Benefit Captives
Department of Labor Policy Shift
Are the floodgates opening?
Prepared by: Ronald Collins and Cameron Chason
Palmer & Cay Consulting Group
Atlanta, GA
A recent shift in policy by the Department of Labor has prompted many companies to file for prohibited transaction exemptions with the Department for approval to include their employee benefits program in their captive arrangement. Captives, a long familiar term among property and casualty insurance professionals, is making its entrance onto the employee benefits scene. A captive is basically a risk transfer vehicle that allows companies whose core business is not insurance to transfer risk to a wholly owned or rented subsidiary. Companies use captives to do everything from hedging against the volatile movements of the insurance market, to placing undesirable or uninsurable risks, to providing a tax favored funding mechanism. What is happening in the world of benefit captives may provide even greater incentives for companies to examine the suitability of a captive for their insurance needs and risks.
Companies with current captive arrangements may be interested in these new developments in the benefits captive arena. Currently, in order for a captive’s premiums to be fully deductible, 30% of its business must be considered “unrelated.” The IRS considers employee benefits as “unrelated” because the risk of loss is not the company’s as it is an “insured” loss (Revenue Ruling 92-93). So why do companies not place all of their insured employee benefit programs in a captive to attain the 30%? Previously, companies could not place their benefits program in a captive unless 50% of the captive’s business was “unrelated.” This policy was a result of ERISA’s “prohibited transaction” rule. The recent filing of Columbia Energy Group (CEG) (65 Fed. Reg. 50223, 50237) prompted the DOL to drop this requirement to 30% once certain conditions are met. These conditions provided by the DOL to CEG include:
Each company requesting an exemption of the “prohibited transaction” must submit their own application to the DOL, however, after two filings have been approved, applicants will be able to take advantage of “EXPRO,” the DOL’s expedited application process. This process takes 45 days, and if no response is received, the request is considered approved. On March 3, 2003, a second proposed exemption was issued to Archer Daniels Midland Company (ADM), which when finalized would allow ADM to reinsure certain employee benefits, primarily life insurance benefits, through their captive. As the ADM exemption proposed the same conditions as the CEG proposal, it is expected that the DOL will consider the two “substantially similar” and pave the way for others to file through the EXPRO process.
Though the new captives market is still primarily for larger companies, the recent shift in policy by different regulatory bodies has made captives more “benefit friendly.” Now that the 30% seems attainable and the EXPRO process seems all but assured, it will be worthwhile for many companies to examine the feasibility of placing certain benefit programs into their captive. For many companies, placement could be a significant pay-off if the 30% level is reached. Others will find the costs of “enhancing” benefits, independent fiduciaries, and legal fees to be cost-prohibitive. At least there is now a new funding option on the horizon that may be the key for rate relief, cash flow, and tax advantage in the world of rising insurance costs.