What are Captives?
A captive is a collection of like-minded midsized employers that come together for the purpose of sharing risk and purchasing power as it relates to healthcare spending. Captive members save money on stop-loss insurance by pooling together and often see a return of premium with favorable claims experience, since each member of the company becomes a part-owner of the captive.
What is the History of Captive Insurance?
Early captive insurance companies were used almost exclusively to insure their owners’ property and casualty risks. Today’s captive insurance company can provide virtually any type of coverage, as long as it is within the regulations of the selected domicile. Captives are routinely used to insure such diverse risks as contractors professional liability, environmental liability, terrorism, directors and officers liability, employment practices liability, cyber security, and warranty programs.
Today, a number of organizations also utilize some form of captive insurance to fund the costs of employee benefits such as medical and life insurance, accidental death and dismemberment, long-term disability (LTD), and retiree benefits.
What are the Advantages of Captive Funding?
Five reasons are frequently cited for covering employee benefits in a captive.
- Claims and loss control. If the risk is insured in a captive, it will be easier for the employer to take control of loss data and institute proactive claims management processes that have been proven effective in reducing workers compensation loss costs.
- Tax efficiency. Writing the risk in the captive will 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 US 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 noncontrolled foreign corporation status can also provide an efficient way of financing benefits that are to be paid in the future.
- Unrelated business. The Internal Revenue Service (IRS) will treat lives insured in a captive as unrelated risk, which may strengthen the case for deducting all premiums paid to the captive. Even though 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.
- Reduction in insurance expense. As with property and casualty insurance, medical 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 reduced because more of the premium goes toward loss payments.
Is Captive Insurance Funding Right for Your Organization?
Captives are ideal for employers with a minimum of 50 employees, but if you are a smaller organization with a fairly healthy group of employees a captive could be a good fit as well. In order to fully take advantage of the benefits of a captive, you will want to have a good sense of your claims experience. The more you actively engage in claims management, the better because your organization will gain transparency through claims allowing you greater ability to control cost and manage the health and well-being of your employees.