Over the past four decades, captive insurance has proved its value to various segments of the healthcare industry. Since the Harvard Medical School established the nation’s first medical professional liability captive in the mid-1970s, a strong case can be made that both the evolution and the availability of captive insurance platforms have seemingly kept pace with the rapid changes that continue to take hold in healthcare.
From the late 1980s with physician groups and continuing in the 2000s with nursing homes, medical care providers encountered a professional liability crisis resulting from a rise in the frequency and the cost of litigation. Captive insurance emerged during this time as a vital risk management strategy for medical providers. As opposed to insurance companies with an unfailing eye on achieving the lowest claims cost possible, healthcare concerns with captive platforms found themselves well-positioned to make the decision that was best for their organization between settling or litigating claims.
Today, as the Affordable Care Act (ACA) becomes an ever-present reality for healthcare providers across the US, captive insurance serves as a key element in what is becoming a time marked by an increasing number of mergers and acquisitions. Hospitals acquiring physician practices are establishing or expanding captives as part of the rollup process. In addition, physicians and practices have teamed up to form large provider groups, offering the size and resources necessary to employ captive platforms or risk retention groups (RRGs) for professional liability and other significant risks.
Looking toward the future, the next great growth area for captives within the healthcare industry is projected to take place within hospital and practice group medical malpractice captives and RRGs.
While the ACA has greatly contributed to a new era of consolidation, it should be noted that some acquisitions and mergers can be delayed or completely abandoned based on the difference in risk management effectiveness and the claims experience between multiple medical providers. A deal-breaker or deal-interrupter can occur when a physician or practice group with a high frequency of claims for professional liability and/or workers’ compensation forces the projected captive premium expense to a cost prohibitive point.
FINANCIAL METRICS MATTER
When examining captive options, organizations typically look at two key financial metrics to make a cost/benefit determination:
- Annual business insurance premiums; and
- Overall annual facilitation cost for the captive.
While there are some variations depending on industry, a good candidate for a captive insurance platform is a group or company that typically pays in the neighborhood of $300,000 in premiums per year for its current commercial coverage, and the organization should have better-than-average claims experience for its industry. In addition to premiums, the group or company utilizing a captive must be prepared to cover claims administration fees, actuary fees, captive manager fees, audit fees as well as premium and income taxes.
For organizations with consistent cash flows and a strong risk management program, captive platforms provide an opportunity to leverage premiums in a manner that is not available through traditional commercial insurance. By minimizing claims against the premiums paid, those entities utilizing captive insurance platforms can realize additional cash savings that can be accessed for future use or investment.
Establishing a captive insurance platform requires detailed planning and a commitment by the organization. A captive insurance start-up also needs cash on hand. Organizations have to be able to initially capitalize the captive insurance program, and funding has to be present to continue to operate through the years.
As an example of what it takes to properly initiate a captive, consider the start-up funding needed to establish a captive in the state of Tennessee. A captive insurance program in Tennessee is generally going to require an initial capital commitment of $250,000. Additionally, it will likely take up to $80,000-plus to facilitate the setup with a feasibility study and the other information needs related to the legal work. This includes an initial actuarial study, which has to be performed in order to establish premium funding levels needed to pay claims and operate the captive.
GAINING IN STRENGTH AND ACCEPTANCE
Given that 15 percent of the captive platforms in the world are related to a healthcare entity, the answer to whether captives can benefit healthcare organizations is a resounding “yes.”
It is well documented that the healthcare industry became a prime target for lawsuits in this ever-increasingly litigious era, and the market response to the parade of legal action has been one of exponentially rising premiums offered through commercial insurers. Nursing homes, with trial lawyers actively soliciting claims from residents’ families, found themselves under an intensified scrutiny that resonated throughout the healthcare industry.
The impact of the litigation action within healthcare was so powerful that securing medical malpractice insurance in the commercial market has become problematic. In fact, healthcare providers with low claims profiles have typically not been rewarded with lower rates from commercial insurers.
For those entities which meet the optimal financial parameters, captive insurance options offer an avenue to improved rate structures and the ability to focus coverage on particular areas of risk. By establishing either primary or excess layers of insurance through a captive, organizations again are in a position to realize savings, provided the claims experience is less than the amount of premiums paid. Healthcare providers using captive structures may be required in some cases due to regulation or contractual requirements to use an arrangement called ‘fronting’ to achieve a captive structure.
In a fronting arrangement, the captive insurance company utilizes the services of a commercial insurance company to serve as the fronting company. The commercial insurance carrier must be licensed in the same state in which the risk to be insured resides and actually issues the insurance policy. Meanwhile, the risk moves from the fronting company back to the captive through a reinsurance agreement.
At the end of this process, the insured party will gain insurance coverage through a policy written under the authority of the commercial insurance company. But, due to the reinsurance arrangement, the insurance risk rests in the captive insurance company. These type of arrangements will frequently require cash deposits or letters of credit to be established to ensure the ability of the captive to pay claims.
CHIEF CAPTIVE ADVANTAGES
One of the greatest advantages captive insurance platforms offer healthcare organizations can be found in the decision-making process related to pending litigation. The decision to move forward with litigation or to reach a settlement in a lawsuit is much different within a captive construct than how it is viewed by a commercial insurance provider — which, more times than not, will seek to achieve a settlement in the effort to mitigate the claims cost. Meanwhile, the decision-making process for a captive insurance organization allows the owners and directors of the captive to make more strategic risk management judgments independent of the interests of commercial policy underwriters.
In addition to professional liability, healthcare providers — particularly hospitals and large practice groups — have combined captive insurance platforms with a progressive approach to workers’ compensation to significantly reduce the overall costs associated with on-the-job injuries.
Much like the flexibility found when making decisions on professional liability litigation, workers’ comp coverage through captive insurance affords organizations the ability to step outside the formulaic approach to workers’ comp claims taken by the majority of commercial insurance providers.
A great example of the power in the flexibility offered by a captive insurance program can be seen in the work of Dr. Richard Rehm, who is the former CEO and chairman of the board of Concentra, the largest occupational medical company in the U.S. Dr. Rehm is one of the world’s foremost experts on workers’ comp issues and, through his most recent business venture, Occusystem Services, Inc., he is continuing to work with healthcare providers and many other industries on taking a proactive approach in assisting organizations to mitigate the financial and productivity impacts of workers’ comp claims.
“In my opinion, workers’ comp is the best insurance option for the captive because we have shown that it works in reducing the cost. We proved that our approach works and it has worked for 25 years. It is how we built a $1.2-billion market cap public company in just five years,” said Dr. Rehm of Concentra, which was acquired by Humana in 2010.
“When a captive works the way it is supposed to work, you have people focused on doing the right thing within this field of insurance,” he added. “Our approach with Occusystem Services is to work with companies on getting the people who have suffered on-the-job injuries the best medical care as soon and as medically practical as possible.
“We also work to get them through the system and back to work as fast as possible. This method works well with captive insurance, because it is company controlled and you are not bound by some of the mandatory rules that can exist within commercial coverage. We have saved hospitals and nursing homes millions of dollars over the years.”
With professional liability and workers’ comp as the leading examples, the savings potential and the flexibility offered through captive insurance platforms continue to gain greater acceptance across the healthcare landscape. Today, captives are becoming commonplace among a wide range of providers, including non-profit healthcare institutions, for-profit healthcare systems, small- to mid-sized hospitals, long-term care facilities, physician groups and managed care concerns.
MAIN STRATEGIES BEHIND EMPLOYING A CAPTIVE
The strategies that most often drive the formation of a captive are the ability to establish a highly effective risk management program, the opportunity to better control and protect the organization’s assets and the tax shelter provided for wealth transfer of profits realized by the captive.
Of these three motivations for forming a captive, risk management rises above the rest. Without a focus on reducing potential claims to the lowest levels, organizations could see a reduction in available assets due to claims coverage. And, if the claims experience is equal to or greater than the premiums, the strategy of wealth transfer will become a moot point. Simply stated, the level of commitment paid to risk management will determine in large part the level of success for the captive entity.
Organizations with strong risk management structures understand that they are not just paying premiums to the captive. The premiums are an investment and their money is at stake. Increased losses translate into increased funding needed. Organizations operating captives quickly realize this brand of insurance is not the same as a monthly payment to a commercial provider—money that they will never see again.
Like commercial insurance payments, captive premiums come out of the pockets of the organization, but the organization has the opportunity to retain control of that money through effective risk management. Captive insurance puts the power to tailor and customize insurance policies in the hands of an organization.
With the savings potential, organizations have a greater capacity to facilitate asset protection. Captives offer organizations a mechanism for insuring non-traditional risks. Cyber security risk, major customer loss, earthquake (outside major fault zones) and regulatory changes are examples of nontraditional risks with circumstances that do not occur with a great amount of frequency. However, when they do occur, the results can be catastrophic. Due to the low likelihood of these types of claims, captive insurance coverage for these and other boutique risks create opportunities for organizations to retain more of their cash within the organization’s control.
Profits from operating captive insurance companies offer a unique opportunity for wealth transfer, which can also be viewed as another form of asset protection. When the captive is owned by a trust, wealth transfer can take place when an exit strategy comes into play as the captive winds down. Current tax rules governing off-shore captives can provide an avenue for the surplus held in the captive to be transferred to beneficiaries outside the estate tax structure.
TAKING THE FIRST STEPS
If your organization has the established financial infrastructure discussed here, the first major step toward establishing a captive insurance platform is securing the involvement of a captive manager on the front end who understands your industry. An effective captive manager is vital to the success of a captive platform. When conducting your search, a good strategy is to find a captive manager who has a track record of success in establishing captives with entities that are similar to your organization. It is also important to secure a captive manager who has experience operating within the state or domicile that the organization has chosen.
While risk management should always be considered first (as the rest of the benefits found with a captive will likely follow), organizations should also be realistic about the ability to have predictable, successive cash flows that can support a long-term strategy as opposed to a short-term goal.
Captive insurance offers the potential to mitigate volatility with premiums as well as the potential to build savings that become reserves which can benefit the organization. At the end of the day, captive insurance is very much a risk-reward scenario. If your organization is able to manage the risk, you can reap the rewards.
We Can Help!
Elliott Davis Decosimo has assembled a strong team of experienced professionals who can help your company initiate a feasibility study and walk you through every step of building a strong captive insurance program for your business. For more information concerning captive insurance, contact an Elliott Davis Decosimo subject matter expert.