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Monique McDonald of Global Captive Management provides a captive manager’s perspective on the healthcare sector and the vital benefits captive insurance can provide.
Captives and healthcare have been intricately linked since the first healthcare captive was created in the Cayman Islands in 1976. Initially the focus of such captive structures was the element of control given the associated benefits of costs savings, enhanced loss control and protection from commercial market pricing swings.
Most of the early healthcare captives were created to write deductible reimbursement policies for related workers’ compensation risks and assume liabilities from the healthcare system’s trust. Over time the coverage provided by healthcare captives grew to include coverages for a variety of risks including general liability, property, D&O, E&O, cyber, equipment maintenance, employment practices liability and excess coverage.
Given the breadth of the captive’s participation in its parent’s insurance programme, the success of the healthcare parent’s risk control systems can be seen in a captive’s performance. Indeed, you could say that the captive is a risk management ‘thermometer’ for its parent.
The temperature of this thermometer then should be monitored on an ongoing basis—by the captive board, the parent’s management staff and the insurance manager. It’s no use having a thermometer if nothing is done with the reading it provides. For example, adverse losses (high temperatures) can be the result of environmental factors, accidental or deliberate actions, failures in processes or equipment, an increasingly litigious environment, or a combination thereof.
As those in the healthcare industry know, at some point, a hospital will experience adverse loss development and the concern is whether that claim relates to one incident or a series of incidents. And if the latter, it’s important to evaluate whether the claims relate to a particular specialty or institution. The level of scrutiny on loss development at the captive level helps the healthcare system to identify areas of concern and focus its remedial efforts accordingly. Such remediation may include enhancements to people, institutions, or resources at the parent and/or captive level.
Is this thermometer still relevant? Are healthcare captives still an important risk management tool? The answer is yes, more so than ever, if properly structured and managed.
The healthcare model has changed significantly in the last 10 years. Hospital systems used to be modelled as providers of community-based care housed in sprawling campuses. Long stays, handwritten charts and bad food were the norm. In the present day, healthcare systems focus on the provision of value-based services along a continuum of care; ie, managing care for patients through a comprehensive array of health services through their lifespan with care provided by minute clinics, urgent care centres, diagnostic centres and hospitals, as well as rehabilitation and other tertiary facilities.
This allows the hospital system to focus its services on provision of core or specialty treatment and true emergency services. Non-emergency care and routine care can then be handled by the tertiary facilities.
Horizontal and vertical integrations are leading to an unprecedented level of mergers, acquisitions, joint ventures, and other non-equity collaborations. Digital healthcare is replacing handwritten notes and personal visits to the doctor with the utilisation of electronic medical records (EMRs), and systems of telehealth, remote monitoring, and wearable technology. Healthcare systems focus on population health, with the goal of providing better care at lower costs.
And everyone is using the fun new buzzword, disruption. The Oxford dictionary defines disruption as “disturbance or problems which interrupt an event, activity, or process”. And while disruption has a negative connotation on its own, disruptive innovation can be a positive thing. Wikipedia defines disruptive innovation as “a term in the field of business administration which refers to an innovation that creates a new market and value network and eventually disrupts an existing market and value network, displacing established market leading firms, products, and alliances”.
In the healthcare industry, this disruption includes changes to executive management as CEOs and CMOs retire and the younger generation take the reins; a focus on strategic growth both horizontally and vertically, not for the sake of growth itself, but in terms of population health and operational profitability; and emphasis on innovation where physicians are allowed to brainstorm and create better processes and medical products.
Just as the healthcare industry is in disruption, so is the healthcare captive structure. While still functioning as a measurable risk management tool, a captive doesn’t just take the temperature of its parent and the healthcare industry, it provides strategic evaluation and adaption through changes to form and function. These changes should be deliberate and tactical, taking into account the captive parent’s long-term goals and strategic initiatives.
Changes to form include single parent captives converting into segregated portfolio captives (SPCs) so that they may provide coverage for both equity and non-equity collaborative partners. The SPC structure allows a healthcare captive to provide coverage to these partners in cells separate from the general account or core of the captive.
This form is most helpful to a system with plans for expansion as it can allow for the ring-fencing of riskier or standalone lines of business as the assets and liabilities of each cell can be legally separated from other cells and the core. This then reduces the risk that the capital in the core or a cell is eroded.
Providing coverage for third parties in a cell structure provides the ability to separately evaluate their performance. For greater control, a cell may form a portfolio insurance company (PIC). A PIC is Cayman’s version of an incorporated cell and allows the third parties greater control and flexibility as a PIC can form its own board, although it is subject to the SPC’s overall board. A PIC can also provide or obtain coverage from other cells or the core, something that a regular SPC’s cell is not allowed to do.
Changes to function include captives providing additional coverages in other traditional and non-traditional lines such as deductible reimbursements on fiduciary, regulatory and commercial crime lines, and the provision of medical stop-loss coverage. This stop loss coverage tends to be provided above the entity’s deductible layer for the healthcare system’s own health plan or its accountable care organization (ACO).
For its own health plan, this would take the form of stop loss coverage for employee benefits. This coverage can mean that the captive provides the system with another set of eyes on the losses incurred since employee benefit programmes tend to have separate claim administrators, brokers, and actuarial personnel than the other lines
Employee benefits can be a volatile line of business and lead to larger than expected losses which can erode the captive’s capital base. Captives assuming such risk should monitor the loss development of such coverage carefully. It is important to note, however, that adverse loss development in one year is not indicative of a trend. And provision of such coverage by the captive can assist its parent system in obtaining excess reinsurance for higher loss layers.
Stop loss coverage can also be applied to the downside performance risk for an ACO where the captive provides coverage for any associated penalties. As the penalties can be substantive, this coverage requires more in-depth feasibility analysis prior to being added to the captive. In addition, the captive must consider whether additional capital is required to support the level of retained risk. It should be noted however, that a well-functioning ACO may not incur a penalty at all and so the captive may rarely have any claims on this line of business.
Another function that a captive can provide is in terms of strategic financial analysis. Traditionally healthcare captives built up their capital surplus over time based on subjective analysis, be it a 3-to-1 premium to capital ratio or a multiplier of the captive’s retained loss limit. However, these methods didn’t appropriately consider factors such as the captive’s plans for expanding its insurance programme, an emerging pattern of adverse losses, or even disruptive changes to the industry.
In some instances, the level of adverse claim development is leading some reinsurers to increase premiums and/or demand that the captives providing underlying coverage retain a greater level of risk. This can result in reductions in the captive’s underwriting profits at a time when their parent healthcare system must focus on providing enhanced services at a lower cost. A captive should then utilise financial analysis to ensure that it is well funded and capitalised for future operations.
After all, if you fail to plan, you plan to fail. Such analysis can employ fiscal projections, financial ratios, and decision trees and can assist in determining appropriate level of premium credits or dividends by projecting the fiscal effect of such income reductions or distributions on a captive’s capital surplus.
While healthcare captives continue to be effective risk management thermometers; properly structured, they can also be tools for strategic evaluation, combining elements of both risk management and financial analysis into essential tools for healthcare systems. Are captives still relevant? Yes, increasingly so.
Monique MacDonald is senior vice president of Global Captive Management. She can be contacted at: email@example.com
healthcare, captive, coverage, management, development, capital