Entering the captive market can be challenging at the best of times. The complex regulatory, tax and legal issues, start-up fees and initial capital costs alone are enough to make the collective eyes of any organisation water...
Entering the captive market can be challenging at the best of times. The complex regulatory, tax and legal issues, start-up fees and initial capital costs alone are enough to make the collective eyes of any organisation water. However, in the case of not-for-profits, the fundamental advantages given to them by the US government have proven to be something of a secret weapon.
As opposed to a for-profit entity that can enjoy the tax benefits of establishing a captive insurance entity, not-for-profits are already tax exempt under the Internal Revenue Code. Consequently, the motivation for establishing such a captive is usually based on the analysis that, by doing so, the captive will provide a mechanism to stabilise and/or reduce insurance costs over the long term.
According to Jesse Crary, counsel at law firm Primmer Piper Eggleston & Cramer, these entities can also benefit from increased control over the investment of funds, the ability to reduce premiums and the option to retain profits earned by successful claims management.
The more, the merrier
If an entity covered under section 501(c)(3) of the Internal Revenue Code structures its insurance arrangement through a reciprocal, then the tax can also be avoided at the insurance company level.
Partner at Morris, Manning & Martin, LLP, Skip Myers, comments: “A 501(c)(3), such as a not-for-profit hospital, charity or educational institution, can form as a reciprocal. Groups, of five or six hospitals for example, tend to join together so that they don’t get taxed. In the US, if a charity engages in anything other than its exempt function, then the benefit would not be applicable. A university’s exempt function would be providing education or a hospital’s exempt function would be delivering medical services.”
If an organisation can avoid paying tax on its insurance income, then it becomes able to put the profit into surplus to support its exempt function, rather than pay it out to the government in tax.
Client manager at RCM&D Healthcare, Angela Stoddard, explains: “Our clients issue an excess policy that is fully reinsured to an A-rated reinsurance carrier for excess limits above the primary policy. The policy will sit above the typical coverages above excess such as automobile, helipad, individual physician medical professional liability, employers’ liability and employee benefits liability. The policies are then retrospectively rated and maintained on a claims-made basis.”
Another inherent advantage of these formations is the added participation of key hospital personnel on the captive’s governing boards and committees.
These personnel can contribute useful insights on patient safety, quality, claims, and risk management. This can also lead the captives to develop broader forms of coverage than the direct market is able to provide.
The majority of these healthcare captives are domiciled in places such as the Cayman Islands or Bermuda. Doing so also means that premium, capital gains and withholding tax can be avoided.
Cayman in particular has been a premier domicile for healthcare captives since the 1970s. According to recent statistics from Honigman, Miller, Schwartz, and Cohn, out of the 110 tax-exempt hospital captives and risk retention groups it works with, three are domiciled domestically in the US, while the remaining 107 are domiciled offshore.
Keeping the faith
Faith-based, not-for-profit organisations are also tax-exempt but under a different section of the Internal Revenue Code, namely section 501(a). As with the 501(c)(3) structures, every one of these organisations exists because of donations and, as a result, cannot increase production or move into new marketplaces in order to deal with any wider price increases.
This led organisations to find new ways to ensure as much of the donations were available as possible—and saving on insurance costs was a way to do that.
The Lockton Alliance for Ministry Protection (LAMP) is a department that helps such organisations. It has a single parent and two group captives on its books.
Whether they are US-based ministries, aid organisations providing relief to disaster-stricken countries or church schools at home and abroad, they need to cover their potential losses. For LAMP in particular, the principal lines of coverage they offer are general liability, workers’ compensation and auto liability/auto physical damage. LAMP also arranges some specialty lines within the captives it oversees.
LAMP executive director Terry Brandt explains: “Our clients vary in size and complexity, in a lot of different locations with a lot of different functions, but there is not a large frequency of losses. The insurance marketplace tends to be overpriced and we thought we could do a better job of retaining risk and underwriting profit as well as being able to continue to increase their retention of risk over time, all the while maintaining insurability. We also have to make sure that we are helping them to manage, from an international standpoint, to comply with local regulations in each different country.”
Rolling with the punches
Crary claims that employee benefits and medical stop-loss are the most notable lines at the moment, and not-for-profit captives are no exception to this. He comments: “The year-to-year increases in employee health insurance are having a crippling effect on the ability of not-for-profit companies to accomplish their charitable missions. These entities, including higher educational institutions and religious organisations, have been among the most aggressive in seeking captive solutions to control employee medical expenses.“
Many captives have been adding other new lines of coverage. Cyber liability deductibles in particular are growing in popularity, according Linda Jones, managing director of RCM&D Healthcare. This widening of healthcare captives’ offerings has also allowed them to absorb some of the lesser entities in the market.
Jones explains: “We are seeing more group captives emerging as the healthcare market rapidly succumbs to mergers and acquisitions. This is resulting in single-parent captives shutting down and joining a larger group captive.”
