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Navigating Disability Risks: The role of EB captives and how to manage the associated complexities

Vittorio Zaniboni is captive and insurance excellence leader at EY Luxembourg. Before joining EY in September 2022, Vittorio was chief insurance officer at General Employee Benefits.

In the intricate world of corporate risk management, Employee Benefits Captives (EBCs) have risen to prominence as essential tools for organisations seeking innovative ways to address the biometric risks of their employees and their families.

Within this framework, disability risks play a central role in providing financial security to employees facing disabilities. In this article we will provide a thorough exploration of EBCs and their approach to disability risks, with a specific emphasis on the complexities linked with disability annuities.

The role and differing structures of disability benefits

Disability annuities, within the realm of EB, serve as the linchpin for effectively managing and mitigating the financial consequences of disability for corporate employees.

These annuities are contractual arrangements that provide periodic payments to employees who have become disabled, thereby replacing a portion of their lost income. By incorporating disability annuities into their EBC structures, organisations can ensure that their workforce receives reliable financial support during times of adversity.

Disability benefits can be provided under different forms, and according to different triggering events: in some cases the benefits are provided as a lump sum (typically in case of total and permanent disability), or an annuity, with different benefit structures in case of short-term or long-term disability.

In some cases the disability benefit is also provided under the form of a premium waiver for the death cover, or the contribution to the old age pension plan.



The structure of the disability benefits provided in the various markets is heavily dependent on the local social security set-up and local market specificities.

In Anglo-Saxon markets there is a prevalence of annuities, while in South American and South European markets the lump sum is more widely present.

While the lump sum form is relatively more straight forward, both in terms of pricing and portfolio management, the annuity form, mixing both morbidity and longevity elements, brings to the risk-taker more elements of uncertainty and volatility.

A key point of attention linked with disability annuities is the mathematical reserves (and the IBNRs) set aside following proper actuarial evaluations, to properly represent these contracts in the balance sheet of the insurer.

Several considerations and assumptions play a crucial role in the assessment of these reserves, namely:

  1. New claims notification timing and pattern
  2. Mortality rates for disabled lives
  3. Return-to-work assumptions
  4. Financial return of assets backing the liabilities

Any change in the evaluations of the points above can determine a major shift in the absolute amount of the disability reserves accounted in the balance sheet.

A snapshot of disability coverage within captive EB portfolios

In terms of size, disability covers represent a significant share within captive EB portfolios.

The EB portfolios managed by captives worldwide have been growing significantly in the last years, with a CAGR close to 20% in the last five years, and the current global EB captive GWP, mediated by the major EB networks, sits at more than €2bn.

Out of this €2bn, around 20% is linked to disability contracts, and within the disability book, disability annuities represent on average 85% in terms of GWP.

These volumes are projected to grow steadily, driven by increasing awareness of the importance of financial protection in the event of disability.

The countries where captives are more exposed to disability annuities are UK, Canada, France and Ireland, which alone contribute typically for more than 50% of the global disability annuity portfolios ceded to captives.

Considerations for establishing a successful disability annuity program in an EBC

In general terms, creating a successful disability annuity programme within an EBC demands meticulous planning and consideration.

Here are practical recommendations for managers seeking to underwrite disability risks within this specialised context:

Thorough Risk Assessment: A disability risk assessment is necessary for EBCs to identify their exposures and develop risk mitigation measures proactively. Disability risk assessments should cover several areas, including the nature of the exposure, the demographics of the workforce, their roles, and the potential financial impact of disabilities.

The assessment process should be conducted regularly to identify any emerging risks. By conducting regular assessments, EBCs can identify trends and adjust their coverage accordingly.

Understand the Nature of Disability Risks: The first step in managing disability risks for EBCs is to understand their nature. The risks of disability can be classified into two categories: the risks of long-term disability (LTD) and the risks of short-term disability (STD).

Long-term disabilities refer to a disability that lasts for an extended period and prohibits an individual from performing their duties permanently or for a prolonged timeframe, whereas short-term disabilities only last for a limited period (typically less than six months).

Understanding the nature of disability risks is essential as it helps in developing effective strategies to manage the risks. EBCs can create a disability risk model to understand the potential impact of these risks.

Customisation is Key: Tailor disability annuity programs to align with your organisation’s unique needs. Ensure that coverage levels and benefit structures are in harmony with the results of your risk assessment.

The involvement of the captive as final risk-taker presents the unique possibility to offer, to the local workforce, insurance conditions which might not be easy to obtain in a standard client/insurer relationship. The captive should capitalise on this opportunity for flexibility.

Engage Actuarial Expertise: Collaborate with actuaries specialised in disability risk modeling to accurately assess and price these risks. Actuarial data is essential for setting appropriate premium rates and reserves, and in general necessary for proper portfolio management.

If not accurately assessed and governed, disability liabilities cumulated over the years can potentially endanger the stability of the captive balance sheet. Considering the significant impact that small changes in the local product design can have on the relevant liabilities (indexation, possibly linked with CPI Indexes; interactions with local Social Security systems; waiting periods etc.), having the possibility to rely on actuaries with specific knowledge of the local markets is key.

Efficient Claims Management: Establish robust claims management processes that are both efficient and empathetic. A streamlined claims process is essential for disabled employees relying on timely benefits, and the direct involvement of the captive (in conjunction with local HRs) plays a fundamental role.

One of the most effective ways to manage disability risks is by implementing return-to-work programmes. Return-to-work programmes encourage employees with disabilities to return to work as soon as possible after an injury or illness.

By implementing and/or supporting such programmes, EBCs can reduce the total cost of claims, provide employees with a sense of purpose, and reduce the risk of long-term disability. Return-to-work programmes should also include physical and psychological rehabilitation, access to modified jobs, and other support services necessary for successful recovery (e.g. Employees Assistance Programmes – EAP).

Offer Health and Wellness Programmes: EBCs should also provide health and wellness programmes to their employees. Such programmes can help reduce the risk of disabilities by promoting preventive measures and encouraging healthy lifestyles.

Programmes could include access to fitness centers, nutrition education, stress management and mental health support. Offering employee incentives for participating in these programmes can also encourage higher participation rates.

Some captives even facilitated the local implementation of H&W initiatives, by setting up a system of “credits” linking these initiatives to discounts on the medical and disability premium rates. This approach must be implemented with caution, as the effects of H&W initiatives tend to impact the financials of the insurance contracts only in the medium/long term, and assuming immediate effects on the local claim ratios, can generate negative impacts on the captive P&L.

Collaborate with Medical Professionals: EB captives should collaborate with medical professionals to ensure that their employees receive excellent healthcare and rehabilitation services. Collaboration with medical professionals can provide valuable insights into different types of disabilities and how to manage them. Medical professionals can help identify potential risk factors, recommend appropriate interventions, and offer guidance on return-to-work programs. Collaboration with medical professionals can also help in identifying options for alternate work arrangements that would help an employee return to work sooner.

Transparent Communication: Effectively communicate the availability and benefits of disability annuities to your employees. Transparent communication fosters trust and ensures that those in need are aware of the support available to them.

Regular Review and Adaptation: Continuously review and adapt your disability annuity programme as your organisation evolves. Changes in workforce demographics or regulatory requirements may necessitate adjustments.

Conclusion

In conclusion, EB captives have emerged as key tools for organisations seeking innovative solutions to manage disability risks effectively. Disability annuities, when incorporated into EB programmes, represent an effective and efficient means to protect employees from financial hardship during times of disability.

The market statistics underscore the rising significance of disability annuities within the realm of EBCs, emphasising their potential for financial security and cost savings.

In an era where safeguarding the financial wellbeing of employees is paramount, disability annuities stand as a beacon of security, offering a win-win scenario for both organisations and their workforce.

It is a testament to the power of innovation and customisation in modern global corporate risk management.

The views expressed are those of the authors and do not necessarily reflect the views of Ernst & Young LLP or any other member firm of the global EY organization.