Boss of the stop-loss

The Patient Protection and Affordable Care Act (ACA) has had the tendency to push a greater number of middle-market companies into self-funding their healthcare programmes and buying medical stop-loss insurance to protect them from catastrophic claims experience. The concept is simple. Rather than using a fully insured plan, the employer sponsors a self-funded health benefit plan and includes medical stop-loss coverage through the commercial insurance market, a captive insurance company, or a combination of the two. Reasons for taking this approach include: reducing overall costs associated with state premium taxes and ACA requirements, providing greater control over the plan design, and taking advantage of a younger and healthier workforce to avoid the adverse selection encountered by the insurance exchanges.

A primary advantage to using a medical stop-loss programme is that the regulatory burden is greatly reduced because these plans are not considered an employee benefit programme under the Employee Retirement Income Security Act and so prior approval is not needed from the Department of Labor. This is primarily due to the fact that the policy covers the employer for catastrophic loss experience associated with a self-funded health benefit plan. For this reason, it also cannot be considered a third-party risk.

There are additional benefits when a captive is included in the plan, such as greater tax efficiency, and the ability to minimise the effects of exclusions in the commercial insurer (often referred to as a reinsurer) medical stop-loss coverage, the ability to smooth out claims volatility from year to year and the ability to customise the terms and attachment points at the division level.

Also, greater risk distribution is achieved by adding medical stop-loss to captives that insure other lines of coverage. The use of a captive to insure all or part of a medical stop-loss programme provides significant benefits for the right companies.

The structure of a medical stop-loss programme

The stop-loss coverage can be either specific or aggregate, or a combination of these. Specific stop-loss covers claims in excess of an amount for any covered individual.

Aggregate stop-loss covers the risk that the total of all claims within the policy period exceeds a stop-loss threshold. These two forms of medical stop loss are often purchased together.

The structure of each medical stop-loss programme can take many forms, including:
  • The employer purchases the medical stop-loss coverage from a commercial insurer and self-insures all losses under the stop-loss attachment point.

  • The employer purchases the medical stop-loss coverage from a captive insurer and self-insures all losses under the stop loss attachment point. The captive may be owned by or affiliated with the employer as a single parent captive, exist as part of a captive cell company (generally for smaller employers), or be a group captive.

  • The employer purchases the medical stop-loss coverage from a commercial insurer that cedes a layer to the captive insurer. The employer then self-insures all losses under the stop loss attachment point.

  • There are countless combinations of how the layers can be pieced together based on the individual goals of the employer. The factors to be considered in the planning process consist of having a coordinated team of experts, including a benefits consultant, programme administrator, claims manager, medical stop-loss provider, captive manager, actuaries and experienced legal counsel.

    Considerations in forming the captive

    Employers that want to use a captive to participate in a medical stop-loss programme will also need to analyse the feasibility of forming the captive for that purpose. There are legal, tax and regulatory considerations in addition to the technical risk management issues. The legal structure, ownership and corporate governance need to be seriously addressed.

    Also, multiple layers of tax planning should be addressed, including federal and state income taxes of the employer associated with the deductibility of premium payments, state premium taxes of the captive, and issues involving the definition of insurance from the perspective of the Internal Revenue Service.

    The relative merits of the regulatory environments of the many captive domiciles should also be assessed in relation to the goals of the employer.

    These and other considerations are to be addressed by competent experts as part of the feasibility study. In the case of medical stop-loss, an actuarial study should be the first step to make certain that the employee census and the resulting loss experience can support a medical stop-loss programme and to identify alternative costs associated with different attachment points in light of the employer’s level of risk aversion.

    Once the actuarial analysis is complete, pro forma financial statements covering the next five years should be generated for both the expected scenario and an adverse scenario to assess the surplus requirements and rate adequacy. These pro forma financial statements will then be included in a detailed business plan to guide the formation and implementation of the captive.

    Once the feasibility analysis is complete and the parties agree that the use of a captive insurance company to participate in a medical stop-loss programme is feasible and the preferred option, the captive will be formed in the appropriate domicile, the sponsored plan should be created and the reinsurer identified. The captive will be incorporated and licensed to issue the medical stop-loss policy and any other policies that fit into the overall programme. Finally, the other service providers will be identified and brought into the overall programme.

    Self-funded health benefits plans are not new, and neither is the use of medical stop-loss coverage to protect against catastrophic losses or high aggregate losses.

    These plans have been used by larger employers for many years. However, the ACA changed the rules for these programmes by making fully insured programmes significantly more costly. This in turn has pushed the point where medical stop-loss programmes make sense to smaller middle-market employers.

    The reduced cost of these plans compared to fully insured plans, along with other significant benefits—such as greater control over plan design and the ability to avoid the adverse selection that is causing chaos in the commercial market and the exchanges—creates incentives to form captives and utilise stop-loss policies that did not exist before the passage of the ACA.

    Since many of these middle-market employers currently use captive planning to manage other operational risks, it is a natural tendency to include medical stop-loss coverage in the existing captive, or to form a separate captive for that purpose.

    While some states are hostile to the trend and are exploring ways to increase minimum attachment points in order to squeeze smaller employers out of the market, other states are embracing the concept.

    The formation of a medical stop-loss captive is not a simple project, so great care should be taken to secure knowledgeable strategic partners that will lead you away from the many pitfalls that can arise. However, with the right team, proper planning and a supportive corporate culture, medical stop-loss programmes that include a captive insurance company can provide powerful benefits.
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