Understanding Captive Health Plans

March 26th, 2019 by Thomas Harte

In a recent conversation with a company that represents captive health plans / arrangements, I inquired with this representative of the basis of the hype with regard to these solutions and he responded, “well, Tom, this is just the new shiny, cat toy.”  This was quite the response but as a someone that is responsible for providing our clients with relevant data and supporting evidence, it would not be prudent to simply accept one person’s opinion.

The fact is, employers and employees are clamoring for solutions that will have an impact on the cost of health insurance plans. According to Price Waterhouse Coopers, medical trend for 2019 is expected to be 6.00%, which is comparable to recent years.

What Are Captive Insurance Companies

Captive insurance companies are simply insurance companies that are formed under a parent company, or group of parent companies. The primary function of these captive arrangements is to provide insurance coverage for the parent company that forms the captive. In some cases, the captive may also provide coverage for the parent’s customers. These captives are part of the parent company’s strategic risk management and allow the parents more control than they would if they purchased policies from a third-party insurance company.

Benefits of Captive Arrangements

An article called The Benefits of Captive Insurance Companies that was published in the Journal of Accountancy notes that captive insurance companies are usually formed by fairly large companies that found insurance difficult to buy or very expensive. However, the number of captives has been increasing recently as large and small companies have begun to discover the advantages of operating their own insurance company.

Similar to self-funding plans, a captive arrangement may present the following opportunities:

1. Underlying Insurance:  The plan will provide an insurance policy for those individual and group risks over a certain value.  By example, a specific stop loss of $100,000 will insure the employer against any one claimant with claims in excess of the specific stop loss.
2. Transparency of health care costs:  Most employers within a fully-insured arrangement have limited access to supporting data pertaining to the underlying costs of a health plan; however, self-funded and captive arrangements provide extensive access to claims data.
3. Control of health plan costs:  With many health plans, the employer is restricted to a portfolio of products and services; however, within many captive arrangements, the Parent or their clients have the ability to gain more control over their health plan costs.
4. Plan Profitability:  In the event of plan profitability, those profits may be distributed to the participating employers versus the health plan (absent a shared risk agreement).
5. Risk Management:  A self-funded and/or captive solution may also usually encourage a focus on risk management. Instead of having claims paid by a third-party insurer, they come out of employer’s own pocket. To reduce claims, both the parent company and captive may focus on minimizing and avoiding risks, making the entire enterprise more profitable.

Unlike a self-funded health plan, the captive may provide the following advantages:

1. High cost claimants:  Some captive plans may spread the risk of high cost claimants among the participating companies instead of each employer bearing that risk on their own with a self-funded plan.
2. Reduced predictability risk:  In the calculation of the health care risks within a plan, an employer with 100 employees is considerably less “predictable” as compared to an employer with a membership of 10,000.  As a result, the smaller the employer the greater the volatility in claims, which results in a elevated predictability risk from the health plan.  Under a captive arrangement, with a larger population, the evaluation of the risk will be lower due to the increased population.

What are the drawbacks of a captive?

1. HMO Dominant Market?  For those employers that reside in an HMO dominant marketplace, the available plans will most likely only have access to a more expensive PPO network.
2. Lack of control over membership?  From one employer to the next that joins a captive, there is limited to no ability to restrict access to an employer that previously joined the captive, abides by the rules, but demonstrates consistent high claims.
3. Subsidizing another employer:  For an employer within the captive that has low claims, it is reasonable to expect that your low claims will result in this employer subsidizing the plan costs of employers with higher claims.
4. Healthy Employer Exit:  For employers within the captive that identify their claims as “favorable” (above average) – these healthy risks will typically exit the captive to leave the average to poor risks behind.

Requirements for a Captive

Even though a captive arrangement may only exist to insure the parent companies, the insurance company still has to meet state insurance licensing and federal Internal Revenue Service (IRS) standards. For example, the IRS has listed illegitimate captive insurance companies on its dirty dozen list of abusive tax filings. State insurance board requirements vary by state. For these reasons, most companies employ insurance management specialists or hire consultants to make sure that the captive arrangement is set up and operated in compliance with the law.