The only constant is change

Being adaptive to change has helped the healthcare captive industry grow over the past 30+ years. Monique MacDonald, senior vice president, Global Captive Management, offers a look at the industry then and now, with a small glimpse into the future.

Healthcare captives were initially set up to insure certain risks of parent healthcare systems and affiliates. A captive is a long-term risk management tool that provides risk management and risk financing benefits to its healthcare parent entities. Captives are much more flexible than commercial coverages in that they can provide tailored coverage in a way that best fits the needs of the corporate parent. This is an important feature in a world where adaption to change is vital to continued existence.

While healthcare captives were traditionally set up to assume the liabilities of their parents’ self-insurance trusts and ongoing medical malpractice risks, they have evolved to cover a variety of risks areas such as general liability, property, and worker’s compensation. Additional coverages such as deductible reimbursement for cyber, special property risks, deductible buyback for regulatory coverage, and employment practices liability have been added over the last few years. In some cases, these coverages have been added due to commercial policy exclusions. The flexibility of captives has allowed coverage to be added with limits and premiums appropriate to the healthcare system and the captive.

Captive utilization has assisted in greater loss control due to an increased focus on the claims themselves, given their direct impact on the captive’s bottom line. When the two significant balances on the captive’s balance sheet are investments and insurance liabilities, the focus will naturally go to increasing one and reducing the other—and working to get it the right way around. This focus on claims has in some cases led to identification of gaps in loss control processes. The issuance of grants from the captive to the parent have assisted in closing those gaps.

“ATTENTION IS NOW TURNING TO THE APPROPRIATE USE OF THIS CAPTIVE SURPLUS BY ALIGNING THE NEEDS OF THE CAPTIVE AND ITS CORPORATE PARENT.”

This in turn has reduced claims and in turn increased the captive surplus. The accumulation of surplus greatly benefited the captive, and in turn its corporate parent. This was evidenced in the aftermath of the 2008 financial crisis, when captives could offer their corporate parents premium holidays, increased grants, or dividends given their decades of careful financial planning and surplus accumulation.

The flexibility to retain independent counsel of choice has resulted in better claim management, as the focus will be on benefiting the insured healthcare system and not on balancing the needs of the commercial carrier and the insured healthcare system. The healthcare parent may also utilize its own in-house counsel to greater degree to manage claims on their own terms from the onset resulting in a more effective process and overall cost savings.

For many years, the use of captives focused on the benefits of greater control, flexibility and cost savings over that of commercial coverage. This was of great significance especially during hard markets. But what happens when you have a continuing soft market in which commercial carriers with excess surplus can offer coverage at attractive prices? Then the conversation turns to one of value. After all, a captive insurer is not formed just to provide benefits in the short term, but as a long-term risk management tool.

Here and now

The only constant is change, and as the healthcare industry itself continues to change, captives evolve along with it.

The Affordable Care Act of 2010 (ACA) certainly changed the landscape and led a large increase in mergers and acquisitions (M&A) in the healthcare industry. While such M&A activity had been seen before, the volume of such consolidations vastly increased. In some cases, the focus was on vertical acquisitions where hospitals merged with physician groups, outpatient clinics, and radiology groups to provide more of an integrated approach to healthcare deliverables.

M&A in the industry resulted in larger captives, albeit fewer of them. These larger captives cover the risks of their merged entities which may previously have been insured by smaller captives, the commercial market, or self-insured trusts. The resulting captive is larger yet more efficient as the surviving healthcare system increases its focus on increasing value and reducing costs.

Cost savings have been realized by tightening policy language, greater risk management/loss control, and consolidation of coverage. There has been an alignment of corporate governance and risk management strategies to benefit the overall entity. This alignment is key to handling the challenges of a changing world where an increased use of technology, vertical consolidations, and greater number affiliations between healthcare systems are all being utilized to maximize value—for the health systems and for their patients.

The healthcare reimbursement model also began to change to a fee-for-value instead of fee-for-service, enhancing discussions of the concept of value. Part of this value assessment is the evaluation of continued captive utilization for risk management and risk financing in a way that maximizes the value the captive provides to its corporate parent. Captives are therefore transforming from general risk management tools, to value-added risk management vehicles.

Additional lines such as medical stop loss are being assessed for feasibility of captive coverage. The stop loss coverage may include participating in reinsurance of claims excess of deductibles retained on employee benefit coverage, or reinsuring financial penalties associated with their parent’s Accountable Care Organization’s performance targets. In both scenarios, the captive acts as a reinsurer of the corporate entity or group itself (ie, the health plan sponsor) and not the health plan itself. In addition, such coverage is considered self-insurance and so does not fail under the Employee Retirement Income Security Act of 1974 (ERISA) rules.

In terms of risk financing, benefits traditionally focused on smoothing of premium cycles and costs savings at the parent level, and the accumulation of surplus at the captive level for use as a war chest.

Risk management programs at the parent level assisted in mitigating claims and the amount of losses incurred by the captive. Lower incurred claims results in greater accumulation of retained earnings and in turn greater availability of surplus for grants, premium credits and dividends to be paid to the parent entity. Attention is now turning to the appropriate use of this captive surplus by aligning the needs of the captive and its corporate parent.

The evaluation of the available surplus that can be distributed in this manner should consider the captive’s financial position, requirements of the captive’s current insurance program, and future for expansion of coverage. Such assessment can be using financial metrics and stress testing. The metrics are used to first set the minimum amount of surplus the captive should maintain for ongoing and future operations, and then assessing amounts available for distribution in excess of that minimum level.

Stress testing is then performed to determine the effect of adverse claims and/or negative investment performance on the available surplus and determining how the captive’s financial position could absorb such possible adverse scenarios. Performing this review on an annual basis ensures that the captive will maintain a reasonable amount of capital and surplus while still providing additional financial benefits to its corporate parent.

Ever-increasing regulation is also impacting healthcare captives in that greater review of risk management and corporate governance is becoming the norm. Captive boards are being tasked with reviewing on an ongoing basis all aspects of their operations in terms of risk identification and risk mitigation. The documentation of this process in turn assists a captive board in evaluating proper allocation of resources for ongoing operations and preparation for future expansion of the captive’s insurance program.

Looking ahead

As we look ahead, we see the landscape changing even further. Included in this changing landscape is the concept of disruption. The Oxford English Dictionary defines disruption as “disturbance or problems which interrupt an event, activity, or process”. In this context, the term is meant as disturbing the current process, changing things, thinking outside the box. It can involve changes in dynamics, processes and people to achieve better results and results in an entity becoming proactive instead of just reactive. Disruption can be purposeful, with planned changes to structure and processes such as streamlining of boards and executive committees, use of additional technology in terms of interoperability across clinical platforms, or allowing physicians opportunities to brainstorm and create new products or technology.

It can also be inadvertent, with changes in corporate cultures with the introduction of new corporate officers or entire boards. This disruption can trickle down to the captive level and result in changes to the focus and structure itself. An example of this can be seen in how the increase in M&A in the healthcare industry led to a number of captives converting to segregated portfolio companies so that they would have the ability to separate insurance programs with varied risks or in terms of direct versus third party insureds.

The conversation of value and utilization will continue against a backdrop of uncertainty of possible changes to the ACA and how that could impact the healthcare industry. In any case, as captives have adapted to change over the last 30 years, they will continue to do so.