Capturing control: since regulators made it easier for companies to use captives for employee benefits, U.S. businesses are hoping that life/health business, like property/casualty, can be better controlled in a captive.

Key Points

* The federal government has eased restrictions on companies using captives to fund employee benefits, allowing them to qualify for "fast-track" approval in 75 days.

* With spending on employee benefits up 24% in four years, interest in pursuing captives is on the rise.

* Cutting costs and gaining more control over claims are two reasons companies are seeking captives to fund employee benefits.

The executives at Columbia Energy had a simple wish: to apply the lessons they'd learned from their property/casualty insurance captive to their long-term disability program.

The long-term disability program had skyrocketing premiums and claims costs. What if Columbia could use a captive to fund the risk, allowing the company to gain more control of claims and premium dollars?

It may have been a simple wish, but it would require more than a simple plan. At the time, no U.S. company had ever received the federal exemption necessary to use a captive to fund employee benefits. But Columbia Energy was convinced it could work.

"Instead of fully insuring the [long-term disability] program and giving millions of dollars to a life and health company, we decided it would be more of a benefit for Columbia to retain most of the risk and get the benefit of investment income from the premium," said Tim Bucci, director of corporate insurance for NiSource Inc., which purchased Columbia Energy in 2000.

The company applied for and was the first to receive an exemption from the U.S. Department of Labor to use its property/casualty captive to also reinsure its long-term disability program. Columbia Energy's theory turned out to be even more successful than its leaders first imagined. Since the financing of the long-term disability was moved to the captive after the DOL approval in 1999, the company has been able to cut its long-term disability premiums in half, while also reducing claims costs by half, Bucci said.

Other companies are following in the steps of Merrillville, Ind.-based NiSource, seeking to harness the power of captives to fund employee benefits--including employee and retiree life insurance, long- and short-term disability, medical stop-loss, accidental death and dismemberment and medical insurance. With spending on benefits by private sector employers rising 24% in four years, primarily because of escalating health-care premiums, more companies are looking to captives to give them more control over costs. Unlike Columbia, which paved the way, companies that apply for the exemption today can qualify for a fast-track approach and receive approval in its little as 75 days.

Blazing the Trail

Bucci, who was working as a consultant with Strategic Risk Solutions on behalf of Columbia in 1999, knew the company had been able to save money and reduce claims on the property/casualty side by using its Bermuda-based captive, which funded the company's all-risk property, general liability and auto liability. Why not use the same method to reduce the long-term disability insurance costs?

Long-term disability is a long-tail risk, just like workers' compensation, another type of property/casualty business often placed in captives, said Bucci. "In many ways, LTD is a lot more predictable than workers' romp," Bucci said. "And it's the same as in P/C. Once you have skin in the game, you can really look at how you are doing business underneath, and how you control claims. It's not denying benefits; it's actively managing benefits."

Brady Young, president of Strategic Risk Solutions, a Boston-based independent captive management company, said when the company worked with Columbia to establish its then property/casualty-only captive in the mid 1990s, the goal was to insulate some of Columbia's smaller operating units from the volatility of taking large deductibles.

Taking the Fast Lane

The U.S. Department of Labor requires that companies seeking the exemption needed to use a captive to fund employee benefits meet several requirements to be considered for the "fast track" approval process, including the following:

* The captive must be licensed by a U.S. domicile, although the U.S. captive can be a branch of an offshore captive.

* The plan will pay no more than adequate consideration for the insurance contracts.

* The plan will not pay commissions for the direct sale of insurance or reinsurance contracts.

* The captive has undergone an examination by an independent certified public accounting firm during the past fiscal year or past five years.

* The plan will only contract with insurers that are rated A (Excellent) or better by the A.M. Best Co. or an equivalent rating from another rating agency.

Source: Spring Consulting Group