Medical Stop Loss & Healthcare Captives

Introduction

Hospitals, health systems, and physicians were some of the earliest adopters of captive insurance, opting to use captives for their medical malpractice risks. Today, these healthcare providers remain some of the largest industry sectors of the captive market. In fact, healthcare captives are currently among the biggest, most successful, and most stable entities in the entire industry.

This success has led healthcare captives to expand, extending from structures and programs primarily aimed at medical malpractice risk to include a wide variety of other coverages (workers’ compensation, general liability, property, cyber, provider excess, etc.). The success has also prompted healthcare captives to segment their underwriting into cell structures to cover physicians separate and apart from hospital exposures.

One specific area of expansion has been medical stop loss coverage for both health systems’ and physicians’ own health plans. Beyond being leading users of captives, hospitals and healthcare systems are among the industry segments with the largest percentage of self-insured employee benefit medical plans; the highest average number of covered employees per employer; and the highest average specific stop loss deductible (retained risk) assumed by employers. For many self-funded healthcare risks and mature captives, it makes sense to bring the funding of the health plan or the stop loss risk into the captive.

All in the Family – Unique Considerations for Healthcare

One of the unique aspects of hospitals and health systems self-funding their employee health plans—and participating in a stop loss program––through their captives is the ability to control the cost of employee care within the systems’ respective facilities. This has a twofold effect:

1. 1. It affects the rate at which a health plan is charged for the treatment of employees within the corresponding health system’s own facilities (“domestic charges”), as well as…
   2. The system’s ability to direct and prioritize care for its employees.

For the former, healthcare providers that self-fund their employee healthcare coverage typically “discount” their domestic employee claims by removing some percentage (if not all) of the normal profit margin that would be charged to the general insured public for treatment.

Because the plan is self-funded, maintaining a normal profit margin for claims charged against the benefit plan would be redundant to the employer, and would therefore result in unnecessarily inflated loss costs charged to the plan. In such cases, if the actual costs for treatment at the self-funded hospital or system are less than the allowable charges applied to the benefit plan, the potential for unnecessary overpayment by the plan and over-reimbursement by the stop loss policy also exists.

There is a wide swing in the rate at which self-funded healthcare entities discount their domestic claim charges. Most facilities tend to use 60 to 80 percent as the normal (discounted) reimbursement rate for medical expenses charged to the health plan. Alternatively, some healthcare employers absorb the full cost of in-facility treatment charges incurred by their employees by assuming a zero-percent reimbursement for domestic charges against the self-funded health plan.

Having the ability to discount the cost of domestic claim charges is an enormous advantage for self-funded healthcare providers (in comparison to other employers) in reducing the overall cost of employee care. In addition to benefiting the self-funded health plan, the ability to discount also reduces the size and number of claims in the stop loss program. Most stop loss carriers will not provide coverage to healthcare facilities that request a 100-percent domestic reimbursement rate, as this would include the respective facility’s normal profit margins.

However, discounts should be offset against the financial health and viability of the health system in question. Providing services at cost or below to employees removes internal profit from the self-funded health plan, but it also removes it from the health system overall, which can create a financial disincentive to treat employees within the health system. For this reason, most healthcare entities now elect to include some level of domestic claims within the self-funded health plan and stop loss coverage.

The second aspect of internal treatment is the ability to direct and prioritize care. Do hospital and health system employees have better access to care than employees in other industries? The answer to this should be “yes,” but health system experience can be poor, with low utilization. The high stress and long hours of many medical work environments present challenges for healthcare professionals to engage in healthy lifestyle behaviors. Studies have shown that, compared with the general population, healthcare providers are at an increased risk for coronary artery disease, type 2 diabetes, obesity, musculoskeletal injuries, and some cancers[1]. Health systems therefore remain highly susceptible to an increasing frequency of large, potentially catastrophic, claims.

Ongoing consolidation in the healthcare industry—due to health systems merging and acquiring physician practices—is also expanding the range and complexity of treatment capabilities that can be offered on an in-facility basis.

Captive Structures

Both single-parent and group captives are active in medical stop loss coverages, but with different goals and motivations.

• • Single-parent captives: For larger health systems that can support a single-parent captive for property & casualty risks, there are risk-spreading benefits to including medical stop loss in the captive. For the health system, self-funding a health plan creates volatility. In years when claims are high, the system will need funds to meet the worse-than-expected claims experience. The mature captive can be a source of such funds, using the surplus in the captive to protect against adverse claims experience. For the captive, this represents a way to deploy excess surplus and add more value to the parent organization. Going forward, funding medical malpractice (a longer-tail exposure) with medical stop loss (a short-tail exposure), both of which should be independent of each other, provides a better spread of risk for the captive, as well as a more efficient use of capital. Such coverage can also help to centralize the funding of retained risk for the health system, ensuring consistent approaches and central warehousing of risk data.

• • Group captives: Captives can also be a very useful tool for smaller, more rural community hospitals. Combining as a group allows them to achieve some of the economies of scale (in both risk retention and group purchase of excess coverage) available to larger hospitals and health systems. This is true for medical malpractice and property & casualty exposures as much as for medical stop loss. The same risk distribution benefits of incorporating both coverages apply to a hospital group captive as they would to a single-parent captive.

Nonprofit Considerations

Many hospitals and health systems are organized as nonprofits. If not structured correctly, the use of captives in these instances can create unrelated business taxable income [1] (UBTI), meaning the hospital will pay tax on any underwriting profits from the captive. Still, there are ways to structure a captive’s participation in a stop loss program to minimize the potential for UBTI.

For single-parent captives, this often involves doing the opposite of what’s generally needed to qualify as an insurance company for tax purposes. Failing this standard means transactions with the captive are most likely treated as deposit accounting and therefore are not subject to income tax.

For group captives, many look to a reciprocal structure to avoid the creation of UBTI. Under the reciprocal structure, each participant or member of the captive has a subscriber account, with all “profits” from the captive then allocated to said subscriber accounts. These accounts are subject to pass through taxation and can benefit from the hospital or system’s nonprofit status.

Understanding the tax statuses of hospitals and health systems, and how proceeds from a hospital/health system captive are treated, are key considerations for a nonprofit hospital and/or health system when setting up a captive or participating in a group captive. Status should ultimately be reviewed with a qualified tax expert who has a deep understanding of captive structures.

[1] The Health of Health Care Professionals, American Journal of Lifestyle Medicine, December 2020

The Future – Community Health Captives

As hospitals and health systems expand the use of their captives, what additional health insurance coverages can they include?

Two areas we would look to are: provider excess and community health captives.

• • Provider excess: With the increased use of value-based care, we’re seeing greater numbers of larger health systems using mature captives to assume a layer of the provider excess. This insures the risk of treatment costs are greater than the fixed price in the value-based care contract.

• • Community health captives: A natural captive expansion beyond providing medical stop loss to internal employees would be to write third-party business to provide medical stop loss to unrelated employers. This structure can be a companion to direct contracting with local area employers, adding the financial protection of the health plan to the contracting process. For the health system, the structure builds stronger links with local area employers and captures additional revenue from the insurance savings delivered through direct contracting. Over time, this model could extend outward to include employer experience refunds or group captive cells for groups of local area employers. This would likewise build stronger ties between the health system and local businesses, creating a forum with aligned financial incentives to address healthcare for the surrounding community.

Conclusion

Self-funding of employee benefit medical coverage is a particularly effective and efficient risk-financing mechanism for larger hospitals and groups of healthcare entities. Adding a layer of a stop loss program to a captive brings additional stability and efficiency. There’s an increasing trend toward using captives in this area, and we expect it to continue, expanding into other stop loss-related areas.