the International Foundation of Employee Benefit Plans recently wrapped-up their 32nd Annual Health Benefits + Conference Expo (HBCE) in Clearwater Beach, Florida. The conference brought together healthcare and benefits professionals from a range of industries to discuss leading topics and share expectations for the future. Having heard such positive feedback about the event, Spring was glad to attend, exhibit, and speak at the conference. Below are some of our biggest takeaways.

Spring Booth HBCE

1) Pharmacy Cost Containment

This year there was a lot of talk surrounding the price of prescription drugs and tactics employers can adopt to help control costs without cutting benefits. There are many factors influencing the high costs of pharmacy drugs, some of which include chronic disease prevalence, the aging population and the growing volume of specialty medications. Below are some of the top sessions focused on controlling Rx costs.

– Representatives from Express Scripts explained the upsides to working with a Pharmacy Benefit Manger (PBM) and how they can help address pharmacy policies in their session titled, “How to Work With Your Pharmacy Benefit Manager.”

– The CEO and Co-Founder of TruDataRx, Cataline Gorla, discussed how comparative effectiveness research (CER) is being used by other countries to decide which drugs work best for specific medical conditions, and how self-insured employers can save money with said data.

2) Addressing Chronic Conditions

According to the Center for Disease Control (CDC), 90% of the nation’s healthcare spending goes towards people with chronic and mental health conditions1. As chronic diseases are very common among the American workforce, employers have started implementing specific benefits and policies to address common conditions, such as diabetes and obesity. Some of the sessions around this topic that we found most interesting include:

– Speakers representing the Nashville Public School System explained how they were able to introduce free resources such as telenutrition and fitness center access to help combat obesity and other health disparities.

– Dr. Mudita Upadhyaya from St. Jude Children’s Research Hospital presented on prevention strategies to address mental health and obesity in a pre- and post-COVID world; and why a mixed approach may be best.

– The Diabetes Leadership Council’s CEO, George J. Huntley spoke on diabetes and chronic disease risk management strategies, including medicines and technology that can help patients manage and prevent the disease.

3) The Future of Healthcare & Benefits

In recent years we have seen a great shift in the healthcare and benefits industry; we saw a great increase in telehealth, mental health resources, new/alternative types of paid leave, including sick leave and more. As we transition to a post-COVID world, we expect the evolution to continue. Below are some of the top trends professionals believe we will face in the coming years.

– Our Senior Vice President, Teri Weber, presented on market forces employers can utilize to meet future absence management challenges. Her session listed techniques employers can adopt to improve day-to-day administration of disability, absence and accommodations.

– In a session titled “Innovative Health Care Models—The Future of Direct Primary Care,” the presenter explained how many employers are changing to value-driving healthcare models to boost access and reduce costs.

– A session titled “Breaking the PTO Mold, Without Breaking the Bank,” reviewed how typical Paid Time Off (PTO) programs can be altered to better support employees’ well-being and financial health.

– The final session of the conference spotlighted how the pandemic has led to an increase in personal, economic and other stressors and has had a drastic impact on mental health, substance misuse and addiction. Attendees were informed on how they can implement workplace solutions that address these issues as well as identify warning signs.

The warmer weather was certainly a bonus, but the insights we gleaned and connections we made were what will keep us coming back to the HBCE conference. We want to thank IFEBP and our fellow colleagues who took the time to share their experience, stop by our booth, and make the energy so positive.

1https://www.cdc.gov/chronicdisease/about/costs/index.htm

As seen on Alera Group’s Insights Page

In the cyclical market for Property and Casualty Insurance, we are more than a year into hard-market conditions, leading growing numbers of businesses to consider alternative risk funding. That, in turn, has created an abundance of work for insurance actuaries and Captive Insurance consultants.

OK, that’s a lot of insurance speak for one paragraph. Let’s unpack:

— A hard market for insurance is characterized by a rise in rates, a reduction in options for coverage, heightened scrutiny by policy underwriters and reduced carrier capacity for coverage limits. A combination of catastrophic weather events and so-called “nuclear verdicts” in liability lawsuits — as well as the cyclical nature of the Property and Casualty (P&C) Insurance market — were the driving forces behind the hardened conditions before the onset of COVID-19, and the pandemic exacerbated matters. Rate increases have leveled off to some extent in 2022, but, in general, most conditions in the market remain unfavorable to consumers.

— Alternative risk funding — also known as alternative risk financing or alternative risk transfer — is a mechanism for providing coverage by means other than commercial insurance. Types of alternative risk funding include Captive Insurance programs, in which a business or group of like businesses creates and funds its own private insurance company to cover one or more risks in the realms of both P&C and employee benefits. Workers’ Compensation, General Liability, Auto, Professional Liability and Medical Stop-Loss are the more common coverages to start with when insuring through a captive, but captives often expand into a funding mechanism for many of an organization’s other lines of insurance, including Cyber and Umbrella (also known as Excess Liability Insurance).

— Insurance actuaries use math, statistics and financial models to analyze the cost of risk and determine how much money a company should pay to protect itself against risk. All insurance carriers employ actuaries to help set policy premiums and limits. Some insurance agencies work with actuaries to negotiate policy details with carriers or, in a captive arrangement, to determine a premium that will cover claims and, in the long term, reduce the insured’s total cost of risk. Captives have the advantage of also building up retained earnings over time and allowing companies to take on more risk, generating additional insurance cost savings for the parent. Among multiple P&C capabilities, actuaries who work with or for an agency also educate clients on the cost of risk and how to manage it.

Now that we’ve cleared that up, let’s talk about the role of an actuary in managing the cost of risk and protecting your business with a customized insurance program — whether you’ve chosen to pursue alternative risk funding or not.

Why an Alternative Solution? And Why Now?

Business leaders know all too well about the hard market for Property and Casualty Insurance. Just as the pandemic began to wane early in 2022 and there were some signs of casualty rate increases leveling off, Russia’s invasion of Ukraine escalated supply-chain disruption and fuel shortages, accelerating the rise in economic inflation. Damage resulting from Hurricane Ian only made matters worse, of course, driving reinsurance — insurance for insurers — into what the Bank of America termed a “true hard market” of its own, with rising costs getting passed on to consumers. These issues have led to overall increases in U.S. P&C industry combined ratios over the past few quarters, sparking further rate increases for certain lines.

It’s no wonder more organizations are looking at captives and other alternative risk-funding solutions.

“Overall, between 2017 and 2021, captives added $4.3 billion to their year-end surplus while returning $5.8 billion in stockholder and policyholder dividends, representing $10.1 billion in insurance cost savings over purchasing coverage from commercial market third parties.”

“The number of U.S. captives continues to rise, although the growth of captive formations was tempered by the onset of economic uncertainty resulting from the pandemic, as well as ongoing scrutiny from the IRS and greater regulatory and reporting requirements.”

“However, these adverse conditions can serve to highlight the benefits of the captive segment and provide businesses an incentive to establish them,” said Fred Eslami, associate director, AM Best.

“‘This current environment allows captives to customize coverage for risks that may be uncommon or difficult to write or place in the standard market,’” Eslami said.

The growth in Captive Insurance has led to an increasing willingness on the part of carriers to work with captives and regard them as partners rather than threats, increasing options for captive solutions. And even if an organization in the end chooses to forgo alternative risk funding – either for an entire P&C program or for individual coverages, such as cyber or commercial umbrella – simply exploring an alternative and having it as an option can improve its position in the insurance market.

Actuary Capabilities: Your Data, Your Future 

For insurance agents and brokers, designing an insurance program tailored to your industry and company is as much art as it is science. Working with an actuary enables you to incorporate greater amounts of empirical evidence into evaluating risks and determining insurance solutions: Here’s what the numbers demonstrate about your situation now, and here’s what our analysis shows about how you’ll perform using this solution.

While any good broker will work to design an insurance program customized for your business, a broker working with an actuary will be especially well-equipped to design a solution tailored to your unique needs and goals. Among the key issues an actuary can help brokers work through are:

  1. Determining appropriate retention/deductible levels to help the client reduce the total cost of risk;
  2. Estimating client retained unpaid claims liabilities at quarter/year-end;
  3. Estimating carrier letter-of-credit need for a large deductible program; 
  4. Estimating possible retained loss outcomes at various confidence levels;
  5. Performing a captive feasibility study.

Many brokers work in silos, taking a vertical approach in evaluating risk based on industry. Actuaries generally don’t distinguish by industry; they analyze across various industries, focusing on each individual client’s loss history (including frequency and severity), claim status, policy details, exposures and risk-control program before determining financial projections for the organization. Taking the long-term view allows for consideration of fluctuations in company and market performance over a period of time, and increases the likelihood of long-term savings and profits.

Optimizing Your Insurance and Benefits Solutions

As companies grow, they generally reach a point where their claims experience is predictable across one or more lines of coverage. Able to determine such predictability, an actuary can then help you:  

If you’ve reached the point where your business is paying, say, $100,000 to $250,000 in annual premium, a group captive might be the best solution because you probably aren’t yet structured appropriately to meet the insurance tests required to form a single-parent captive and the economies of scale may not be there for a single-parent captive solution. In such a case you may need to diversify your risk with other organizations (heterogeneous or homogeneous) — in a group captive or in a shared-risk pool solution utilizing reinsurance — for at least the time being.

The bigger, more complex, more diversified a company becomes, the more a fully funded, single-parent captive emerges as an optimal solution in which the business is insuring only its own risk. A single-parent captive also allows for more coverage flexibility and transparency than a group captive program. Quite often, both benefits and P&C risks are insured by a single-parent captive.

What drives the decision to move from traditional, carrier-based insurance to a captive program is savings and, ultimately, return on investment (ROI). How? By moving expenditures that create carrier profits into the captive solution. Captives are highly efficient, with very low expense ratios, unlike carriers. Free from providing a carrier with underwriting income and investment income on held reserves, you’re able to retain this income to ultimately generate a profit and facilitate an insurance mechanism that competes with the commercial market.

An Organization-Focused Approach

In taking an organization-focused approach toward financial analysis, actuaries look not only at funding for Property and Casualty Insurance but also at spending on employee benefits. Most captive insureds will see annual savings between 10% and 40% for premiums that flow through a captive instead of the commercial market.

As we approach the end of the year, Alera Group invites you to the final event in our 2022 Engage series of employee benefits webinars, A Look Ahead to 2023: Hot Topics and Trends. Join us on Thursday, December 15 as we discuss benefits financial officers and HR professionals need to think about now — including alternative solutions — as they plan for the year ahead.

ACCESS ALERA’S WEBINAR HERE 

Spring Consulting Group provides a wide range of Captive Services when it comes to the Employee Benefits and Property & Casualty (P&C) industries. In this Whitepaper, you can learn more about our captive services and how we approach captive implementation/optimization.

Our Actuarial Team teamed up with Alera Group experts on this COVID-19 and Mental Health Trends whitepaper which looks at the post-pandemic mental health landscape, including impacts on employees, children, plan costs, care gaps, and substance abuse.

In collaboration with Alera Group, our Actuarial Team helped create a whitepaper which provides guidance around eligibility, procedures, and plan costs for coverage of over-the counter COVID-19 tests within health plans, as mandated by President Biden. You can find the full whitepaper here.

Captive International has released the winners for the 2022 US Awards. Spring is proud to announce that our company and our Managing Partner, Karin Landry were selected as winners for Best Feasibility Study Firm and Best Feasibility Study Individual (respectively). We were also highly commended for Best Actuarial Firm, Best Individual Feasibility Study (Prabal Lakhanpal) and Best Actuary (Peter Johnson).

A (Brief) VCIA Session Recap

I had the pleasure of speaking at Vermont Captive Insurance Association (VCIA) Annual Conference last week, joined by two colleagues with impressive backgrounds. Jeff Caudill, Director of Risk Management at Haskell and a client of Spring’s, and Mary Ellen Moriarty, Vice President, Property & Casualty at College Insurance Company (EIIA) joined me to discuss different ways that captives can be used to tackle the hard market hurdles we’re currently facing in the insurance industry.

With myself as the moderator and consulting actuary, Jeff representing a brand new single parent captive, and Mary Ellen representing a veteran captive, it was a well-rounded panel that pulled in multiple perspectives.

The Clouds Behind the Hard Market

 

This visual does a great job at illustrating the many challenging atmospheric effects in the insurance air right now, particularly on the property & casualty (P&C) side of the fence (no pun intended). With Mary Ellen representing the higher education space, we felt it important to highlight unique risks that colleges and universities are grappling with, in addition to the other complicating factors (or clouds) we see here.

In my work I’ve seen that this climate has resulted in increased carrier profitability for certain lines over the last couple of years, such as auto liability, but decreased carrier profitability in others (such as cyber and commercial property).

In higher education, Mary Ellen explained there have been hard market consequences due to underwriter inability to achieve profitability, and as noted in the visual, they are dealing with risks many organizations don’t need to think about, like traumatic brain injuries, the general public accessing the property, and a different kind of medical malpractice. As a result, there are a limited number of carriers willing to provide coverage in this space. As a nod to captive advantages, EIIA was able to grow surplus from their captive prior to the hard market, from 2002 to 2022, which has been extremely helpful in this “stormy environment.”

This success story led us to a discussion around the business case for captives, a snapshot of which you can see here in this video.

Jeff then gave a bit of a play-by-play regarding the process, implementation, timelines and driving forces behind Haskell’s decision to switch from a group captive to a single parent captive (a synopsis of which you can find in this case study).

Looking Ahead

Both Jeff and Mary Ellen described some next steps for their captives, which may include writing in:

Food For Thought

Like most good things in life, you kind of had to be there to get the full experience and maximize your take-aways. So I don’t want to give it all away, but I will leave you with some food for thought that came out of the Q&A for the session. If you want to know the answers, please get in touch!

And last but perhaps most importantly:

As you can see, we can have some fun in the captive world, and much of it was had at VCIA! Before you leave, check out our captive business case video here, inspired by this presentation.

We are all feeling the impacts of inflation, and as the word “recession” continues to be a popular one among political, economic and social conversations, we thought we would sit down with our captive insurance experts (Karin Landry, Prabal Lakhanpal and Peter Johnson) to get their two cents on how a possible recession or economic downturn interplays with risk and financial management tactics, with a focus on captives. Here’s what they had to say.

1. What are some possible impacts of a recession on captive insurance companies?

Peter: Changes in risk profiles driven by economic changes (examples include commercial auto frequency moved down then up, cyber ransomware on the rise, healthcare workers’ compensation programs utilized, excess liability/umbrella rates increased substantially, etc.). This also impacted the commercial market and captives often stepped in to fill the gap.

Prabal: Changes in exposure units: a recession may lead to reduction in workforce and therefore a change in insurance spend. On the employee benefits side, during times of uncertainty we typically see an increase in disability claims as well as a spike in usage of health insurance. When taken together with the change in exposure units, benefits programs may see a reduction in performance.

Karin: A continued increase in captive interest. Clients are looking at different ways to save money during a recession. For those organizations that already have captives, risk managers will need to prove the value of the captive, as typically there are a lot of dollars funding reserves that management wants access to in order to improve cash flow during a period like a recession.

2. Are there steps captive owners can take to safeguard their captive against a recession? If so, at what point should they implement them?

Peter: We recommend having service provider and reinsurer relationships in place to be enable the ability to make quick changes and file a captive business plan change to adapt according to the market.

Prabal: For existing captives, we advise undertaking a captive optimization or “refeasibility study” every few years, and this will be especially important if we enter a recession. This process assesses captive performance against original goals, aims to realign the captive according to changes in corporate objectives or priorities, evaluates impacts from recent regulatory changes and/or market trends, considers additional lines, analyzes the domicile, and so forth. Captive optimization helps organizations understand the vulnerabilities of your captive and help you shore them up.

Further, have your actuaries undertake stress testing of the captive to ensure financial stability and consider getting rates as a captive, where appropriate. Then, implement a dividend return policy, which ensures that in the time of need, there is a clear outline of how the parent organization can access any surplus in the captive. Be careful here as you don’t want the parent entity drawing down the surplus so much that the captive loses financial strength.

Karin: Risk managers should determine whether or not their captives are optimally funded. They should calculate the value of the captive to the organization before it becomes a management issue. They should explore other lines of coverage to determine whether or not it will save money, improve investment income, and/or increase cash flow for the organization going forward.

3. How would a recession affect underwriting?

Prabal: Insurance companies have two main revenue streams: 1) underwriting income and 2) investment income. In a recession environment, investment income becomes less likely or harder to come by. Therefore, underwriters are laser-focused on ensuring underwriting income, resulting in tighter underwriting standards. For example:

Peter: Carriers often tighten underwriting standards and may refuse to underwrite certain risks and/or business types all together. We’ve seen this for certain casualty lines like cyber, GL, and excess liability. Carriers may also be forced to remove manual rate discounts and/or increase rates all together while narrowing coverage at the same time.  

Karin: Because underwriting practices may tighten, risk managers must understand their organization’s risks better than the marketplace.  You could find that your experience is better than the book of business at the carrier level. If this is the case, a captive may make sense.

4. What about reserving?

Peter: To the extent a carrier’s or a captive insurer’s reserves are in a strong position due to favorable experience, reserve releases can be expected and may offset some of the poor 2022 investment experience we’ve experienced. The opposite also holds for exposures with loss trend on the rise that are driving up overall loss costs.

Prabal: Actuarial stress testing of the captive also comes into play here to ensure stability and dividend return strategy so that there is a consistent approach.

Karin: For captives that book discounted reserves, changes in the discount rates will affect the level of reserves captives carry. For those lines of coverage that are sensitive to recessions like workers’ comp and disability, the impact of negative experience should be factored into the reserving process.

5. Could the economic environment cause changes in captive methodology or the lines placed within a captive?

Peter: We’ve seen captive owners become more interested in captive utilization particularly when they feel like carrier coverage and pricing is unjustified based on their own loss experience.

Prabal: Captive optimization helps with optimal capital utilization. In a recession where capital is scarce, companies benefit from being efficient with how they use it.  

6. What sort of pressures might captives face during a recession in terms of loan backs or dividends to the parents, or any impacts on capitalization?

Peter: We’ve certainly seen dividend policies put into place for certain clients that have been hit harder during the recession than others. Some have looked to access their captive capital that was built up to significant levels over the years.

Karin: As noted earlier, management may see the reserves of the captives as a pot of money to access; proving the value of the captive negates that issue.

7. The Great Recession around 2008 caused a stall in captive formations. Do we think that could happen again?

Peter: It seems fairly unlikely to have a similar scenario to 2008 since a portion of the collapse was driven by extremely poor mortgage underwriting standards in place. But anything is possible.

Prabal: Further, unlike in 2008, the commercial markets are still in a hard market cycle. This will likely be accentuated in a recession and therefore yield an increase in captive formations.

Karin: Because capital is scarce during a recession, this may spur the use of cell captive programs as opposed to pure captives to meet the needs that risk managers have to control costs and minimize price increases.

8. Anything else related to economic volatility that captive owners and risk managers should keep in mind?

Prabal: One thing would be the potential to free up captive capital by using loss portfolio transfers. The current interest rate environment is likely to create a preferential market for these opportunities.

Karin: Organizations’ hurdle rate might change as a result of the recession. This would necessitate looking at the opportunity costs associated with captives and their reserving process. Additionally, organizations should evaluate their insurance partners to make sure they are sound as they will be grappling with some of the same recession issues noted here. I wouldn’t be surprised if some of the insurers experienced difficulties and either left the marketplace, contracted and changed the coverage levels that they offer, and/or focused in on certain risks while excluding other risks from their policies in accordance with market shifts.

A critical starting point in setting up a captive is the captive feasibility study. Captive feasibility studies come in many forms, and there are no industry standard report formats. As a result, many captive owners do not know what to expect as a final deliverable, and we see many feasibility reports that are severely lacking.

The feasibility study forms the cornerstone for the establishment of a captive and is usually one of the first documents that would be requested for in the event of an audit by the IRS.

Every captive actuarial study should include both qualitative and quantitative aspects. Not only should it clearly map out expected financial results, but it should also highlight important insurance considerations that ensure an appropriate and compliant captive structure.

To help provide a framework, here are five key questions that captive owners should be able to answer based on their captive feasibility study.

1. Do you have appropriate data?

As part of the captive feasibility study process, captive owners should work closely with their current insurance carriers to gather as much high-quality data as possible. The study should reflect at least the following for all proposed lines of coverage:

This data will be used to develop future loss estimates once the coverage is placed in the captive. All of it should be readily available, and organizations should be reviewing this data regularly, regardless of whether it is undertaking a captive feasibility study. 

2. Has an actuary reviewed your loss experience?

Once you’ve gathered the necessary experience data, it is important that an experienced actuary review it. All experience reports are different in layout and content, and an actuary will know best how to interpret the data, develop the best estimate of future losses, and ask the right questions of the carrier.  A captive feasibility study should always include a robust actuarial analysis.

A good actuary will ensure that plan changes, rate changes, and overall population changes have been properly reflected in the experience report.  If they aren’t, the actuary can make the necessary adjustments.

The actuary should also review the claim reserves that the carrier is reporting.  In our experience, carriers typically overstate reserves due to conservative assumptions, inflating the loss ratio. A good actuary will independently calculate reserves to compute a more accurate estimate of historical loss ratios and future losses.

3. Do you have a clear sense for the expected administrative expenses – at the start of the program and ongoing?

Administrative expenses related to operating an employee benefits captive include actuarial, captive management, legal, audit, letter of credit (if used for collateral), carrier fronting fees, premium taxes, captive domicile fees, taxes, and state procurement taxes (if domiciled outside of home state).

These fees play a large role in determining whether the captive will be profitable at fully-insured market rates.  If your captive charges rates higher than market rates to turn a profit, then the fees are too high. Carrier fronting fees are typically the largest expense and the most important to get right. Captive owners need to understand how these fees were determined in the captive feasibility study and if they are market competitive and realistic.

We always recommend that a company placing employee benefits in their captive conduct an RFP process to select vendors, and that includes competitive fee arrangements.

4. Is the party that conducted your feasibility study independent, or could there be a conflict of interest?

We have seen many captive feasibility studies completed by non-qualified entities or by organizations that have a vested interest. For instance, many insurance brokers will conduct a high-level analysis to conclude a captive program is not feasible. It is essential to understand the interests of all stakeholders and to work with organizations that have the appropriate credentials to help you make an informed decision.

Find an independent party who can provide an objective, transparent, and unbiased recommendation.

5. Will the coverage qualify as insurance?

Every captive feasibility study must comment in detail on the qualitative aspects of captive insurance including what it means to qualify as insurance. This is an important consideration from a captive owner’s perspective and must be fully understood. There are many case laws that have commented on the lack of understanding of insurance company operations.

For instance, an important aspect of any insurance transaction is that it must achieve risk transfer and risk distribution. There are a few industry-accepted risk transfer tests that will demonstrate that the coverage adequately transfers risk from the insured to the captive.  The “10-10 Test” is the most common, determining whether there is a 10% chance of a 10% loss.  Alternatively, there is the Expected Reinsurance Deficit (ERD) Test where the threshold is an ERD ratio of at least 1%.

Risk distribution requires that the captive distribute its risk among several insureds.  Typical risk distribution tests are meant to ensure that no more than 30%-50% of the risk is from the same insured, and if the captive is a brother-sister insurance company, there must be at least 12 participating entities, each having no more than 15% of the risk.

We also recommend the Coefficient of Variation test to better understand the impact of the law of large numbers.  As the number of independent exposures increases the less volatile actual loss experience will become and therefore more predictable.

Employee benefits or not, all captive feasibility studies should address whether there will be adequate risk transfer and risk distribution.

To summarize, a captive feasibility study is one of the most salient parts of placing employee benefits in a captive.  Captive owners should aim for feasibility or refeasibility studies that are transparent, objective, highly robust, and consider all aspects of the captive transactions.