Captive insurance companies are traditionally thought of as being used to cover an owner’s property and casualty risk – from professional liability coverage to EPLI, environmental liability, D&O liability and Cyber Liability, among others. Today, increasingly more organizations are also looking to captives to fund the costs of employee benefits such as health and life insurance, accidental death and dismemberment, long-term disability (LTD), and retiree benefits.
There are several reasons for using a captive insurance company for employee benefits including:
- Greater claims and loss control. With a captive, it’s easier for an employer to take control of loss data and implement proactive claims management processes that have already been proven effective in reducing workers’ compensation loss costs.
- Cash flow generation. If the line is actuarially predictable and with a slow payout such as life insurance and long term disability, the captive can earn investment income on the reserves and underwriting income on the portfolio of risk. In addition, the tax-favored treatment of life insurance reserves may enable an employer to reduce the cost of providing benefits below the cost of a traditionally insured or self-insured program.
- Tax efficiency. Writing the risk in the captive can be more advantageous than self-insurance if it allows the insured to accelerate the tax deduction for incurred losses, deducting premiums paid to the captive. For captives that pay U.S. federal income taxes, there is also the possibility that the effective tax rate on all of the captive’s income can be reduced. This happens if the captive qualifies to be taxed as a life insurance company. Captives that pay no income tax because of non-controlled foreign corporation status can also provide an efficient way of financing benefits that are to be paid in the future. As with any captive, reviewing all tax implications with an adviser is critical.
- Unrelated business. The IRS treats employee lives under the captive as unrelated risk, which may bolster the case for deducting all premiums paid to the captive. Although there is no long-term investment income or acceleration of the tax deduction and there may be an increased expense of front company or captive premium taxes, the advantage of increasing the amount of unrelated risk in the captive may make it worthwhile.
- Insurance expense reductions. As with P/C carriers, life insurers have profit and administration loads that are included in premiums. If the captive is able to write the benefit risk directly, the expense load is lower because more of the premium goes toward loss payments.
There are, of course, disadvantages that one must be aware of when looking at whether setting up a captive for employee benefits makes sense. For instance, plans seeking Department of Labor (DOL) approval will be required to use a fronting insurer. Establishing an agreement with a sound fronting company for the services required by a captive can be difficult and expensive. Captive programs established for plans not subject to DOL approval, such as for medical stop-loss coverage, are not required to use a front. Caitlin Morgan can assist you medical-stop captives.
Additionally, as with any other type of self-funding arrangement, a captive may suffer losses greater than an employer’s projections. Some types of employee benefits involve very long tail liabilities. For example, long-term disability benefits might have a 30-year payout. If a captive insurance program covering such benefits is terminated, the captive will need to manage or transfer the tail liability. Inadequate loss reserves can trigger significant increases in the rates charged by a captive and in the capital requirements in order to ensure its financial solvency.
About Caitlin Morgan
Caitlin Morgan provides a broad range of captive insurance solutions, including a medical stop loss captive program, which we can review with you in detail. Give us a call at (855) 975-4949.
Source: IRMI – Captive.com