During the current economic crisis, companies are even more focused on looking for ways to reduce benefits costs and minimize risks. Many are turning to captives to achieve this, often starting by funding life and disability insurance.

Recently, Spring Consulting Group conducted a survey of captive insurance company owners and regulators to understand what best-practice approaches were in use or contemplated for implementation over the next year.

In the survey, 60% of organizations are or have considered using a captive for employee benefits in addition to funding their property and casualty coverages. Companies with premiums greater than $10 million are more likely to use or consider using a captive to fund employee benefits (70%). Funding employee benefits in a captive has become a best practice because it may help employers save money.

More recently, the range of benefits considered for captive funding has expanded, with companies like Whirlpool and Coca Cola contemplating using a captive to fund retiree medical, and others now looking at funding pensions in a captive.

It is clear that there is a significant movement in the industry, and an increasing number of insurers are now providing captive fronting services in an effort to keep up.

Advantages

There are many advantages to using a captive to fund employee benefits, including improving cost management through control of premium costs; accelerating cash flow; reducing administrative and claims costs; and improving management reporting and understanding of risks.

Captive owners can have increased control through tailor-made benefit designs and improved data and claims cost- management. They see advantages from centralized financial management and purchase of insurance on a wholesale vs. retail basis. In addition, some captive owners see benefits in expanding their captive to fund employee benefits, since the IRS decided that certain employee benefits can be classified as unrelated business, facilitating tax-effective treatment.

Even though funding employee benefits in a captive takes some time, increasingly the cost savings of using a captive outweigh the time commitment in the minds of some employers. In fact, YKK Corporation of America, United Technologies Corp., Heinz and AGL Resources have expanded their captives to cover employee benefits.

In a recent example, a health care organization with 20,000 employees found that its life insurance premiums were excessive. To lower these costs, it funded the $4 million life insurance program through a captive, found a commercial insurer fronting arrangement in the market and as a result, lowered premiums, eliminated broker fees and generated a $720,000 (17%) cost savings in the first year. This cost savings is expected to be generated every year.

Once a captive is established, maintaining its operation requires working with service providers to meet regulatory requirements, establish a board of directors, create a business plan and secure some new service providers.

As a result, the Captive Insurance Company Association and the National Association of Insurance Commissioners created best practice guidelines to help captives reach an optimum level of operation and meet requirements. For instance, CICA's best-practice guidelines, released in March 2008, focused on three main areas: business alignment, corporate governance and regulatory compliance. Now captives are looking to provide alignment with the organizations' benefits.

Most captive owners develop comprehensive business plans to maintain captive efficiency. They prefer formal feasibilities and actuarial analyses to less-rigorous diagnostics. They often outsource captive management services and perform annual captive strategy assessments. In fact, 79% of those surveyed by Spring Consulting identified a carefully developed business plan as the most important tool for effective captive operation.

Treasury and risk managers are working with benefits groups to develop operational guidelines.

A majority of survey respondents use captive managers; however, some survey participants use a combination of outsourced and in-house management resources. While 70% of survey respondents evaluate their captive strategy and business plans once a year, all survey respondents review their captive strategy at least once every five years.

Almost half of the survey participants meet annually with regulators to stay apprised of their captives' activities.

Looking forward, as the captive industry continues to grow and change, the survey participants expressed a few concerns about tax regulation (39%) and regulatory compliance between on-shore versus offshore domiciles (21%).

However, more than 25% of respondents do not expect any significant operational barriers or adverse regulatory changes.

Karin Landry is a managing partner at Spring Consulting Group in Boston.

Captive statistics

• 83% of board of directors members are covered under directors & officers insurance and bound by conflict-of-interest agreements.
• 31% have introduced an independent director as part of their board.
• 43% use TPAs to administer plans.
• 17% of survey participants' captives are rated by an agency, like A.M. Best.
• 25% of survey participants operate multiple captives.
• Average years of operation is 12.6 years, with a high of 35 years and low of eight months.
• Only 45% use benchmarks to manage operations. The most commonly used are reserves to surplus (31%) and premium to surplus (32%).