Reinsuring international employee benefits into a captive provides many advantages for employers and employees, and is a risk financing strategy increasingly popular having been pioneered in the 1990s. It is important, however, to get execution right. Bill Fitzpatrick explains why some EB captives can struggle to succeed.
Many global employers are facing challenges in providing competitive employee benefits that attract and retain the best talent, while contending with escalating costs.
These cost pressures stem from a changing workforce in both demographics and employee expectations, a rise in chronic diseases, double digit medical inflation in many locations, heightened demand, a heavier reliance on company sponsored medical plans over public healthcare systems and advancements in technology.
These dynamics are leading employers to look for alternative solutions to confront the challenges and continued fulfilment of their benefits strategy.
Captives have proven to be one of the most effective means in both controlling overall risk benefit costs and enhancing prevention and mitigation opportunities by augmenting the management of medical costs and disability cases.
In addition, companies are realising the impact captives can have in maximising employee engagement through both effective plan management and the heightening of their DE&I opportunities.
If we examine the history of EB captive programmes, the first global programmes were established in 1996 by two European companies. Much of the attention at that time encompassed how the insurance networks would write and reinsure the local policies, while managing the cashflow requirements that captives entail.
To address these issues, a specific platform was established that allowed the fronting networks to both maximise the cashflow opportunities to the captive while minimising the unnecessary administration that existed with locally insured and pooled arrangements.
The main components of this structure still exist today, albeit different companies have applied their own variations in order to meet their specific structural needs:
- Significant premium discounts (25%) were applied to entice country stakeholders into joining the programme.
- All employee benefit plans were allowed to join no matter the claims experience, maximising geographical risk spread and premium volumes.
- The local insurer would retain the local administration fees (retention) and a 25% claims fund (covering medical & short-term disability clams) that would be replenished once a quarter, with the remaining funds being ceded to the client’s captive.
- The premium and claims bordereaux were produced within 45-60 days following the quarter’s end.
If we fast forward to present, each of these captives are thriving and continue to bring major benefits to their respective organisations with minimal changes to the original platform.
Additionally, many other global companies have since implemented and maintain highly effective EB captive programmes. Considering such a long-established track-record of success, what would cause the breakdown of such a tried and tested practice when funding employee benefit insurance plans through a captive?
This article will address certain short falls or limitations that can result in either the closure or unsuccessful implementation of an EB captive programme. The following are common triggers that can create such a scenario:
- Tactical policies are applied to strategic initiatives
- Profitability targets erode local subsidiary benefits
- Inability to align key corporate stakeholders
- EB captive structure platform is over-complicated
- Failure to convey the value proposition of the EB captive
Let’s address each of the main causes in greater detail:
Tactical policies are applied to strategic initiatives
One of the primary objectives of a captive is to maintain long-term pricing stability for its local country participants. While employee benefit claims’ experience is extremely predictable year on year, there will be instances when a large loss (large life claim) or poor claims experience (a spike in medical claims) occurs, significantly deteriorating the local country’s claim results.
Applying aggressive premium increases to recoup such losses at subsequent renewals can allow for local carriers to undercut the captive’s pricing or create resentment from country management, eliminating a level of trust between the local subsidiary and the home office.
Most captive programmes operate on a long-term rolling annual combined ratio basis of under 100%, making EB risk benefits desirable to risk management for its predictability and spread of risk versus that of many P&C coverages.
Profitability targets erode local subsidiary benefits
Numerous companies have taken advantage of utilising their captive as a profit centre. This can be accomplished by writing different customer-oriented third-party coverages, such as: warranty coverage, auto and fleet cover, marine cargo, etc.
Most EB captives will operate on a breakeven basis (no profit) when writing cover for subsidiaries of the parent cover. When a captive seeks to reinsure cover on a for profit bass, it places the captive in direct competition with the local insurance market.
Such an approach erodes the advantages that reinsuring risk benefits brings a company in controlling long term benefit costs.
It also removes revenues from local businesses that can be applied to core business opportunities within its respective industry sector or detracts from plan design improvement opportunities impacting the attraction and retention of key talent; further affecting innovation and productivity.
Inability to align key corporate stakeholders
There is a saying attributed to Peter Drucker, management consultant and author, that states: “Culture eats strategy for breakfast”.
In other words, culture can either hinder or enhance the implementation and application of key strategic initiatives.
Various companies rely on policies that have been demonstrated to be effective in the past, which is a respectable position to adopt, but can stifle a company into accepting approaches that have grown obsolete or ineffective compared to new opportunities.
As EB captives are relatively new to the market, companies may be risk adverse into accepting EB insurance exposures into a subsidiary of the parent company. Also, clients may be reticent to make changes due to external opinions from subject-matter experts that have conflicting agendas.
While a company may be already operating or currently considering an EB captive, it is important that key stakeholders (risk management, human resources, finance and legal) are aligned to the employee benefits strategy and are well versed in the short and long-term advantages and challenges with the overall funding methodology.
Early and regular engagement across stakeholders can help avoid confusion and/or misinterpretation, especially around claim results and annual pricing changes.
EB captive structure platform is over-complicated
While many companies have modified the process used for reinsuring employee benefits into their respective captives, there are key components that should be maintained for a programme to stand the test of time:
- One of the main purposes of an EB captive is to minimise the premiums being paid for reinsured benefits, while simultaneously offering subsidiaries long-term rate stability. Programmes will struggle when rating actions are based on short-term claims results or head office profitability requirements, reducing the appeal to local stakeholders impacting both plan design enhancements and/or financial advantages.
- The risk of reinsuring benefits into a captive should be viewed more so as a timing risk as opposed to an underwriting exposure (assuming proper geographical and line of cover spread of risk can be achieved). Historically, successful programs strived on securing as many countries into the program as quickly as possible, resulting in greater geographical spread of risk, increased predictability with larger premium volumes, thus limiting the effect of large losses or poor results in single country. Applying selective country implementation based on underwriting criteria stagnates the growth of the programme while exposing the captive to large losses and/or poorly performing policies.
- Maintaining pooling or locally insured programmes that are less complicated. Quarterly captive reporting versus that of annual pooling results enhances the tracking of premiums and claims resulting in the following improvements: cashflow optimisation, prevention and mitigation campaigns, and effective plan design management (governance and plan enrichments).
Failure to convey the value proposition of an EB captive
Introducing an EB captive programme can present challenges, especially in gaining stakeholder buy-in, notably from HR. In most countries, HR oversees the local placement of EB schemes.
It is imperative that HR understands how an EB captive programme will impact their role and improve the management of employee benefits.
HR and benefit specialists are responsible for a multitude of tasks ranging from; sourcing and managing local insurers, designing plans, negotiating terms and costs, to overseeing renewals and employee inquiries.
Managing these tasks alongside other HR responsibilities, especially when multiple benefit programmes exist, consumes time and detracts from strategic priorities.
Implementing an EB captive program can significantly streamline these processes, serving as a valuable time-saving tool for HR.
These time efficiencies, combined with enhanced access to data and flexible plan designs, empower HR to concentrate on the core aspects of benefit management, designing and delivering benefits in line with their strategic goals and engaging employees effectively.
Effective communication about the value of an EB captive programme across all organisational levels: globally, regionally, and locally, is vital.
Such communication ensures alignment and commitment among stakeholders which is essential for maintaining a sustainable programme in any organisation.
While EB captives may not be appropriate for all companies, a properly implemented and managed programme can promote cost savings, plan design management, enable a company’s global DE&I strategy, prevention and mitigation opportunities; all via a single platform that is more effective than most currently available funding mechanisms.
Those companies that lack the necessary volumes/sufficient premiums, risk tolerance and/or geographical spread may not be suited for such an approach and will need to rely on multinational pooling, self-funding or locally insuring their risk benefits coverages.
That said, even with these caveats’ consideration should be given to reinsuring EB risks into a captive to gain financial savings and efficiencies, but to also achieve the following:
- A better understanding and an ability to report on your global employee benefit spend and exposures, resulting in superior governance of your global benefit promises.
- Control over these exposures and costs centrally without necessarily changing the current benefit offering, but ensuring that it is not altered without approval and proper cost consideration (both present and future).
- Enhanced control and oversight of divestitures and acquisitions affecting EB costs and liabilities.
The ability to deliver to your global benefit strategy by introducing global diversity and inclusion initiatives at minimal cost and time effort.