The captive industry may be about to receive a significant boost, which at least one insurance expert confidently forecasts as “likely to constitute a flood of new business”. With the Cayman Islands ranked as the world's second-largest captive jurisdiction, that can only be good news for Cayman's insurance industry.
The catalyst is a decision by the US Department of Labor (DOL) to change the rules regulating the funding of employee benefits. Under a 1974 law, only captive insurers which were already writing at least 50% of unrelated business were permitted to fund employee benefits. Few captives could meet that test and, as a result, practically all US employee benefits have until now been underwritten by third parties.
The DOL is proposing an exemption from Employee Retirement Income Security Act of 1974 for one company, on the basis of which others are expected to apply for and earn a similar exemption. That company is the Columbia Energy Group, a major producer of natural gas and oil, based in Herndon, Virginia. Columbia Energy intends to use its captive to reinsure the company's long-term disability plan. The exception is to be based on a series of conditions, all of which must be met before the exemption will apply.
Columbia Energy's plan relates to the long-term disability programme for the company's 100,000 employees. The company proposes to insure the plan with Employers Insurance of Wausau, which was recently acquired by Liberty Mutual, and then reinsure the business into its captive, Columbia Insurance Corporation Ltd. (CICL), based in Bermuda, with an authorised branch in Vermont.
The conditions that the DOL requires to be met before the exemption will be granted are specifically designed to protect the participants in the plan and their benefits fund. They include ensuring that CICL is a licensed insurer and reinsurer, and that the company has undergone a financial examination by the Insurance Commissioner for the State of Vermont.
One key DOL condition requires that, in the initial year of any contract involving CICL there has to be an immediate and objectively determined benefit for the plan's participants and beneficiaries, in the form of increased benefits.
Considerable improvements have been made to the Columbia plan. Previously, it promised a benefit of 30% of salary, up to the social security wage base, and 60% of salary above that threshold. The combined disability income from all sources, including social security benefits paid to family members, including social security, could not exceed 70% of earnings.
Under Columbia's proposed plan, the limited benefit up to the current social security wage base would be removed. The new benefit would be 60% of salary for all enrolled employees. The 70% maximum would no longer include payments to family members. In addition, Columbia proposes to adopt a more liberal definition of disability.
A further condition is that CICL must retain an independent fiduciary, at Columbia's expense, to analyse the transaction and render an opinion that the requirements of the law have been complied with. Charles Waldron, a principal and consulting actuary at Milliman and Robertson, has been appointed as an independent fiduciary.
The DOL has insisted that, in subsequent years, the formula Wausau uses to calculate premiums must be similar to those used by other insurers which offer comparable long-term disability coverage in similar programmes. The Department also insists that the premium charge to be calculated in accordance with formula must be reasonable and comparable to the premium charged by the insurer and competitors offering the same rating, or a better rating, for the same coverage under comparable programmes.
In Milliman and Robertson's opinion, the rate proposed for the Columbia plan is consistent with the actuarial projections, and the formula to be used by Wausau is similar to those in use in plans offered by other insurers.
The DOL also requires that the plan's insurers maintain an ‘A' or better rating from A.M. Best. Best currently rates both Wausau and its parent Liberty Mutual ‘A+'.
The extent to which the Columbia Energy exemption will be suitable for other companies is uncertain. Most insurance professionals believe that owners of comparable plans will be interested in pursuing a similar programme, but the complicated structure might deter operators of smaller plans.
The plan may attract certain tax advantages. A captive writing its own employee benefits programme may be considered to be writing a significant amount of third party business, which might allow for premium deductibility by the parent company. At issue are the US Internal Revenue Service rules on premium deductibility, which generally require companies to write more than 30% third-party business. Regulations in other jurisdictions require a higher percentage of third-party business.
The news about Columbia Energy comes in the wake of the increasing use of captives and other risk financing vehicles to handle international employee benefits pooling structures.
Freelance journalist Alison Cranbourne writes frequently on insurance-related matters.