The implications of captives for association health plans

Earlier this year, the US Department of Labor (DOL) issued a proposed rule that provides direction to businesses seeking to create association health plans (AHPs). An AHP is a grouping of small employers that have banded together to replicate the profile of a much larger single entity.

The rule, still in proposal stage, would effectively broaden the definition of an “employer” under the Employee Retirement Income Security Act of 1974 (ERISA) to include AHPs which provide properly qualified health benefits to participants. The AHP rule would allow the grouping of smaller employers to be viewed as if it were a larger single employer for underwriting, rating and regulatory purposes.

Key points and considerations

In the world of employee benefits, groups of employers banding together to form a communal health plan are typically known as multiple employer welfare arrangements (MEWAs) and are structurally analogous to most medical plans provided by Taft-Hartley qualified labour unions and professional employer organisations (PEOs).

In a typical MEWA, premium contributions from several employers are commingled into a single trust or custodial account or fund and used either to purchase insurance or to pay claims directly to providers or employees. All MEWA funds are controlled and managed by a centralised administrator, with little or no direct control by participating employers.

The DOL, via ERISA, empowers individual states with regulatory authority for MEWAs, which in turn tend to be tightly regulated to ensure their fiscal solvency. MEWAs are currently prohibited in a significant number of states.

The ruling, if adopted, would not impede a state’s ability to regulate MEWAs but would allow for their broader application and increased expansion.

The rule, as proposed, would allow for two types of qualified structures relative to membership composition:

The proposed rule will also allow AHPs to be formed specifically for the procurement of insurance. Current MEWA regulations generally prohibit associations being formed solely for insurance purposes. Since individual states currently promulgate differing regulatory standards for MEWAs, it is hoped that the finalised rules would create more uniform regulation across all states.

MEWA background

These structures were popular in the early 1980s until the early 1990s when tighter regulation became compulsory. MEWAs commingle the premium contributions from several employers into a single trust or custodial account that is used to purchase insurance or pay claims directly to providers or employees.

All MEWA funds are controlled and managed by a centralised administrator. Improper administration and instances of fraud caused widespread insolvency of MEWAs, causing many states to mandate increased regulation and reporting or simply abolish them entirely.

The future for regulation

I would expect that AHP legislation will continue to promulgate federal qualifying requirements relative to funding levels, minimum surplus, and asset investment guidelines that follow ERISA’s prudency standards. The proposed rule seems to require that participating members (employers) maintain control and direction of the AHP/MEWA assets. Thus, while outside administration of assets would be acceptable, control of assets must remain with the participating members rather than a third-party sponsor.

The proposed AHP rule appears to mandate an allowance for AHP formation in all states. It is hoped that the governing regulations for AHPs, in terms of structure, solvency and administrative standards, would be consistent across all states. I would expect, however, that each state would still maintain regulatory sovereignty over specific benefit provisions as they now do for insurance carriers and fully-insured benefit plans.

Size and credibility will determine structure

As the AHP will essentially be treated as if it were a single large employer for underwriting (and regulatory) purposes, it can assume either a fully-insured or self-insured MEWA structure. The structure is likely to be dependent on the collective size of the membership. Since AHPs are targeted to small (ie, fewer than 25 employees) fully-insured employers, it is expected that most AHPs will be initially formed as fully-insured entities and eventually make a conversion to self-insured after attaining an appropriate size and establishing a history of credible loss data.

After establishing a credible track record as a self-insurer, it would be logical to assume that some larger self-insured AHPs would seek to assume some of the related medical stop loss (MSL) risk in a captive. Small, fully-insured entities are typically unable to get sufficient loss data reports from their insurance carriers, and what is available is not considered very reliable, due to small risk size, from an underwriting standpoint.

A larger population (eg, 1,000 lives) is considered to have sufficient underwriting integrity. It also takes three to five years of credible loss data to constitute the reliable track record for optimising alternative risk predictability.

Potential captive implications

I expect that it will take several years before captives come into significant play relative to AHPs. As discussed above, AHPs will be targeted primarily at small employers and allow them to be collectively treated as a single entity for underwriting and regulatory purposes. Until a sufficient critical mass (ie, more than 1,000 lives) having credible experience data and track record (ie, three to five years) can be attained, most AHPs are likely to remain in a fully-insured structure.

After a few years of established credibility, I would expect many AHPs to make a conversion to self-insured structures to capitalise on the benefits associated with assuming greater levels of predictable risk while continuing to transfer higher levels of catastrophic-level exposure to a re/insurer.

As the AHP continues to enhance its underwriting credibility, its ability to convert retained risk into stop loss coverage funded through premiums paid to a captive expands. The self-insured AHP could structure the stop loss as a single-parent captive and self-issue its own stop loss policy.

Excess MSL coverage could be purchased as reinsurance by the captive to help optimise expense efficiency. A significant number of self-insured AHPs will likely explore the assumption of stop loss risk in a captive to maximise the effectiveness and efficiency of the overall programme.

Closing thoughts

AHP legislation is expected to pass in some form and will enable broader and, hopefully, more uniformly regulated formation of MEWAs. It will take a few years for AHPs establish the requisite underwriting credibility needed to subsequently convert to and establish themselves as self-insured entities.

As positive track records are established, more self-funded AHPs will explore the establishment of single-parent captives for MSL.