Just over 12 years ago this magazine published my article on establishing a captive insurance company for managing employee benefit risk with R J Reynolds International, now part of Japan Tobacco. Many other captives have been established since then and much progress has been made in the evolution of multinational pooling, which I propose to share with readers. In the context of this article I am assuming that a benefits manager is considering the creation of a wholly owned subsidiary to absorb all or a portion of its parent’s global employee benefit risk.
Establishing clear objectives in creating a benefits captive are critical and taking the time to clarify and share these with the senior management team will save a great deal of time and resources later. For most organizations, the primary objective will be to cut costs but it is important to communicate the fact that operating a captive means more volatility. There will be times when costs appear, albeit temporarily, to have spiked upwards – if your company cannot tolerate financial unpredictability, then perhaps a captive is not for you. Recognize too that there are (often substantial) set-up costs in terms of advice and management time. Preparing a projected return on investment to win over senior colleagues is a wise idea.
Understanding the potential savings from your company’s individual profile will be helpful to gain support for the initiative and so will the many additional advantages that need to be explored and communicated. For example:
- greater transparency of the component costs of employee benefits (e.g. risk charges and commissions);
- a readymade vehicle for the monitoring, accounting and , where necessary, funding of other employee liabilities beyond traditional benefits;
- exposure of excess broker commissions and other related ancillary expenses;
- scale savings in benefit service fees and risk charges (but expect claims administration charges to increase when stripped out of an insurance premium);
- consistent levels of service and, if desired, multi-country service agreements; and
- the potential to add locations where no pooling partner is established
When considering the potential organizational advantages, a company needs to think beyond the traditional boundaries of employee benefit programs.
PHILOSOPHY, VALUES AND CULTURE
Employee benefits, in comparison with other risks borne by an international company, represent a relatively low risk which, in normal circumstances, is unlikely to jeopardize the existence of the enterprise if self insured. Nonetheless, many organizations may want to follow a conservative approach and take on more risk only in matters that they are expert in (i.e. their core business). Others may be unable to cope with the potential changes in cash flow year on year (albeit manageable) and still others may be highly decentralized and not want to impose a corporate view on subsidiaries. The most successful arrangements fully reflect the style and management approach adopted across the business as a whole and if the management issues associated with a captive do not fit with that profile it may be difficult to fit a square peg into a round hole.
As a part of the initial feasibility study, an organization should decide whether the benefits captive will be a separate entity or whether the liability is to be added to an existing property and casualty (P&C) captive. This will be an important consideration in determining the ongoing management approach and in order to ensure that benefit objectives are compatible with those of the P&C program (e.g. what happens to favorable experience gains and dividends?)
Most P&C captives are established to manage risks that may or may not occur, whereas with employee benefits it is a question of “when” rather than “if” claims will occur. In this context, perhaps more appropriately, potential catastrophic spikes could be reinsured to a P&C captive (e.g. from a facility explosion or a company jet disaster or even a highly compensated individual’s excess LTD or Life benefit). Experience suggests that the approach and style of P&C captive management do not generally lend themselves to the nature and human resource considerations of employee benefits management.
The successful launch of an employee benefits captive requires a champion inside the company. Such an endeavor cannot be spearheaded by a consultant. Consultants can be of enormous assistance but to carry off the internal socialization and approval process requires a respected internal sponsor. Ideally this should be the most senior person responsible for employee benefits as, despite all of the other attractions and disciplines involved, the project remains an employee benefits one at its core.
Such a team leader needs to be comfortable with risk management considerations, insurance structures and cross-border tax, as well as have familiarity with legal, employee equity and accounting principles. In other words, a management generalist. Our hero will need to have the respect of other head office functions, whose buy-in he or she will need, to get the project to implementation. As well, our sponsor will need the internal fortitude to deal with the various challenges during project feasibility and, later, the various takeover attempts as colleagues, for their own ends, covet the benefits of cross-border tax avoidance and cash management that the captive offers. This is where sticking to one’s objectives remains critical. While a benefits captive can be supportive to other parts of the company, its primary purpose must be in considering your own company’s circumstances, in order to improve the management of employee benefits.
This is the point at which most feasibility projects founder or are shelved as the project leader fails to convince colleagues, executive management or the Board that the features and advantages of such a project far outweigh the potential pitfalls. In deciding whether to proceed, consideration should be given to how important the management of global benefits is to the organization and where the additional executive support that will be needed to secure this might lie.
The organizational culture will determine how the project should be approached and the support needed from subsidiary businesses to secure its success. In many ways, this lies at the heart of the project as, without the support of operations, the project will not succeed. They need to fully understand and recognize that the project is in their best interests. There will be a number of considerations, as follows:
Communication. It is never too early or too trivial to debrief international colleagues so keep them involved at all times.
Management. The most successful captive projects are totally transparent about their objectives and intentions and some even invite subsidiary representatives to sit on the captive’s management or advisory board.
Sharing the wealth. Unlike a P&C captive, employee benefit arrangements require a great deal of change at subsidiary level (e.g. change of carrier, re-enrollment, removal of brokers and timing of contributions). Shared savings in the form of lower future premiums as a reward for taking these steps are the best way to garner the willing participation of operating subsidiaries.
Brokers. A significant contribution to savings will be the discontinuance of broker arrangements, as local contracts will no longer need shopping or maintaining. However, this often generates resistance from local managers, particularly where the broker has been in place for a long period. Head Office may want to allow the relationship to continue for an agreed transition period, with the commission embedded in the premium, or levy a net premium and encourage local management to pay commissions directly as advice is provided.
Premium payments. A new benefits only captive will require capitalization and, dependent upon the organization’s profile, a call on the company can sometimes be avoided by having local subsidiaries pay premiums several months in advance.
I am aware of two captives that were wound up after the sponsor left the organization. ln both cases, the organization lost touch with the initiative and was ill prepared for increased volatility when it arose. Such a strategically important change needs to be sustainable, as full gains may not be visible for several years. An organization should target several executives familiar with the project, who are jointly responsible for its ongoing health.
As mentioned above, it may also suit the organization’s culture and management style to have subsidiary representatives sit on an advisory committee or on the Board of the captive and be actively engaged in its management.
In any international company there are numerous areas of employee liability that remain simply promises. They are not accounted for, monitored or funded, the reasons being that they have been overlooked, are not considered significant or are prohibitively expensive to purchase. These may include top-up pensions where local rules may make it difficult to fund while working abroad. There may be gaps in an expatriate’s social security benefits or medical evacuation cover. A captive provides a mechanism for keeping track of these and enabling them to be backed up by an insurance policy. We all dread the expatriate returning home after a lengthy international career brandishing a letter from a long gone senior executive with promises of being kept “whole”. Now there is a mechanism for managing that.
A substantial advantage that the captive has over any other benefits management structure is that a sponsoring company can determine what risk is appropriate for it to absorb on a global basis, both at the aggregate and the individual claim level. Rather than obtain risk coverage locally or aggregately, tailored internal or external reinsurance can now be developed to cater for a company’s specific needs on a cost-effective basis.
Some of the challenges that will need to be addressed in considering whether a captive will work for your company may not at first be evident but there will also likely be several unique advantages that will only come to light when the project is fully operational. In setting out these considerations, I hope to assist those companies for which a captive is clearly not the right solution and where multinational pooling might be a better choice, to reach that conclusion before they start the feasibility process.
In the final analysis there are two key points that make or break the decision:
- In pursuit of cost reduction, are we prepared to live with the resulting increased volatility?
- Can the arrangement be adapted to fit with our organizational culture and management style ?
Multinational pooling provides an excellent alternative that protects the sponsoring company from volatile premium flow and is less intrusive in the way it captures local subsidiary involvement. In addition, it provides an excellent reporting capability on how benefit plans are being used. For example , a company can accumulate and use benefit claims information on a global basis. With a pooling arrangement, the insurer usually has a vested interest in collecting and analyzing this information on behalf of a client – with a captive where the client bears the entire risk, there is no such interest and this information will likely have to be paid for.
Increasingly, over the years, pooling organizations have evolved their offerings to transfer more risk to their client companies that wanted to absorb it . There is a little further to go until the total risk in a program lies with a client. Pooling partners tend to think of themselves as insurers first but I challenge them to go beyond this thinking and to develop a service that would offer tailored reinsurance on a multi-country basis, and to provide the detailed analysis that is the byproduct of a pooling arrangement, all within a multinational pooling structure with its advantage of being less intrusive in obtaining the involvement of local subsidiaries and, most attractive of all, avoiding the need to go through the process of creating a competing internal structure (i.e. the captive insurance company).