The basics of health insurance captives for small employers
Health insurance captives, also known as medical stop-loss insurance captives, have been around for a while — even though they are still not widely adopted — and can be a successful part of a cost control strategy for clients.
Their origins tie back to when large employers (5,000+ employees) needed a way to manage healthcare risk across their organization, lower costs for employees and reduce administration and underwriting costs from carriers. Most of these large companies had already successfully utilized the captive concept for other insurance purchases (workers’ comp, medical malpractice, etc.) and were able to apply the method for their medical stop-loss needs.
The size of large companies and their medical claims history yields a high degree of predictability, which in turn means lower risk and cost across the organization. Captives work well for large organizations because they have enough volume to stabilize their risk and allow companies to lower the fixed cost of insurance by returning unused risk fund premiums back to the company.
Once medical stop-loss captives became successful for large employers, they then began to be adapted for smaller and midsize organizations. In theory, joining forces of multiple employers to mimic a large company's size enables the smaller companies access to the same bulk-buy benefits when purchasing healthcare benefits. Volume is critical.
Similarly, when an adviser does not have the size or client volume to create their own captive, joining together with other advisers is a seemingly smart way to overcome size-driven limitations. Hence, the introduction of public incubatory captives. Available through wholesalers, public incubator captives, also known as group captives, provide access for advisers who want to leverage the captive technique for their clients, but do not have enough volume to build one on their own.
Group captive basics for small-to-midsize companies
Captives for smaller employers are typically partially self-funded, share risk and purchase reinsurance together within a tiered structure utilized by the captive program. The profile typically looks and acts as follows:
- Tier 1: Employer layer or specific stop-loss risk. The maximum risk an employer is responsible for on a large claim. Similar to a typical partially self-funded specific deductible plan, this risk layer generally ranges from $10,000-$150,000, depending on the size and risk tolerance of the client and captive member pool.
- Tier 2: Captive stop-loss layer or shared risk pool. This shared risk layer sits between the employer risk and traditional reinsurance. It pays members’ claims that are over their specific stop-loss maximum, but under the reinsurance deductible. It is funded by a large portion of the reinsurance premiums that members pay to the captive manager. The percentage of premium contributed to the pool is determined by the captive manager, or managing general underwriter, who has structured the program, but generally ranges from 45%-70% of the total paid premium paid by each client in the captive. The balance of the premium is used to purchase actual reinsurance and cover costs associated with the management and running the captive. Any unused premium in this layer after the policy year is completed typically is returned to the member clients.
- Tier 3: Traditional reinsurance layer or excess risk. The reinsurance layer protects the shared risk layer from substantial claims by capping the cost it is responsible for. Typically set at a high limit ($250,000-$750,000), reinsurance covers excess costs of a claim after the employer pays their portion (Tier 1) and the shared layer pays its portion (Tier 2). Since the Affordable Care Act requires no limits, the excess layer has no cap on what it will pay.
Two of the most powerful aspects of captives are:
1) the tremendous flexibility of the process and the products; and
2) the large opportunity for returns from unused premiums in the shared risk layer to the employers that participate.
Captives can support small employers on level-funded programs, mid-sized employers with more traditional partially “self-funded” programs, or large employers seeking savings in place of a lost fixed stop-loss cost. They can be used for similar employer industries (homogeneous pools) or dissimilar industry employers (heterogeneous pools). Captives can support direct contracting efforts, ACOs, PPOs or reference-based pricing clients. All clients, no matter what their choice of funding, can choose their own plans and networks; and they can all be different.
In the right circumstance, a captive can even support all of the above situations in the same pool at the same time.