Inclusion of Employee Benefits Risks Into a Captive Aids Human Resources
by Paul Wöhrmann and Reto Heini
With large international companies managing and financing their group-wide risks centrally, there is a pressing need for a central risk management tool. Captive concepts, which have been around for many years, answer this need and have become very popular in risk management.
A captive company is an insurance or reinsurance company − most often a wholly owned subsidiary of a non-insurance company, whose primary role is to insure, or reinsure, the risk exposure of its owner and fellow subsidiaries. Given strict capitalisation requirements and regulatory frameworks for insurers in many countries, most owners choose to establish reinsurance captives.
Essentially, reinsurance captives offer their owners the entire range of proportional and non-proportional reinsurance instruments.
Captives have recently been used in the international marketplace for a number of reasons including:
- optimisation of insurance and reinsurance structures in the Solvency II environment;
- bringing two ‘worlds’ (life and non-life insurance) into one reinsurance captive;
- allow companies to benefit from arbitrage opportunities in the markets (with regards to pricing, coverage, and capacity);
- assist in strengthening the core business of the captive owner;
- allow the collection of data that, once analysed, can drive risk prevention initiatives; and
- have served the development of solutions for new, emerging risks.
Since the implementation of the European Solvency II Framework, which provides for capital credits for reinsurance companies with diversified portfolios, we have seen captive owners showing an increasing interest in employee benefit programmes.
The European Solvency II Framework rules assume that life and non-life risks do not correlate, so, in effect, if both risks are assumed by one single reinsurer, the diversification of the captive’s portfolio is increased. This helps organisations meet Solvency II capital adequacy rules.
Risk and HR Collaboration
Very often, risk managers are responsible for the non-life exposure management and are asked to oversee the operational management of existing captives; while human resource (HR) managers are responsible for employee benefit programmes (EB programmes) and are constantly seeking greater transparency in their regional or global employee benefit programmes to identify potential improvements. Captive owners interested in following the so called “holistic captive approach,” thus, seek stronger collaboration between risk and finance managers and their HR colleagues. Furthermore, market variety sees risk management increasingly interested in optimising the financing of the Employee Benefits and, crucially, their risk management.
In the past, with strict separation between life and non-life insurance on the provider, consultant, and purchaser side, it was common for many companies to have the risk management or insurance departments running the non-life insurance programmes, whereas EB insurance tended to fall under the remit of HR or the compensation and benefits teams.
The challenge for an organisation wishing to implement an EB captive programme is to, therefore, convey the advantages of participation to colleagues responsible for EB plans – and the inevitable question is how to best set out to achieve this?
The structure and decision making process within the HR team is important to understand in this scenario: large international organisations can be extremely complex when it comes to their HR and benefits and compensation units with layers of international, regional, and local structures. A good understanding of these structures and the respective interests of the stakeholders is crucial.
Risk management and finance tend to focus more on the financial advantages gained by inclusion of EB plans into the captive, which may be of lesser interest to HR, whose traditional remit has been the recruitment and retention of employees (supported by benefits plans). For example, the efficiency benefits arising under Solvency II through portfolio diversification and the increase in cash flows may not be relevant to HR.
Therefore, they need to be provided with practical examples of how the captive can help them achieve their goals.
Given this, we set out to highlight actual case studies where the involvement of the captive has helped human resources departments achieve their objectives. In some cases, these are financial – and there are a number of cases where, in order to enable a swift transition to the captive, straightforward percentage reductions to existing plan prices (on equal terms) have been agreed. More commonly though, we find the focus switching to aspects such as set up design, tailoring of policy conditions, and taking a more flexible approach to underwriting in order to provide custom-fitted cover for the local policyholder.
Practical examples where we have seen captives use their influence as the risk taker to influence the quality of the local contract to the advantage of the HR function and as well as employees include:
Companies involved in reconstruction and development in dangerous regions have secured cover for ‘Passive War’ risks, which would normally be excluded by a local insurer.
In addition, we have seen several inclusions of risks such as ‘High Risk Sports,’ ‘AIDS/HIV treatment,’ and ‘Suicide,’ which insurance carriers typically have little appetite for.
We have also seen flexibility granted to underwriting conditions applied to employees joining a company, where these easements are particularly useful for human resources when looking to provide matching cover in order to attract talent.
Examples include waivers of exclusions that might normally apply under a local policy due to an employee’s medical history. This could be an exclusion that would apply to a disability policy because the covered person has a history of back problems, for example. More fundamentally, under a medical policy it could provide cover for the employee (or indeed a covered family member like a spouse or a child) where they may already be receiving treatment for a condition. Being able to provide cover in this way when trying to attract new employees to the company is potentially a big advantage to the HR team when recruiting.
Similarly, the captive may look to increase the normal limits in order to improve immediate cover on joining and make coverage more attractive to new hires.
For example, in one case in Ireland, a captive was able to make a meaningful difference: the local operation was looking to appoint a new manager from a competitor who had a serious existing ailment. The prospective hire was refused cover in excess of the Free Cover Limit (a local limit up to where evidence of health is not required) due to the illness. The captive was asked to intervene, and by increasing the local Free Cover Limit to the required level of cover, the employer was able to offer improved terms which enabled the company to recruit the employee. Had the captive not been in a position to do this, the employee would have remained with their previous employer.
Claims acceptance and management
Both of these examples are pre-loss situations in which the captive improves terms the local employer can offer. However, the captive may also assist post-loss in case a claim or claims process falls outside the normal local rules, a common situation under medical policies – often surfacing in cases of hardship. The captive can either speed up the local process or make voluntary payments.
One such case arose in Guatemala, where a covered person developed an acute condition requiring immediate treatment. Unfortunately, while the local diagnosis was not in dispute, standard local practice required the medical records to be provided prior to admittance of the claim in order to validate the claim. To add to the complications the covered person was actually out of the country at the time and the relatively costly treatment of USD 20,000 required payment up-front. Given these circumstances, the health of the covered could have deteriorated in the event of any delays.
Following a discussion between HR, the customer’s Head Office, Zurich and our local partner, the captive immediately authorised our partner to release a pre-certification, which allowed the covered person to undergo immediate surgery abroad.
There was also recently the case of a manager in Thailand with benefits in excess of free cover that had not been insured. To become part of the international EB captive programme, the customer’s Thai operation decided to switch the local Group Life solution to our partner, but given the high salary of the manager, she was asked several times to complete a medical questionnaire but failed to do so.
When the manager suddenly died, the local insurer followed the normal process and paid out a lump sum up to the Free Cover Limit of USD 100,000. The balance of USD 200,000 was not paid as the member had not provided the required medical questionnaire. The captive agreed to increase the cover by a further USD 50,000 – substantially improving the situation compared with what would have happened had the member died while the solution was placed with the previous insurer.
We could list several other examples of how the captive may be used to convince an HR team that participation in the arrangement can only be advantageous. This in turn will help broaden support of the arrangement and increase the chances of a successful EB captive implementation.
The current market environment does provide attractive and comprehensive risk self-financing and risk transfer solutions for captive owners.
The holistic captive approach of bringing together the non-life and the life world results in tangible value for human resources teams. Thanks to the captive’s inclusion of EB exposure, local coverage optimisation of is possible, HR receives transparent risk reports, and benefits from an attractive loss ratio. The latter can be used to initiate investments to increase the quality of risk, which in turn results in more efficient local insurance pricing.
Furthermore, recent regulatory developments should motivate captive owners to explore this path, provided an operating captive is in existence.
Insurance companies and captive fronters, who are experienced with such an approach, can provide the necessary advice in order to facilitate a productive discussion between risk management & human resources management.
Corporate insurers operating globally might be faced with an increasing demand from captive owners to keep their network infrastructure available for EB frontings, since most popular EB captive reinsurances are proportional reinsurances up to 95% of 100%. The traditional role of an EB Insurer will consequently shift to a comprehensive service provider for the issuance of international EB programmes.