As US healthcare costs continue to spiral, Matthew Siciliani, executive vice-president and healthcare growth officer for Brown & Brown, explains to Captive Review the benefits offered by writing medical stop-loss into a captive structure and why more and more are turning to this innovative solution.
Captive Review (CR): Can you explain how a captive stop-loss arrangement works?
Matthew Siciliani (MS): Typically, the captive provides medical stop-loss to the owner/parent for the covered plans or contracts, usually at either the same or lower specific and aggregate retention levels than the owner currently purchases in the commercial market. The captive then retains a working layer of excess claims cost and purchases, specific reinsurance to cover catastrophic specific and/or aggregate claims cost. The medical stop-loss product line can be added to a general use captive or insured separately in a new or segregated cell captive.
CR: What are the benefits of using a captive for your stop-loss insurance?
MS: Commercial employer and provider medical stop-loss is an admitted, annual, claims-paid insurance policy. The stoploss policy has a relatively short extended reporting period, usually less than 12 months after expiration. Employers and providers are not licensed insurance companies so they may only recognise expense annually as paid. Using a captive enables them to employ statutory accounting principles, allowing for the expense of an incurred but not reported (IBNR) claim at the time premium is received and the amortisation of annual underwriting deficits over time. More importantly, the captive allows them to accrue underwriting surpluses into a stabilisation fund that can be used to reduce claims or premium expense and future dependence on commercial reinsurance.
A captive also benefits the owner by allowing them to tailor coverage to their needs, experience-rate their risk, reduce premium and total incurred cost, eliminate stop-loss claim disputes, improve recoveries, conserve cash and access the reinsurance market where more favourable terms and conditions may be available. For licensed health maintenance organisations and insurance companies, a separate medical stop-loss captive may offer a vehicle to separately fund and reinsure emerging or troublesome product lines separate from their general book of business. For example, they may use a captive to reinsure the risks they delegate to others or set up separate funding for new or troublesome products or jurisdictions.
CR: How popular are captive stop-loss arrangements compared to non-captive arrangements? Would you say captive arrangements are becoming more popular, and if so, why?
MS: Driven by rising medical expense, insurance and reinsurance premiums and direct provider contracting, the interest in and use of medical stop-loss captives have increased over the years. The 2021 Aegis Risk Survey notes that the number of respondents expressing an interest in captive arrangements increased from 12% to 18% between 2000 and 2021. While Aegis’ survey respondents also listed captives as the top risk management strategy, medical stop-loss captives still represent only a small percentage of the marketplace.
CR: Why are we seeing such growth in the US medical stop-loss market?
MS: The US stop-loss market has grown steadily over the last decade as the number of employers offering self-funded plans grew, and they responded to the 2010 Affordable Care Act requiring plans to provide unlimited individual and lifetime benefits. Since 2012, gross written stoploss premium has almost tripled, driven by a 68% increase in covered lives and a 91% increase in premium rate.
CR: With claims inflation outpacing commercial premiums, do you expect captives to reduce their risk exposure?
MS: In fact, it may do just the opposite. Employers with better member demography, claim history and lower medical inflation may increase interest and use of a captive to avoid the less favourable industry trends and reduce dependence on the fickle commercial insurance market.
CR: Will premiums eventually rise to restore profitability? And does this mean retaining more risk in the captive is a good idea?
MS: Like any insurance company, captives always adjust premium rates – up or down – to meet the owner’s stabilisation needs and the captive’s surplus objectives. The owner’s goal obviously is to use accrued surplus to stabilise annual results. Remember, as the owner/parent assumes all financial liability either directly or though the captive, the issue of how much expense and risk to assume in the captive is just a funding discussion. The captive looks to retain a layer of expense with an acceptable degree of volatility. We always recommend our clients to buy catastrophic specific excess loss reinsurance – it’s not predictable or preventable (in the near term) and presents exposure to an unlimited loss.
CR: What do you think is driving the declining underwriting performance of insurers in this space and will it lead to significant price hikes?
MS: Increasing claim frequency and severity are resulting in higher loss ratios. All stop-loss carriers are reporting that the frequency of high-cost claims superior to $1 million annually is increasing, with the highest claims running north of $5 million annually. Cost drivers include high-cost gene and cell therapies, specialty drugs and injectables, and spikes in behavioural health and Covid-19 claims. These trends, coupled with inflation fears and lower investment returns, will result in higher prices and non-renewals as commercial underwriters look to restore profitability.
CR: How concerning is the uptick in catastrophic claims and how should captive parents be responding to this trend?
MS: Catastrophic claims cannot be predicted or prevented to any great extent over any single policy year. It’s really just a roll of the dice. The only way to truly avoid both the incidence and cost of catastrophic claims is to transfer it to a reinsurer. Other than that, the captive must look to aggressively manage or negotiate treatment cost. But the ability to manage the claim cost requires an alert third-party administrator who can provide early warning and intervention on the potential claim before it develops.
CR: Should captive parents keep their captive’s exposure away from insuring the highest risk areas (eg malignant neoplasm)? Can they ‘laser’ their exposure in this way?
MS: It’s important to remember that the captive owner does not avoid the financial liability for the total claim cost. They either assume it within its retention or within the captive. So, anything the captive does not cover, the parent must expense. Consequently, lasering only returns the financial liability to the parent, which might make sense if the parent is in a better position to manage the claim.
CR: What effect could medical inflation have on the stop-loss market and how can companies protect themselves from being under-insured?
MS: Medical inflation historically has run about 200 basis points above general inflation. We expect this macro trend to continue or perhaps worsen as healthcare providers negotiate higher fees to address current labour shortages, wage increases, supply chain issues and the expiration of pandemic-related federal subsidies. Stop-loss inflation rates will generally be higher than medical inflation due to the leveraged effect of these rates excess of a fixed deductible. To offset this impact, the captive may want to correspondingly increase deductibles, but that will simply return the inflation risk to the parent. Alternatively, the captive may want to purchase aggregate stop-loss on its retained layer to cap the impact of inflation. For the parent, the first line of defence is to request clear line of sight on the renewal dates and rates for the preferred provider network that the third-party administrator plans to use.
