Traditionally, only big companies considered self-funding employee benefits. The expenses could be so volatile that small- to medium-sized firms couldn’t risk the bottom-line impact.
Recently, though, more small- to mid-sized firms are transitioning to self-funded arrangements by pooling their healthcare costs with other employers to establish captives.
What is a captive?
Essentially, captives are stop-loss pools owned by participating companies. They originated in the property and casualty world, but over time they have spread into other insurance areas. These days, captives are gaining ground as an alternative to traditional stop loss policies for health insurance plans.
In an oversimplified explanation, here’s how a health benefits captive would work for you: As an employer, you join forces with like-minded employers to invest in a captive and pay into a health benefits risk pool, agreeing that the money in that pool will be used to cover health claims for all captive participants. The captive works with a third party (often a traditional insurer) to provide stop-loss protection and any other services the captive desires. The primary purpose of the captive is to insure and protect the risk of its owners.
With that description, you might wonder how being a part of a captive differs from contracting with a traditional insurer. There are significant differences, for instance:
- If you join a captive, you become an owner of the captive. As a result, if the captive has a great year and doesn’t pay out as much as everyone has paid in, you get money back that you can re-invest in the captive or accept as revenue.
- In addition, you are able to protect your organization and your workers from “lasers,” those targeted price increases or policy exclusions that stop-loss insurers occasionally enact in the wake of major claims. Most notably, perhaps, you have the opportunity for long-term cost savings—by some estimates, as much as 15-25% reductions in benefit plan costs over a decade—and tax advantages.
Maybe all of this is why a study by the Employee Benefits Research Institute found that over a two-year period, the number of self-insured mid-sized companies jumped by almost 20%, and the number of self-insured small firms increased by 7%.
So, what’s the catch?
Well, before you jump onto the bandwagon, you need to know more. Here are a few things to consider:
- First, you need to understand that, if you already are self-funded, the benefits of switching to a captive will be worthwhile, but not as significant.
- On the other hand, if you currently use a traditional insurer, you will need to make the switch to self-insured coverage, which will require some time, energy, and cost. For one thing, you’ll need to jump through some legal hoops, as you are tying yourself to other firms in a carefully structured legal entity, and that brings with it legal and tax expenses.
- You’ll also need to make an upfront investment (but it is just that: An investment, not an expense).
- Finally, there’s always the chance that the captive might end up with losses, which you will need to help offset.
The good news is that, by working with a partner who knows how to navigate the process and has access to the resources necessary to make the process work smoothly, you can reduce the complications, limit the cost, and stay focused on the long-term rewards. (FirstPerson and our partners certainly can help in this regard.)
As with any business decision, your job is to balance these pros and cons, assessing things like reduced cost volatility, increased control, and possible return on investment against matters such as legal and technical costs, possible losses, and the need for internal expertise.
The bottom line is this: Investment in a captive offers a possible option for combating the volatility and inevitable long-term increases in health benefits costs. Granted, they might not be the one tool that solves everyone’s health insurance problems, but they are proving to be a popular choice for many firms, and one just about every company should consider.