I have a question for you. What is the most basic principle of insurance? Overinsurance. Some pay more than what they use so others can pay less. But what happens when “more” becomes too much, too often? What happens when an employer gets tired of continually subsidizing an insurance pool it consistently outperforms? What is a chronically overinsured employer to do?
A very common approach is to partially self-insure and transfer a portion of liability to a reinsurer/stop-loss carrier. This can work very well for many years—until your first jumbo large claim results in a huge stop-loss renewal. Partial self-insurance has become so commonplace, even among smaller employers, that reinsurers have plenty of greener pastures to move onto at the first sign of trouble with a particular group. And then, you’re back to square one of a different variety—chronic overinsurance on the reinsurance market.
Another option is to eschew insurance carriers altogether and completely self-fund your plan’s liability. That’s a fantastic idea if your goal is bankruptcy. Unless you insure multiple thousands of employees and/or have cash flow that can be tapped like a water main, medical and pharmacy costs are far too expensive and too unpredictable for this to be a viable option.
If you’re thinking the prior two paragraphs have setup a Goldilocks option to be introduced now, you’d be right. Enter the captive into our story. “Captive” is a terrible name for a terrific solution. If partial self-insurance has two layers of risk—self-funded and reinsured—a captive simply inserts a third layer of insurance protection between self-insurance and reinsurance. This third layer of risk is shared by a relatively small, cohesive group of employers, rather than the Wild West of the general insurance pool. This group of employers essentially forms their own insurance company—an insurance company that is captive to group’s interests and the group’s alone. Maybe it’s not such a terrible name after all. The captive’s cohesion is built around a common industry or a common culture of employee engagement—cohesion that yields prudent risk aggregation, buying power, and more sustainable costs.
Captives are not a solution for everyone since they add a degree of complexity to a plan and will not prop up underlying faults in health plan design. They also yield sharply diminishing returns for employers with 400+ employees on their plan. But for the thousands of employers in the realm of 40-400 employees, captives are an increasingly compelling option.