Employee Satisfaction

Placing your US company's employee benefit package into your captive may sound like a good idea. Indeed, there is a tremendous upsurge in interest from risk managers exploring this option. But it's easier said than done. The US Department of Labor (DoL) has many regulations and restrictions about the funding of benefit plans which are designed to protect the employee. The essence of these are encapsulated in the Employee Retirement Income Security Act of 1974 (ERISA) and various amendments to this Act. Regulations also have been defined over the years through various DoL advisories. The result has been a detailed process to get approval for the use of a captive for employee benefit plans. However, some US companies have persevered and have been granted approval from the DoL to use their captives to help finance their benefit plans. Indeed, the state of Vermont has seen some activity in this area in recent years. "The employee benefit activity has been steady ? not busy, but steady," says Len Crouse, deputy commissioner of the Vermont Department of Banking, Insurance, Securities and Health Care Administration. A session of the Vermont Captive Insurance Association (VCIA) conference in the summer was devoted to this topic and a packed audience learned more about how this can be done.

Background

"ERISA was designed to protect planned participants," says P Bruce Wright, partner with New York law firm LeBoeuf, Lamb, Greene & MacRae. The Act pertains not only to pensions, but also to employee benefit and healthcare plans such as group-term life insurance, group-term disability insurance, and medical plans. ERISA says an employer can't enter into "prohibited transactions" with interested parties, says Wright. A DoL advisory many years ago put the placement of benefit plans into a captive as a prohibited transaction. The advisory said if an employer created an entity whereby the employer insured the health plans with a fronting insurer and then the employer's captive, it was not complying with regulations, says Wright. But there are "prohibited transaction exemptions" that employers can apply for to allow captives to write employee benefit plans. The way forward for captives until 1996 was to seek a "private exemption". Burlington Industries, for example, received a prohibited transaction exemption (PTE) in 1984 because less than 50% of their captive's premium was written for the company's employee benefit plans, says Wright. When other companies approached the DoL, he adds, "if you didn't have 50% non-related business in the captive, you couldn't use your captive. We had quite a debate with them about this and while we were debating, three exemptions were issued." Two of these exemptions, in 1996, were banks, Zion's and First Security, and in 1999 Union Carbide received a PTE to place a construction wrap-up programme which included some employee benefit plans into its captive. Following discussions, the DoL set up the 'expedited exemption procedure' in 1996 (known as PTE 96-62), which includes PTEs with less than 50% third-party business. If all the criteria are met, then exemption can be granted from within 75 days to three months of submission, says Wright. The criteria include: ? Upon submission, tentative authorization of the captive is made within 45 days by onshore domicile regulators. If a company's captive is offshore, it must have an onshore 'branch' in a state such as Vermont to write the employee benefits. ? A notice of such a transaction must be distributed to interested parties, including employees involved in the benefit plans. The interested parties must have at least 25 days in which to comment. If, five days after the comment period ends there is no adverse notification, and no substantive adverse comments to which a response must be made, the authorization is final. ? The onshore domicile regulator must be allowed to carry out periodic audits of the captives. Theoretically, such an expedited exemption should work for cell or rent-a-captives, but so far the DoL has not given any expedited exemption to these entities, says Wright. Not everyone has received an expedited exemption that has requested one, however. According to news reports, in 2004 the Whirlpool Corporation withdrew its request for federal regulatory approval of an innovative retiree healthcare-benefits funding arrangement that would have made use of its captive insurance company, a tax-free trust and commercial life insurance. Whirlpool said at the time it was withdrawing the application in the wake of the DoL's refusal to consider the proposal on an expedited exemption basis. At the time of the rejection, Whirlpool said it would seek a standard review of its application, a process that typically takes up to a year. The Whirlpool plan involved the use of its corporate voluntary employee beneficiary association, a Vermont branch of its Bermuda-based captive, a fronting insurer and a group universal life insurance policy. To sum up, a company must go to the DoL for a PTE in order to write benefit plans into a captive, says Douglas J Ley, vice-president and director of the national actuarial practice of Willis. It can be done, but to keep the DoL happy, employers must find a fronting insurer and an independent fiduciary, give notice to employees about the move, and get state regulators to approve the transaction into the captive, says Ley. It's not always easy, however, to get risk managers and employee benefit/human resource personnel to agree to funding benefit plans through the captive, says Ley. "If you're looking to put this type of coverage into a captive, you'll need the risk management working with finance working with human resources," he says. Alcoa has had such a multi-disciplinary team working on the project prior to DoL approval in 2004, says Thomas C Mordowanec, director of people services, North America for Alcoa. This was also a critical issue for Columbia Energy before it received approval in 2004, says Nick Parillo, former vice-president of risk management for Columbia Energy and president of The MollyAnna Company. Everyone was deeply involved in the team process, especially human resources. "If you broaden the scope with a team approach, then the barriers will come down," he says.

Columbia Energy

Columbia Energy, based in Herndon, Virginia, set up its Bermuda-based captive under Parillo's tutelage. It also was Parillo who sought to fund the company's benefits into the Vermont-based branch of the captive in 2000. Columbia Energy (now called NySource following a merger), then had 10,000 employees, and was a publicly traded company whose key businesses were gas distribution and transportation, and oil exploration and production. In 1998, at the time of deregulation of energy companies, "we conducted a comprehensive review of our risks throughout the organisation," says Parillo. "Our chief financial officer did not put up any barriers." Columbia was a conservative organisation. Its employee benefits included long-term disability, and were managed and negotiated by the human resources department. Its workers' compensation, meanwhile, was managed and negotiated by the risk management department. At the same time, there was no co-ordination of the benefit programmes. There was no effort to co-ordinate short-term disability in a timely fashion until the fourth or fifth month when it became a long-term disability, "so that wasn't good," says Parillo. The costs suggested resources were not being optimised. Once Parillo and his team had identified the problem, they approached the human resource steam to discuss the integration of the disability management with workers' compensation management. "Workers' compensation is a complicated area so don't assume human resources understand the complexities," says Parillo. "It is important to ensure they do understand the system." Parillo and his team wanted to adopt some of the techniques used to handle workers' compensation claims to the management of disability claims and non-occupational injuries. They also wanted to become better at financing the risks by using the company's captive. But it was important not to put an unpredictable risk into the captive. "Never put an unpredictable risk into a captive. You can't measure it, you can't define it and you can't fund for it," says Parillo. The risk needed to be measured and aggressively managed first before it was put into Columbia's captive. Company executives got excited about managing the disability claims through an'integrated' disability programme and a multi-taskforce was set up to develop an operational model. This included the development of an implementation strategy, the selection of business partners, a feasibility of financing benefits through the captive and the establishment of claims-handling guidelines. Once this was done, the multi-taskforce requested that the model be used on a 'guinea pig', namely a subsidiary of 500 people in Houston who were non-union. "They really liked it. The majority felt good about the fact that they were getting phone calls now if they fell down the steps at home and that they would have help to get to the doctor." The claims were processed effectively and efficiently, "so it was a win-win [situation]", says Parillo. In 1999, Columbia set up and had approved a branch captive in Vermont to underwrite the disability benefits. In August 2000, the DoL granted the exemption. Since then, the integrated approach to long-term disability (LTD) claims has meant the numbers have dropped to 20 in 2002 from 55 in 1998. The LTD premiums, meanwhile, dropped to US$5m from US$8m in the first year, and to US$4m in the second year. But the savings was as a result of getting employees back to work faster, "and that's harder to quantify", says Parillo. "The use of the captive really is the icing on the cake," he adds, pointing out the savings have been as a result of the integrated management of the disability claims.

Alcoa

At Alcoa, Thomas C Mordowanec has seen the situation from the other side of the coin ? from within the human resources department as director of people services for the company. Alcoa, based in Pittsburgh, Pennsylvania, is the world's largest producer of aluminium. The company employs 131,000people in 43 countries, including 50,000 employees in the US, and posted revenues of US$23.5bn in 2004. Aside from the current benefit costs for those employees, Alcoa has a lot of "legacy costs" including pension and retirement medical costs, says Mordowanec. So there has been some pressure to slow down the growth of the legacy costs as well as the existing and future benefit costs, he says. In autumn 2003, John Wilson, Alcoa's vice-president and deputy general counsel, who is president of Alcoa's captive, initiated discussions about employee benefit reinsurance alternatives. Risk management, finance and human resource folks explored the idea, and decided to look a placing life insurance into the captive. The team went through an evaluation of all risk, but settled on life insurance because: it provided US$56m in total premiums; the coverage was about to go out for a competitive bid; the benefit enhancements were expected to be low cost; and it was the least complex option of the benefits that were considered. Alcoa's human resources executives had some concerns, however, says Mordowanec: ? The benefit enhancements had to be consistent with the company's benefit strategy ? The benefit costs could not increase or affect the budget of the human resources department. It was decided the captive would take any additional costs. ? The length of time that human resources would be locked into the programme ? The 'request for proposal' (RFP) process could not be complicated. The RFP process describes the information required for and from benefit suppliers during the bidding process, which needs to be in a simple form. The captive reinsurance arrangement was incorporated into Alcoa's RFP process and this narrowed the limit of potential suppliers so that only three life insurance companies were interested. "Anything you bring to your human resources people that will increase the cost of benefits will not be received well,"warns Mordowanec. Anything that upsets unions also will not be popular, he adds. Alcoa is a heavily unionised corporation and many union agreements can cause a lot of problems if they are compromised. Employees must be notified about any changes in funding, and unions must have notification of this. "This could potentially open the doors to a bunch of labour-related problems," he says. "As it turned out, we were able to put in the group employee benefits (into the captive) without any labour-relations problems." The company also had concerns about communicating the move to its employees, says Mordowanec."Thank God most people don't read their employee benefit communication material. They read supermarket flyers more than they read their benefit communications. Perhaps we should put coupons in our benefits material." There were some sophisticated readers who did have some questions, but fortunately they had no serious objections to the new funding. Since employees didn't object and unions didn't object, Alcoa placed 50% of its life insurance into the captive on 1 January this year. It is expected employee home and auto insurance will be placed into the captive in the future. Expert advice helped in this process, with Hewitt offering external benefit consultancy and Towers Perrin offering external reinsurance consultancy. "You do need a lot of advice, especially if you're doing this for the first time," says Mordowanec. A word of advice about dealing with human resource personnel, he adds. Find people who maintain a shareholder perspective. Respect their expertise. Realise they want to provide the best benefits for the least amount of money, and provide resources to reduce the workload because "you're bringing a pile of work to somebody who's already very busy". It also helps to recognise the role of the human resources personnel to senior executives when the changes occur.

ERISA: a summary

The Employee Retirement Income Security Act of 1974 (ERISA) is a US federal law that sets minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in these plans. ERISA requires plans to provide participants with plan information including important information about plan features and funding; provides fiduciary responsibilities for those who manage and control plan assets; requires plans to establish a grievance and appeals process for participants to get benefits from their plans; and gives participants the right to sue for benefits and breaches of fiduciary duty. There have been a number of amendments to ERISA, expanding the protections available to health benefit plan participants and beneficiaries. One important amendment, the Consolidated Omnibus Budget Reconciliation Act (COBRA), provides some workers and their families with the right to continue their health coverage for a limited time after certain events, such as the loss of a job. Another amendment to ERISA is the Health Insurance Portability and Accountability Act (HIPAA) which provides important new protections for working Americans and their families who have pre-existing medical conditions or might otherwise suffer discrimination in health coverage based on factors that relate to an individual's health. Other important amendments include the Newborns' and Mothers' Health Protection Act, the Mental Health Parity Act, and the Women's Health and Cancer Rights Act. In general, ERISA does not cover group health plans established or maintained by governmental entities, churches for their employees, or plans which are maintained solely to comply with applicable workers compensation, unemployment, or disability laws. ERISA also does not cover plans maintained outside the US primarily for the benefit of non-resident aliens or unfunded excess benefit plans. Source: US Department of Labor

Prohibited Transaction Exemption

ERISA prohibits certain specified transactions between employee benefit plans and entities defined to be 'parties in interest'. However, ERISA provides that the DoL has the authority to grant exemptions from the prohibited transaction restrictions if an applicant can demonstrate that a transaction is administratively feasible, in the interests of the plan and its participants and beneficiaries, and protective of the rights of the participants and beneficiaries of the plan. The DoL reviews applications for such exemptions and determines whether or not to grant relief. Source: US Department of Labor