by Health & Human Services Division
Control. For most operators, owners and CFOs in long-term care facilities, it’s not a word that comes to mind when insurance is the topic. But with price increases hitting commercial insurance lines, market and coverage limitations within the aging services sector, as well as reduced capacity to service this vertical, greater control is exactly what long-term care executives should demand and a captive insurance structure can be the answer.
The appropriate captive insurance structure will be determined by four key factors: the organization’s financial health, its long-term strategic plan, its appetite for risk and its risk management philosophy.
The landscape of the traditional insurance market has significant implications for the assisted living industry – from long-term care and post-acute care to continuing care retirement communities. Gaining control starts with understanding the changing landscape, learning your insurance alternatives and determining the best fit.
A Changing Landscape
The aging services segment of the Health and Human Services industry is fairly limited in terms of commercially available insurance, meaning there are only a handful of insurance carriers who will even consider underwriting this type of business and will oftentimes only do it under their own terms and conditions. This limits your control as an insured and subjects you to potential increases in pricing with a decrease in coverage.
Several carriers rushed to enter the aging population marketplace due to the strong macro-level fundamentals of retiring baby-boomers. However, some of those carriers now have concerning loss-ratios and consequentially, their availability and limits have suffered. Some carriers have exited the business altogether. Ultimately, the carriers that remain will increase pricing and may also reduce coverage in an attempt to maintain margins and their rating. In addition, reduced capacity within the “admitted” marketplace will require insureds to access the Excess and Surplus Lines marketplace (E&S), which can sometimes result in even less favorable pricing, coverage terms and conditions.
Given our global economy, an increase in natural disasters, as well as an unprecedented extended soft market, carriers now more than ever are looking to protect their underwriting profit. The most direct way for carriers to protect their underwriting profit is to insulate themselves from paying claims. This is accomplished by incorporating coverage limitations into your policy forms. Many of these limitations have different implications by state. It is important that you and your broker have a comprehensive understanding of how your policy will respond with respect to claims in the following areas:
- Sexual Abuse and Molestation: It is not only important that you have this coverage, but also that you understand how it is specifically constructed with respect to defense costs and indemnity payments, as well as final adjudication implications.
- Punitive Damages: Depending upon the states in which you operate, you may or may not be insurable by law. However, it is important that you understand how this would be implicated in the states in which you operate.
- Additional Insured Coverage: How this coverage is designed will have direct implications on whether you are in compliance or in breach of the contracts you sign (with both Federal and State funding sources).
- Vicarious Medical Liability: It is important that you understand how your policy covers this exposure for you and that your employed medical professionals are carrying the appropriate coverage and limits on their own Professional Liability policies.
- Civil Fines and Penalties: These are, in fact, insurable, although some policies do not cover this portion of any claim, which could be significant.
- Crystal Ball Provision: This is a fairly ominous coverage provision found in commercial forms that could potentially preclude you from obtaining coverage for a particular claim depending upon how it was reported.
- Definition of a Claim: This is going to be the primary door into the policy to obtain coverage. It is critically important that this is defined appropriately.
Since the last hard market cycle (2002-2006), traditional market pricing had been declining, and during this time insurance companies were also evaluating the level of coverage offered and restricting terms and conditions to limit the types of claims covered. Insurance carriers can retrospectively look at their book of business and determine which coverage terms have resulted in the most claims activity. Armed with this knowledge, they can draft new terms and conditions to limit their exposure, which is important at a time when pricing is declining. They can try to protect their underwriting profit by limiting the amount of claims covered by the policy.
Now, the pricing tides are changing. Pricing generally seems to be on the rise for P/C insurers – a function of record-setting losses and muted investment income. Three independent insurance commercial lines pricing surveys, The Council of Insurance Agents & Brokers (CIAB), The Commercial Lines Insurance Pricing Survey (CLIPS) and Market Scout, stated in May 2012 that prices have increased approximately 1%-4% since late 2011. However, the surveys suggest rate increases are not equal across the various types of coverage. Because the increase in pricing is not uniform, it’s not considered to be a traditional hard-market cycle. But an increase in cost, regardless of what the cycle is labeled, can be problematic for long-term care facilities.
As pricing starts to increase, coverage omissions that the insurer made during the soft market are not readily given back, which can result in a poorly constructed policy with many coverage gaps. Coverage terms and conditions cannot be ignored, and policies need to be carefully evaluated at each renewal to make sure they adequately address the exposures.
Of further concern are the low interest rates that have weakened operating results for insurers. Low reinvestment rates mean insurers’ underwriting profitability is more critical to maintaining their financial strength. Therefore many analysts expect that P/C insurers will increasingly rely on their underwriting skills and risk-mitigation practices to increase profitability.
With this perfect storm of pricing, sharpened underwriting, reduced capacity, as well as coverage and market limitations, the assisted living industry is considering its insurance alternatives and finding captive structures to be a fit. As you analyze the options, keep in mind the pros and cons of the traditional insurance market and what aspects appeal to your organization – knowing this will help you determine which loss-sensitive structure may be a fit.
Traditional Insurance Market Pros
- Potential short-term cash flow benefits
- Less long-term commitment with any individual carrier
- Potential short-term pricing benefits
Traditional Insurance Market Cons
- Subject to class underwriting
- Limited availability of coverages and limits
- Potentially unpredictable volatility
- Limited control
Ownership for the Long-Term
Captives, either alone or part of a group, provide business owners with the unique alternative of owning their own insurance company. This can translate to greater control over claims handling, professional partners, stabilization and reduction of the cost of risk, risk management and loss control and ultimately, control over underwriting profits and investment income.
Under a captive, coverage prices are based on members’ claims histories and not on industry averages and aggregate books of business. Owners assume a portion of the risk by taking on a large retention, in accordance with their own risk appetite and financial situation. Unlike traditional insurance where business owners pay a premium and let the carrier pay for the claim, captive members are shareholders and are required to fund a large portion of a claim. That is why it is critical that captive owners operate as safely as possible – they have a vested interest to raise their safety standards and elevate their risk management standards.
When a business owner and its executives embrace the concept of a captive, they have to be fully committed to operating as safely as possible in order to reap the rewards of the program. Captive owners see the benefits of good loss performance but also feel the pain when it is not so good. The captive forces them to put the emphasis in the appropriate areas – safety, loss control and claims management. Most business owners are under the misconception that captives are an instant money-saver; the reality for nearly all captive members is that an organization’s safety culture and commitment to upholding world-class safety standards is the x-factor when it comes to captive insurance and cost savings.
Control and long-term cost savings sound great, but ask the following questions of the organization first:
- Is the organization seeking a long-term risk management and insurance program that will last well into the foreseeable future?
- Does the organization already have a strong safety culture with buy-in from the top-down?
- Can the organization comfortably fund the initial captive formation expenses? A captive might require a substantial investment up front, whether to capitalize an in-house captive or to join a group. Recouping the investment usually requires a long-term commitment. (Five years at minimum.)
- Is the organization financially stable? In addition to the initial outlay of costs, there will be administrative costs and will it require internal monitoring, even if it is participating in a group.
- Does the organization have an entrepreneurial spirit?
- If you are for-profit, are you looking to take advantage of tax deductibility? Deductibility of premiums and deferred taxation of insurance income are the two principal advantages. Tax issues can be a major driver, but they should not be the only reason for forming a captive.
- If you are a non-profit, am you looking to generate additional revenue streams for your agency?
Make It a Profit Center
In a traditional insurance program, your full premium is given to the carrier, regardless of how few claims the insured files. In a captive, approximately 35-40 cents of every dollar is put towards reinsurance costs and fixed expenses, while an impressive 60-65 cents of that dollar is invested where it accrues over time and can be used to pay claims under the organization’s control. If claims can be significantly controlled, captive members get their underwriting profit back in the form of a dividend.
For-Profit and Non-Profit Differences
Using your captive as a profit center can be immensely helpful to any organization, but it is critical to understand the differences between captive formations in for-profit and non-profit organizations. Most notably, if you are a 501C3, the tax deductibility is not as important as the unrestricted revenue generated through the repatriation of dividends to your organization. If you are a non-profit engaged in a cost-based reimbursement model, captives can also provide a tremendous benefit to you in terms of the overall profitability of your programs, provided losses are controlled.
This allows you to allocate these additional funds to potentially fund other underfunded programs within the agency. This could effectively begin to decrease your dependence on waiver program reimbursement rates. Inversely, if you are a for-profit corporation, there are not only significant tax benefits to you, but also revenue stream implications via dividend payments.
With a captive, the financial success shared by members is attributed to the exclusivity of the group. Because a captive is a real insurance company, and in order for it to pass IRS rules and regulations, there must be risk shifting and sharing. Part of any group captive formula requires members to share in other members’ losses. But ultimately, you need to limit that as much as possible, so you need to keep it exclusive to members who share in your same safety culture and claims management philosophy. Otherwise, the captive won’t be successful and profitable for its members.
Not Just Groups
Group captives are one of the most common formations you can join. However, there are also other structures available, such as single-parent and rentals, as well as segregated cell captives. Whether or not a specific structure is a fit for your organization is entirely dependent upon your size, structure, complexity and financial situation. I suggest working with your current broker or other trusted risk management advisor to determine which is the best fit for you.
The Best Fit
The move from traditional insurance to a captive will likely feel like a quantum leap; the organization will absolutely need the financial wherewithal to take such a risk, but against the current landscape of the traditional insurance market, that risk is outweighed by the benefit of greater control and potential for long-term savings on insurance. Furthermore, a captive structure by default will require your organization to strengthen its culture – a secondary benefit that should never be discounted. The key to realizing all the benefits of these alternative structures will always come back to the organization’s ability to honestly evaluate its appetite for risk and financial stability against the attributes outlined above.
Health & Human Services Division