Whether an employer, association, municipality or union trust, today's uncertain economy has left plan sponsors scrambling to find ways to manage workers' compensation claims.
Overall claims are down, but the severity of injuries is up over the past 18 months–yet key priorities are the same.
Captive arrangements have traditionally been a strategy used by large employers to address these challenges. Until recently, however, such arrangements were out of reach for many small-to-midsize organizations. But new approaches–including group captives and rent-a-captives–are bringing new opportunities for virtually any size organization and helping to directly contribute to the bottom line.
While they provide a range of benefits, captives are not for every organization. The wrong approach could create problems ranging from tax code violations to poor outcomes and depleted reserves. The key is to enter such arrangements with a thorough understanding of what they are, how they work, current market conditions and the strategies needed to produce optimal results.
Captives are typically attractive during hard markets. Unfortunately, today's market isn't following past historical trends.
Insurer investment income declined about 50 percent in 2009–even more troubling when considering that 2007 saw a rare 6 percent underwriting profit.
With investment income declining, the industry can no longer make up for underwriting losses. Even though market capacity is solid, the market has begun to show signs of hardening in some areas of the country, but in others, although availability is shrinking, pricing remains competitive.
For these and many other reasons, it is time to move beyond considering captives as just a hard market solution. Their many benefits include:
o The ability to respond to multicoverage and multistate programs.
o Greater control through active governance.
o Fully deductible premiums.
o Investment income on funds, which can be set aside for loss reserves.
o The ability to avoid commercial insurers' overhead expenses.
While small-to-midsize organizations typically can't take advantage of single-parent captives, there are other options:
o Group captives, in which members are shareholders and often are tied together as an industry group. Provides cost advantages and offers control over claims and loss control services.
o Association captives, used for homogeneous businesses with a trade association owner and usually formed to stabilize insurance costs for members.
o Agency captives, owned and funded by an agent who benefits from an exclusive insurance program and profits from the program's good loss experience.
o Rent-a-captives, an emerging trend because of the ability to lower start-up costs.
What is the value of rent-a-captive options?
A rent-a-captive company "rents" its capital, surplus and legal capacity to an insured party that wants the benefits of a captive without actually participating in ownership or management. Participants are not required to invest the capital normally needed to form a captive, making entry and exit easier.
To participate in a captive, an organization needs a minimum of $1 million in premium as well as a retention amount large enough to sustain payment for one major loss. The number of participants covered by a captive varies by industry.
Rent-a-captive fees are based on a percentage of premium ceded to the captive and range from 1-to-3 percent of premium. This allows a more predictable expense ratio relative to the size of the program, and is desirable for start-ups and smaller programs of less than $10 million in premium.
When program premium is unpredictable or uncertain, and when a fixed cost of owning the captive will end up with higher than normal expense ratios, a rent-a-captive can become a viable option.
But there are trade-offs. Organizations that enter into rent-a-captive arrangements can no longer select vendors, such as accountants, auditors, actuaries and third-party administrators–those services will be provided by the rent-a-captive.
The effectiveness of rent-a-captives in today's market can be seen in the experience of a California program management company representing national restaurant franchisees with more than 600 locations in 28 states.
In 2004, the firm's restaurant franchisees were facing increasing pressures on their bottom line. Sales remained steady, but profits were diminished because of increasing overhead.
The association's broker recommended using a new risk-sharing group captive to bring in additional revenue. The strategy was to supplement the association's bottom line–and the franchisee's profit margins–with dividends from the insurance program.
The result was that program management directly contributed to cost savings. Franchisees were able to have a say in how they were going to contain costs, and the goal was to return people to work as quickly and safely as possible.
The risk management program included a full-time safety engineer who implemented a behavior-based safety program. This increased accountability and awareness of safety issues as well as proactive claims management practices. The claims management program included:
o Unbundled services for claims administration, network development and utilization review.
o Customized accident protocols, reports to help identify and address claim trends, routine audits, and aggressive response to litigated claims and fraud.
o Loss control strategies including a strong emphasis on safety and compliance.
In addition, because of a partnership approach between the risk-sharing entities–the agency, program manager and service provider–all open claims were reviewed as a group. Strategies for closure were identified and quickly implemented.
The risk-sharing captive for this entity produced strong results to date. In 2004, the program started out with three insureds and $2 million in premium. By 2008, it had grown to include 13 insured companies and more than $6 million in premium. In 2008, the program had a four-year cumulative loss ratio of 9.9 percent.
The captive returned an average of 45 percent of premiums to the association over a three-year period. In the first year alone–the most mature year–61 percent of premiums were returned. To equate the same profit as the insurance program, the association members would have to sell almost 5 million more meals at $5 each (assuming 10 percent profit on meals).
Rick Stasi is chief operating office for Avizent Alternative Risk in Columbus, Ohio. He is responsible for overall operations of alternative risk programs for Avizent, a national risk management service provider. He can be reached at rstasi@avizentrisk.com.
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