Pros and cons of a captive: Should you do it yourself?
You can save money, if you have an appetite for risk
Healthcare providers have been subject to the volatility of the insurance market for years, which has led some to look to the idea of establishing a captive as a way to cut costs, particularly with workers' compensation coverage. A captive can be a great solution in some circumstances, but don't jump without looking first.
A captive insurance company is a property and casualty insurance company established to provide coverage only, or primarily, for its parent company. A captive can be a valuable risk management tool that allows a hospital to more effectively manage corporate risks of all kinds, says Timothy E.J. Folk, vice president with The Graham Co., a healthcare consulting company in Philadelphia.
Captives often are set up to insure risks for which commercial insurance is not available or is too expensive, Folk says. The owner of the parent company is also the owner of the captive, but the captive can be structured so that it is owned directly by the operating company, another person, entity, or a trust, Folk explains.
This structure does not mean, however, that the captive is just a puppet for the hospital or health system. The captive insurance company must act as a legitimate business entity, complying with all insurance regulatory provisions and Internal Revenue Service requirements, Folk says.
The interest in captives is driven by the fact that there is a very limited marketplace to insure a health provider's risks, which leads to insureds being beholden to the whims of the marketplace and subjected to class underwriting regardless of their own claims history, says Christopher M. Keith, a producer with The Graham Co. This situation has necessitated that insureds and their brokers become more entrepreneurial and creative when it comes to insuring their professional liability and workers compensation exposures.
"Savvy insureds are either considering or actively utilizing risk retention groups or captives in an effort to take control of their coverage terms, conditions, price, and availability rather than let the standard insurance marketplace dictate it to them," Keith says. "Professional liability is certainly more of a severity-driven exposure, so the stakes are much higher in a captive structure. This leads many insured's to graduate to this type of a captive arrangement."
However, relatively speaking, other exposures faced by healthcare or social service providers, such as workers compensation, are not as volatile and can be controlled with the right safety and claims policies and procedures in place, Keith notes.
For any large employer, a captive can create an opportunity to reduce the long-term cost of workers' compensation insurance, Keith says. Workers comp is a more frequent, predictable exposure, and loss control and safety measures can be implemented that have a direct impact. Dividends generated from the underwriting profit and investment income of a captive can be utilized to reinvest back into the operation of the business and increase their operating efficiency.
"This savings is all contingent upon their losses. For example, if you have traditionally had good loss experience then the savings in the form of underwriting profit could be significant," Keith says. "If you were an employer spending $1 million a year on insurance, the carrier puts aside $600,000 of it to pay losses. In the event you only had say $300,000 in losses for your captive, then your savings would be $300,000. This is just one scenario, but as you can see, the savings can be significant."
Premium should be similar to traditional
Starting a captive is not an easy task, but one can be created proactively to take advantage of the opportunity created with worker's comp so that claims and losses are managed properly rather than being forced by the lack of a viable option in the insurance market, Folk says.
Furthermore, once the captive is established, a healthcare provider has the captive as a mechanism to take on part of other exposures, such as professional liability, when the market swings. (See the stories on p. 39 and p. 40 for more on how captives work.)
Size matters. Providers considering a captive should have about $400,000 in premiums or more for the option to make financial sense. Also note that a captive will not serve all of your insurance needs. The only lines that will be insured by the captive are general liability, professional liability, workers' comp, and automobile liability, Keith explains.
Captives are most popular with for-profit entities because they can take advantage of tax benefits, Keith says. The premiums you pay to your captive become tax deductible, so non-profits have traditionally not been drawn to the captive option. Other benefits, such as being able to direct savings to underfunded programs and projects, and the tightening insurance market are making more non-profits consider forming a captive, Keith says.
With the right claims control processes in place, the captive premium you pay should be similar to what you would pay with a traditional insurer, yet you are able to keep the underwriting profit, Folk adds.
"In addition, while you are waiting for that period of time it takes for losses to be realized, evaluated, and paid, you're realizing investment income," Folk says. "At a time like this when providers are being squeezed in so many ways while expenses stay the same or get higher, the more you can explore creative solutions like this, the better off you will be in the long run. A captive truly has the potential to put dollars back in the pocket of the sponsoring organization."
A captive also takes the organization out of the notoriously volatile insurance market, Folk notes. In the past, insurers with billions of dollars of premiums suddenly have announced that they were not making enough money in that particular market and would not renew any policies.
"That leaves a lot of people without a home, and with so few insurers to choose from in this market, the only option is to take a policy at a very high rate," Folk says. "In a captive you are subject to a lot less volatility and you are assuring yourself that you have a home through which to procure insurance. It changes the whole negotiation of the insurance procurement process every year because you are no longer at the whim of the carrier. You're now a business partner with them."
Sources
Timothy E.J. Folk, Vice President, The Graham Co., Philadelphia. Telephone: (215) 701-5231. Email: [email protected].
Christopher M. Keith, Producer, The Graham Co., Philadelphia. Telephone: (215) 701-5297. Email: [email protected].
Healthcare providers have been subject to the volatility of the insurance market for years, which has led some to look to the idea of establishing a captive as a way to cut costs, particularly with workers' compensation coverage. A captive can be a great solution in some circumstances, but don't jump without looking first.You have reached your article limit for the month. Subscribe now to access this article plus other member-only content.
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