In the US, the door is ajar and soon should be pushed wide open. The door in question leads to the ability of a company’s captive insurance company to cover the firm’s employee benefits. It has been prised open by Columbia Energy, a major producer and supplier of natural gas and petroleum products, which last year negotiated a deal with the US Department of Labor (DoL) involving the insurance of its long-term disability programme through the Vermont branch of its Bermuda-based captive.
This development is historic because the 1974 Employee Retirement Security Act (ERISA) has traditionally prevented companies arranging benefits through ‘parties of interest’, or connected organisations. There is a loophole, created for insurance companies (these would otherwise be unable to insure their own benefits), who are permitted to insure themselves provided the business represents 5% or less of their overall portfolio, but this facility is of little or no use to captives, most of which would comfortably exceed this limit.
In 1979, the Department of Labor (DoL), which defends employees’ interests and enforces ERISA, ruled that exemptions from otherwise prohibited transactions would be permitted provided that at least half of the captive’s portfolio comprised ‘unrelated risks’. This concession received a mixed reception. Captives welcomed the move in principle but they and their regulators were concerned about the requirement for such a high proportion of third-party business, feeling that solvency could be under threat. The DoL, though, was adamant that a significant volume of unrelated business would help keep employee benefit business at arm’s length.
The 1979 concession, then, was of little practical benefit, and their parent firms’ employee benefits have remained off-limits for captives. Until now, that is. Columbia Energy has negotiated a deal with DoL’s Pension and Welfare Benefits Administration involving reinsurance of its benefits to its captive. The DoL has agreed on the basis that the captive is located in a highly regulated environment and meets stringent solvency tests. Although Columbia Energy’s captive, Columbia Insurance Corporation Ltd, is based in Bermuda, its branch in Vermont naturally comes under US jurisdiction.
There are other stipulations too. First, the DoL laid down that the Columbia arrangement should provide ‘immediate benefit’ to scheme members, a demand which has been met by enhancing long-term disability (LTD) payments from 30% to 60% – the latter figure was previously available only to higher-paid employees. Columbia further strengthened its case by stating its intention to integrate long-term disability with workers’ compensation claims and its overall absence management programme. Second, the premiums paid should be demonstrably competitive for the cover given. Third, the primary insurer of the cover should be financially sound – rated ‘A’ or better by AM Best; Liberty Mutual fronts the arrangement for Columbia Energy. Lastly, an independent fiduciary – in this case Milliman & Robertson – should be appointed to vet the set-up process and keep compliance with the DoL’s requirements under strict review.
Columbia Energy’s coup has caused quite a stir in risk management and insurance circles. Its risk management team has been swamped with enquiries from other companies wanting to know more. But although it might have been opened up, the captive pathway is not necessarily smooth or indeed one that can be negotiated by all companies. Paul Shimer, senior international consultant at William M Mercer’s Hartford office, says “The DoL has insisted that the benefits are improved in some way, but it hasn’t said how, by how much or for how long. Columbia Energy has widened the availability of LTD among employees, but what else is permissible is far from clear.”
Shimer also points out that there are the extra costs to consider. “First, your captive needs to be licenced to write business in a location under US jurisdiction. US regulatory compliance comes at a cost. Then there’s the independent fiduciary. Those outlays must be outweighed by some sort of benefit to the company.”
The most attractive benefits to companies are usually, of course, financial, and here the US tax authority, the Internal Revenue Service, can give a helping hand. Reinsurance of its parent firm’s employee benefits would be regarded by the IRS as third-party business; of that, those premiums represent at least 30% of the captive’s total revenues they are tax-deductible. Given that, in Columbia Energy’s case, long-term disability business is characterised by the need for sizeable claims reserves, that 30% figure is more easily attainable than with some other classes of cover.
Mercer’s Shimer says: “The Columbia Energy ruling is a very significant development, but the hurdles that the DoL has laid down mean that most companies are unlikely to benefit. And since there are extra costs involved, it’s an opportunity only for very large organisations – say those with 10,000 or more employees.”
Even with scale on a company’s side, setting up a captive solely for reinsuring employee benefit risks is unlikely to make financial sense. But if a firm is already insuring its property and casualty risks via that route, or it is considering it, then the new environment could make the financial case even more compelling, or tip the balance in favour of the captive.
Shimer estimates that around half a dozen other companies are building cases to win DoL approval. This is significant not only for the numbers involved at present, but because once a second company has succeeded, others can follow without going cap in hand to the authorities – although the DoL can terminate a captive programme if it is not satisfied that its exemption criteria are being fully complied with.
Plenty of other companies will be watching the handful currently seeking exemption, especially US multinationals already employing sophisticated risk management techniques to deal with the wide range of substantial risks to which they are exposed. Some of these already insure employee benefit risks relating to their overseas-based staff through their global captives. Now they may have the opportunity to cover the benefits for their US-based workforce that way too, with the advantages of cost saving and greater control.
While the Columbia Energy precedent is unlikely to send a tidal wave crashing through the global benefits market, it is sending out noticeable ripples across the pond. It is a sensitive issue for life insurers for whom group risk and multinational pooling is big business. They could be facing a significant loss of market share.