Captive Review - Article of the Month - Group Benefits

The escalating cost of employee benefits and particularly the balance sheet impact of post-retirement benefit obliga­tions has long been the worst nightmare of corporate CFOs.

With the challenge of global competi­tion, big-ticket benefits are no longer an option, and companies are now turning to innovative captive and other alternative funding solutions to control costs over the long term. Most recently, group captives and risk retention groups (RRGs) have come to the fore as an efficient and finan­cially viable way of funding benefits risks.


For organisations worldwide, there are a number of fundamental drivers that make employee benefits increasingly important, expensive and of more concern as a risk area. Captives in general have been used to fund benefits since the early nineties.

Western democratic norms remain the currency of global trade and, except for countries in which there are well-estab­lished social benefits programmes, some form of western-style employee benefits are now critical to attract and retain the new global workforce.


Now we see this increased demand for employee benefits being exacerbated by the historic inflation of benefits insurance costs and tighter accounting standards that define very clearly the magnitude of future employee benefit balance sheet exposure. All this encourages CFOs to step up and take control of their employee benefits risks as they do with risks in other parts of their business.


Alternative funding solutions enable this to happen by allowing employers to decouple employee benefits risk into parts they want to keep and parts they do not. Employers get to keep the money and the interest income and as much of the risk as they want. They put reinsurance and ad­ministration out to bid, minimise premium taxes and eliminate much of the insurer profit and intermediary costs. The net re­sults can demonstrate not only significant immediate savings, but longer-term control over the balance sheet.

Captive trends


Well-established applications, including funding life and disability insurance in a captive, have paved the way for organisa­tions looking to address more serious issues, such as retiree medical and closed defined benefit pension plan obligations.


These risks often run into many millions of dollars and threaten the financial stabil­ity of otherwise well-run companies and public sector organisations. When added to an organisation's existing P&C captive, they can potentially improve the captive'stax efficiency if classed unrelated business.

 In the US, we see a number of major organisations, particularly in the motor industry and large public sector entities, looking to use captives in conjunction with the funding of their liabilities using Vol­untary Employees Beneficiary Association (VEBA) trusts. Funding these transactions through a captive can provide additional control and reduced frictional costs that are real long-term benefits.


On the retirement liability side, the European trend towards selling off pen­sion plan obligations to third parties has faced regulator and trustee opposition. A key theme is that companies are effec­tively passing their retiree responsibilities to a third party who may or may not be concerned about fulfilling their future ob­ligations as laid down in the original plans. Captive solutions can provide similar balance sheet improvements and poten­tially the release of trapped assets where appropriate. Retirees are now part of a fully-funded programme still owned by the employer via the captive.

Funding retiree medical or pensions through a captive can seem a daunting task. For a start, the numbers are often very large (a recent case we examined involved over US$20bn in retiree medical obliga­tions alone). There is often recognition at board level of the competitive damage and EPS impact of these post retirement obli­gations. In the public sector, their impact can potentially damage bond rates. The most successful initiatives we see are driven from the top of the organisation with all the relevant stakeholders, finance, treasury, legal, risk management and HR on the same page.

A benefits captive specialist can then audit the range of risk exposures and indi­cate an appropriate course of action. This would include the structure of an appropri­ate captive funding entity and the savings by benefit class both immediate and over the long term in enough detail for board decision-making. 

The global setting

The increasing globalisation of so many industries has forced employers to move their benefits coverage of overseas employ­ees from an accommodation to a central benefit sourcing and cost management issue. Multinational pooling providers have had to raise their game to meet the growing and rapidly changing needs of fast moving multinationals demanding the same quality, range of benefits and cost management they achieve domestically.  

As employers have begun to define the risk inherent in the multinational pooling 'black box' they are looking for oppor­tunities to reinsure these risks into their captives. Some pooling organisations have embraced this development, but there is still some way to go in terms of freedom of risk transfer and choice of carrier willing to embrace captives. 

Economies of scale 

In the US, when workers compensation coverage began to escalate in cost, some companies found it difficult to obtain cover and a number of group captive structures were established to fill the gap. Now in the US, using either group captives or risk retention groups, the same principles are being applied to groups of small and medium-sized employers looking for better value health insurance coverage.  

We see these arrangements as a power­ful way to stabilise and manage costs for smaller employers while at the same time offering them a range of sophisticated health plans generally only associated with much larger entities. Unlike a purchasing association where participants can come or go depending on the deal, these struc­tures require their members to invest in the captive for a number of years, creating great stability.  

Cash reserves build up in the captive that can be invested by the group and any surplus paid back as dividends to members over time. As membership increases, then administration and network costs can be driven down and reinsurance requirements minimised. Most importantly by investing in the captive structure, participants are more in control of their own destiny, they can add members selectively, customise health programmes to meet the specific needs of their group and choose their investment strategy.  

Once established, the captive pro­gramme is financially very transparent; the profit and risk margins usually buried in insurance costs accrue to the captive and the central owner group can review finan­cial performance in detail and make well-informed management decisions.

Many employers end up spending exces­sive management time trying to ensure their health plan is as economic and effective as possible. Much of this burden can be absorbed centrally with a captive programme which can provide better online reporting systems, benchmarking of performance between participants and focused health management that reduces cost in the long run.  

For associations, buying groups and ex­isting group captives, health care costs are often the most concerning issue for their members. Providing a captive solution cre­ates a valuable benefit for existing groups, attracts new membership, increases reten­tion and generates additional revenue.  

Setting up a captive programme for em­ployer groups requires a great deal of co­operation and obviously some compromise in terms of benefits being provided. In this respect, it may seem that simply negotiat­ing as a group to buy some off-the-shelf insurance plan is a lot easier to arrange. In reality, the lack of long-term commit­ment makes these groups less attractive to insurers. Many will not consider these arrangements, seeing them often disinte­grate into a death spiral whenever a better deal appears from the outside.  

The captive health programmes that are being developed currently are really all about a long- term commitment to make healthcare a non-issue for their partici­pants. They see security in numbers and by selecting the right additional partici­pants that security only increases. Having established successful health programmes the natural extension, depending on the captive structure selected, is to add life and disability coverage.  

It remains to be seen whether this new healthcare captive concept is exportable outside the US. To date it has generally been much larger, often global companies who have funded their employee benefits through captives. This type of programme will require a local initiative from local employers with enough pain from private healthcare costs to unite them.

John Cassell is senior partner of Spring Consulting Group