Responding to the $60bn challenge
Peter Eyre looks at how employee benefits insurance networks can work with captive insurers
With employers spending $60bn (e56bn) every year on employee benefit risk premiums, it is not surprising that risk managers and their captives are taking an increasing interest in this area.
Since the costs of setting up and managing a captive are high, captive risk managers are always looking for ways in which to increase and diversify their portfolios. So far about 20 major corporations have captured a large part of their employee benefit risk premiums into their captive using the major international insurance networks to assist them. Such coverages include group life, long- term disability and medical.
Utilising these premiums offers the captive many advantages:
q It is a stable source of new premium
q Claims are predictable
q Profit margins are generally good
q Poor coverages are easily identified and excluded.
Why have so few captives accessed the employee benefit premiums of the parent companies? The reasons for lack of development until now are twofold. First, national government legislation generally requires that all life business be written locally. This means there are generous tax advantages for issuing local policies and in many countries this is a compulsory feature. Since the captive is usually registered in one location it cannot issue policies that meet the local legislation of its local subsidiaries around the globe. This is where the employee benefit networks come into play.
Second, there has been a widespread misunderstanding that risk premiums are linked to pension plans and consequently pension assets and funds. This may be the case where certain pension benefits are provided by the means of an endowment policy, but these are generally excluded from the interests of the captive.
The greatest problem for the captive is to maintain a good spread of risk. Where the risks are narrow, there is a greater need to increase reinsurance which passes both premium and profit away from the portfolio. There is also a growing difficulty between the multinational domicile and the domicile of the captive. Authorities are becoming increasingly concerned about the loss of local insurance premiums leaving the country in the form of reinsurance and loss of tax revenue.
While on the property and casualty side risk financing techniques have become standard since the first programmes were set up in the 1970s, there were few programmes of this type in existence on the life side, although this is changing.
Below we use the actual example of an international automobile producer with employees in 22 countries spending $12m a year on its employee benefit risks.
By organising and financing the employee benefits through a captive programme, an additional cashflow of $5m for 1999 was created for the client. This dividend reduces the employee benefit risk cost by an estimated 20% in the current year. Moreover, the manufacturer has consolidated its control and understanding of the worldwide employee benefit coverage in place.
Here we have been able to identify key elements in introducing a global employee benefits programme associated with a captive:
q Competent local partners are vital to convince the local subsidiaries to place the local contracts within the global programme. Since much of the employee benefit legislation is enshrined in statute it is essential to issue local policies for full tax relief. Local know-how also forms the conduit by which profit and information can be transferred to the client’s headquarters rapidly via the lead partner.
q The lead partner represents the one-stop point of contact for the client and is generally the partner in the home country of the client. In a rent-a-captive situation (called ‘pooling’ or ‘international account’ in the employee benefit universe), the lead partner consolidates local account information into an international account, provides reinsurance cover and pays pooling profits if there is a positive loss experience. For captive programmes, the lead partner assists a fast and organised cession of global risk premium into the client’s captive.
q Risk financing and captive solutions are newly available as tools, actively marketed by some networks to customise international employee benefit programmes and allow the client to realise synergy effects from similar programmes on the non-life side, particularly captives. Excess-of-loss, stop-loss/loss-carry-forward and CAT protection can be arranged at very competitive prices.
The captive programme As part of the programme to develop the captive programme, the automobile producer was offered the following services:
q Step 1 Pooling exhibit to provide the client with an estimate of cost reductions/dividends that can be achieved through the captive programme.
q Step 2: Network search to check for cover that is already insured and represents a “natural pool”.
q Step 3: Support to the client and client’s global co-ordinating brokers in contacting local subsidiaries and brokers and arranging for switch of cover.
q Step 4: Immediate setting up of a rent-a-captive/pool to achieve cost reductions. These cost reductions allow the client to capitalise the captive.
q Step 5: Advice and arranging of optimal reinsurance cover and foreign exchange hedging strategy for captive programme.
q Step 6: Switch to captive programme with quarterly claims settlement from consolidated rent-a-captive with annual claims settlement (see Figure 1).
Interest in these developments is not merely academic. The ability to work with the captive forms a standard request in most new studies. Judging by the growth in life/composite captives registered in Bermuda (see Figure 2), a significant number of corporations also have the ability to accomplish them.
Peter Eyre is head of All-Net, the Allianz-led worldwide employee benefits network