management
The disciplined funding and loss reserving required of a captive can help to smooth the impact of loss-sensitive programmes on cash flow and budgeted results. Rather than paying for claims out of general operating funds or expensing them as they arise, the insured instead funds a fixed annual amount to the captive, and the captive accrues for the expected claims costs; this serves to smooth annual budget impact through required reserving practices.
A frequently cited objective for captives is to build loss fund reserves over time to offset large ongoing medical claims that could otherwise be isolated (ie, “lasered”) for a higher specific deductible, relative to that of the rest of the insured population, by a stop loss carrier. The captive loss fund may be utilised to absorb large claim lasers and more effectively convert large, ongoing medical claims into a more budgeted expense.
Increased market responsiveness and expense efficiency
The medical stop loss market overall is highly competitive but renewals and rates at some retention levels can be subject to increased volatility depending on the prevailing medical environment and claims patterns associated with any specific employer. Annual medical losses can be unpredictable. A bad loss year is likely to be followed by premium increases dictated by the insurance carrier.
The flexibility afforded by accumulated captive surplus can help the employer manage its future insurance costs. As the captive loss fund builds, the employer can leverage surplus and more readily adjust how much risk it opts to retain in the future. This ability to adapt based upon changing market conditions will enable the employer to further decrease its dependence upon the commercial insurance market.
A single parent captive can also facilitate access to more efficient capacity by purchasing necessary coverage as reinsurance rather than insurance that is likely to have higher policy costs and more restrictive coverage terms. Since medical stop loss is not a statutorily mandated coverage, single parent captives do not usually need to be “fronted” by an insurance company.
The captive itself is recognised as an insurance company by its domicile and can issue a stop loss policy to its own parent, ie, the employer. As reinsurance, much of the expense associated with the issuance of an insurance policy (front fees, premium taxes, collateralisation, and so forth) has been stripped out, thus reducing the cost of coverage. Being able to purchase stop loss as reinsurance is usually the most efficient structure for single parent captives.
Medical risk management and cost control: critical to success
Just as self-insured casualty programmes utilise loss control techniques to improve employee safety and mitigate claims, it is essential for self-insured healthcare plans to employ effective cost-containment measures.
Initiatives such as large case oversight, centres of excellence for complex conditions, negotiated provider discounts, and free standing direct provider delivery arrangements, have proved effective for reducing the cost of claims. Referenced-based pricing schedules that target specific, high-margin cost drivers (such as infusion therapies, diagnostic imaging, durable medical supplies, etc) will also generate significant reductions.
Carving out prescriptions to specialised prescription benefit managers that practise full transparency and pass through all discounts, coupons and rebates to the client can also generate substantial savings within one of the highest cost components of a self-insured programme.
Newer initiatives, such as employee wellness programmes and predictive modelling, strive to preemptively reduce claim expenses by improving the overall health of the employee population. Increasing employee wellness will help significantly decrease the cost of providing employee healthcare coverage—not immediately, but over time as the effects of the wellness programme develop.
There will be some increased fixed costs associated with the implementation of risk management initiatives, but the savings generated by the corollary reduction in claims costs—a much larger expense—will more than offset the initial expenses.
In short, self-funded programmes and especially captives have increased latitude for implementing innovative risk and cost reduction initiatives.
Enhance enterprise risk management
Data analytics can be also utilised as a tool for the employer to track the financial performance of its decisions. Having the increased ability to identify specific cost drivers can enhance the employer’s ability to more effectively control the cost of risk and, more appropriately, to adjust risk management, claims and funding.
Incorporating medical stop loss within a captive can also enhance corporate enterprise risk management (ERM) objectives. By quantifying the probability outcome of adding unrelated risk to the captive, the employer can determine how or whether to effectively hedge those risks. The periodic financial review will provide another tool to track results and measure decisions. Adding stop loss to a captive that primarily writes “long-tail” coverage, such as worker’s compensation or general or professional liability, can provide a protective “short-tail” stability hedge by diversifying the captive’s risk portfolio.
It is also important to note that stop loss is not considered an “employee benefit coverage” and thus generally not considered to be “unrelated (third-party) business” by the IRS for tax purposes.
ERISA and state regulation
For stop loss captives it is also important to distinguish the concepts of self-funding and stop-loss from employee healthcare insurance. The distinction is important as the captive itself must be kept separate from the actual benefit plan (the plan) provided to employees. The US Department of Labor (DoL), by way of the Employee Retirement Security Act (ERISA), has regulatory jurisdiction over the Plan itself but does not regulate insurance.
In this regard, the DoL only regulates a plan sponsor’s responsibilities as they relate to overall plan administration and the delivery of benefits to employees. Individual states regulate insurance, but since the Plan is self-insured, state insurance mandates are not applicable in relation to the Plan.
Within a self-insured structure, the employer assumes the financial liability for all claim obligations of the Plan. Medical stop-loss coverage purchased by the plan sponsor does not insure the Plan; rather, it indemnifies the sponsor for its claim obligations to the Plan. Since neither the DoL nor ERISA have regulatory jurisdiction, a Prohibited Transaction Exemption (PTE) is not applicable to medical stop-loss captive and is not required from the DoL.
Interest in self-funding and stop loss captives will continue to grow as medical costs continue to rise and regulatory uncertainties threaten the amount of control employers are able to maintain within more conventional insurance structures.
More large employers are formalising their retained healthcare benefit risk by converting it into medical stop loss coverage within an existing captive and then purchasing reinsurance for the higher layers of risk that need to be transferred. Accruing surplus through a properly structured captive can stabilise or lower the cost of medical stop loss coverage and facilitate more options for enhanced benefit delivery over traditional self-insurance for many employers.
This article is for general informational purposes only and is not legal advice and should not be construed as legal advice. Actual coverage is subject to the language of the policies as issued.
Phillip C. Giles is vice president–sales and marketing, accident & health, at QBE North America. He can be contacted at: firstname.lastname@example.org
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