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How can companies rein in escalating benefits costs? Get in on the action.
David M. Katz, CFO.com | US
May 6, 2003
St. Peter, don't you call me, 'cause I can't go,
I own my soul to the company store.
In October 1955, Tennessee Ernie Ford's recording of Merle Travis's folk lament, "Sixteen Tons," was released. The song, which was issued by Capitol Records, painted a bleak picture of Appalachian miners forever indebted to their employers for food, supplies, medical care, and other essentials. With its dramatic vocal and chain-gang-pounding rhythm, "Sixteen Tons" rose to the top of the Billboard charts in four short weeks, propelling Ford to stardom.
Since the sixties, however, the concept of the company store has fallen into disfavor, even disrepute. While scores of companies offer their employees discounts at hotel chains, museums, and even movie theaters, employers typically don't get reimbursed for their munificence. And making money off health insurance and pension plans is absolutely taboo. In fact, the framers of the Employee Retirement Income Security Act of 1974 (ERISA) required benefit-plan sponsors to put the needs of the beneficiaries above all others.
But old attitudes about selling to employees may be changing. Indeed, soaring group health insurance premiums and shrinking profits have some employers questioning whether they should be the sole financers of their workers' benefits. And while the primary focus is on cutting benefit costs -- rather than lightening employee wallets -- a growing number of corporates are putting the old company-store idea to fresh uses.
Admittedly, most are doing their selling at the front end of the store. With little cash to embellish benefits they currently offer, some employers are providing a venue where workers can buy a wide array of "voluntary benefits" hawked by outside vendors. Largely supplied by insurance companies, the voluntary-benefit offerings range from long-term-disability (LTD) coverage to legal services to -- most importantly -- pet insurance.
The roaring growth of AFLAC, which markets such non-traditional policies as hospital-indemnity (which pays employees cash for hospital stays) and cancer insurance, is a testament to the potential of the voluntary-benefits business. Pitching policies mostly to workers at companies with under 500 employees, the company with the famous duck has seen its U.S sales more than double, to over $1 billion since 1998.
The success of AFLAC -- and other voluntary- benefit vendors such as MetLife -- has convinced some corporates that employees are keen to purchase a wide range of insurance products in-house. But until now, employers have been prohibited from making money off their benefit plans, voluntary or otherwise. Under a fast-track exemption now being considered by the Department of Labor, however, companies that meet certain requirements can gain quick permission to reinsure benefits via their captive insurance subsidiaries.
While reinsurance doesn't provide a direct source of revenue, captive arrangements can provide parent companies with tax breaks, enabling them to provide cheaper benefits to employees. And in a good underwriting year, experts say, an employer can turn a profit off benefits reinsurance.
The lure of the business rests on a fact insurers have long known: When it comes to employee benefits, the company store is a cash cow. That's particularly true for large employers collecting benefit premiums via payroll deductions. Says Richard Goff, president of Towson, Md.-based insurance broker Mims International: "There can be a tremendous amount of cash flow each month."
In the past, employers have rarely chosen to tap that river of dollars. The major reason, say observers, is that it's hard for an employer to sell coverage to workers and act in their best interests at the same time.
Certainly, selling insurance to minimum-wage workers can come off as sleazy, even predatory. "As soon as you introduce a profit motive for the HR function, you introduce a philosophical conflict of interest," says Michael Main, a director at ChapterHouse, a strategy consulting firm in Downers Grove, Ill. "The idea of employee benefits is to provide health and welfare benefits to employees. It's kind of a selfless act to attract and retain quality employees."
Then again, corporations are not exactly famous for their acts of selflessness. Already, a few employers have purportedly taken the plunge into direct sales of benefits. Main points to one closely held California grocery-store chain where an officer of the company has been selling health insurance to store managers and cashiers for seven years. Main, who once worked as a consultant to the business, declined to name the company.
But he does note that, on paper, the company's health insurance program operates as a pure profit center. The officer who sells the insurance, a licensed insurance agent, turns his commissions over to his employer. The chain's HR department even conducts meetings about the coverage and enrolls employees in the plan, according to Main.
Granted, that plan isn't the stuff of conventional employee benefit programs. But executives of the chain think they're providing employees with a net gain: relatively cheap coverage for an under-served population of "gray-collar" workers.
Not on My Block
Given the raging potential for conflicts of interest, it's doubtful companies will have their HR heads out there selling annuities to factory workers any time soon.
A growing number of businesses are allowing outside insurers to set up shop inside their factory gates, however. Standard Register, a document-management company in Dayton, Ohio, lets insurance vendors sell a wide array of financial products to employees.
Richard Mayer, the total rewards manager of the company, says coining it off the company's 5,600 employees is "not what Standard Register's core business is." So why the company store? To reinforce the idea that "Standard Register is a great place to work," Mayer explains.
Standard Register is certainly a great place to shop. Among the company's current offerings: employee-paid Liberty Mutual auto insurance and homeowners coverage. Workers can also buy extra long-term disability, life, and accidental-death insurance to supplement the coverage Standard Register already provides. The company is also looking at the possibility of adding employee-paid long-term care insurance and pre-paid legal coverage.
Lately, however, reining in health insurance premiums has become a greater priority at the company than enriching its menu of voluntary benefits. Like many other employers, Standard Register was hit with whopping increases in its benefit costs in 2002. Last year, the company witnessed premium hikes of 12 percent to 17 percent for its various health plans. Those increases have company executives homing in on the issue of "what increases we will accept," Mayer says, "and what we are willing to ask the associates to pay for."
A lot of companies are asking the same question. The average employee share of premiums for individual coverage jumped 27 percent last year (to $454 annually), according to a Kaiser Family Foundation study. And for the first time in four years, more workers in the survey experienced benefit cuts than benefit hikes.
By allowing vendors to directly flog financial products to employees, some corporate executives may be hoping to camouflage the drop in company-provided benefits. And when those voluntary benefits purchases come directly from payroll deductions, some employees may barely notice they're paying more money for the same level of protection.
A Comfortable Sort of Risk
While some companies are trying to rein in benefits cost by cutting back on coverage, others are taking a slightly different tack: They're getting in on the action.
Executives at NiSource Inc., for example, have used the company's captive insurance unit to help keep long-term-disability premiums stable in a rising market.
It's a nifty plan. With the captive reinsuring a substantial chunk of the risk covered by UnumProvident, NiSource's LTD insurer, the corporation gets back some of the premium dollars it might otherwise have forked over to insurers. The captive can earn investment income on the premiums it collects. In a good underwriting year, NiSource can even turn a little profit on the business, says Timothy Bucci, the company's director of risk management and insurance. That money then goes toward cutting down on NiSource's benefit costs.
Aside from cost-cutting, experts say the big lure of using a captive to underwrite employee-benefit risk is the chance to lower taxes. For a company to qualify for a federal tax deduction on the premiums it pays to its captive, however, the captive must do as much as 50 percent of its business in risks unrelated to the parent corporation, explains Thomas Jones, a partner at law firm of McDermott, Will, and Emery.
There are other ways for a captive to get up to the half-way mark than reinsuring health and life insurance benefits, however. Sheila Small, the assistant treasurer for risk management and insurance at Verizon Communications, for instance, has added sizable amounts of non-related business to one of the company's captives by putting together a program that offers discounted auto and homeowners insurance and other personal-lines coverages to employees. Under the program, which the company has branded "Verizon Advantage," employees can get quotes over a 1-800 line from three different insurers—Liberty Mutual, Metlife, and Travelers—and pay for it via payroll deduction.
The voluntary benefits provide Verizon's captive with a tidy piece of unrelated business. After agreeing to reinsure a portion of the auto or homeowners coverage, the captive gets paid a certain amount per insured, minus an administrative fee. The captive can profit on amounts left over after claims are paid, according to Small. And auto and homeowners tend to be profitable lines of insurance, since carriers of such coverage don't often provide it if they don't get adequate rates, she observes.
Because the Verizon captive has been able to pile up outside business from other sources, there's less of an incentive for it to reinsure ERISA-regulated employee benefits. "We're still trying to get our arms around the added value [besides] getting third-party business," says Small.
But for other employers, employee benefits might fit the bill for outside business perfectly. Typically, benefits risk is considered to be unrelated since it's the employee -- not the employer -- who's insured. At the same time, the exposure can be a prudent one, since employers are likely to have a fairly firm grasp of the health and mortality risks of their own workers.
Until recently, however, NiSource was the only company able to partake of the advantages of a captive reinsurance arrangement involving benefits. Since 1979, the DOL has banned plan sponsors from buying coverage reinsured by the sponsor's captive. But in 2000, the department granted an exemption to Columbia Energy Group (which was acquired by NiSource a short time later).
The DOL now appears poised to grant similar permission to Archer Daniels Midland Corp. The proposed ADM exemption has passed unscathed through a comment period, and all that's lacking is publication in the Federal Register.
If, as expected, the exemption stands, the two exemptions could trigger a fair number of other employers eager to reinsure benefits through captives.
Under a DOL procedure put in place in 1996, if two exemptions judged to be "substantially similar" are granted within five years, an employer can proceed with a transaction in as little as 78 days from the time they apply for an exemption. Usually, it takes more than a year for the DOL to rule on an individual exemption, says attorney Nancy Gerrie, who also works at McDermott, Will & Emery.
Can Cheaper be Better?
Given the potential tax savings, the streamlined review process will likely have a few corporates camped outside the Department of Labor gates. Even with an exemption, however, a captive must satisfy other requirements in order to reinsure benefits. For starters, the captive or a captive branch must be domiciled in an onshore haven like Vermont. For decades, although the number of U.S.-domiciled corporate captives has grown steadily, most have been operating in offshore locals like Bermuda and Cyprus. A captive must also hire an independent fiduciary to vet the reinsurance deal. And the captive may only do business with insurers rated A or better by A.M. Best.
But the biggest hurdle to captives reinsuring their parents' benefit plans might be the quaint notion that an employer shouldn't profit at its employees' expense. To guard against abuses, the DOL requires the captive arrangement to spur an actual increase in benefits in the program's first year.
For its part, ADM seems to have complied handily with the enhancement requirement. Under the food producer's plan, Agrinational Insurance Company, ADM's Vermont-based captive, would reinsure employer-paid and voluntary life insurance benefits provided by Minnesota Life Insurance Company. Among the resulting improvements: salaried employees would see their maximum basic life insurance benefits hiked from $100,000 to $1 million, depending on salary, and get a new accidental death and dismemberment policy.
Convincing the government that a benefits plan has been improved can be a tricky business, however. If a company intends to use a captive to cut benefits spending -- and that's generally the goal -- its management will be hard pressed to convince DOL examiners the plan's been enhanced, says Richard Hamilton, president and general manager of CSX Insurance Company, a Burlington, Vt.-based captive owned by CSX Corporation.
Hamilton should know about the difficulties of getting DOL approval. In 1995, after a draining two-year process, CSX withdrew its application to fund benefits via the captive.