18 minute read
ROLLING THE DICE ON EMERGING RISKS
by SIPC
CAPTIVES SEEN AS PROMISING SOLUTION FOR REINING IN COSTS RELATED TO CYBERATTACKS, POLITICAL INSTABILITY, EXTREME WEATHER AND OTHER SERIOUS CONCERNS IN THE YEARS AHEAD
Written By Bruce Shutan S S ince the most serious insurance risks will continue to evolve in an ever-changing world, top priorities may shift right alongside the moving targets of catastrophe. But one prudent strategy remains the same: the use of captive insurance to avoid financial ruin. Industry observers say this alternative risk transfer vehicle will keep powering organizations through a maze of uncertainty that includes cyberattacks, political instability, extreme weather, supply chain disruption, the mounting use of drones and legalized marijuana.
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Captives can help minimize any losses from cyberattacks by offering a layer of protection beyond where the commercial insurance marketplace is willing to tread and speed a return to business as usual, says Harry Tipper, III, chief operating officer – insurance, for CaptiveOne Advisors LLC. They serve as a risk-management mechanism that may include state-of-the-art cybersecurity insurance inclusive of a financing mechanism for cyber intrusions.
“Think of a cyber incident your company may experience,” explains Tipper, who moderated a workshop on using captives to cover emerging risks at SIIA’s 2019 national conference in San Francisco. “A captive insurer may not solve the problem of a cyberattack, but it can help provide funds by which you can start to bring in the experts who can do some additional security work, as well as providing the funds
needs to hire a public-relations firm that can rebuild your brand or reputation.”
Captives help fill gaps resulting from numerous exclusions in cyber insurance policies, notes Sandra Fenters, President, Capterra Risk Solutions, LLC and a member of SIIA’s Captive Insurance Committee. “That’s why we’ll write a difference-in-conditions policy,” she says. “A lot of times they keep their traditional policy and buy expanded coverages.” Harry Tipper
One such example is an act of war, which is typically found in property insurance policies and other types of coverage. Fenters recalls how Merck & Co. lost $1.3 billion in a June 2017 cyberattack traced to Russia’s military intelligence agency, which crippled more than 30,000 laptop and desktop computers. Most of the pharmaceutical giant’s 30 insurers and reinsurers denied coverage and the case was later litigated.
Captive solutions come in various shapes and size – from individual and group captives to heterogeneous and homogeneous entities. One example that Tipper cites is a trade association that forms a captive insurer to make some of these insurance coverages and services available at a discount as a benefit of membership.
His company’s clients include smaller businesses that don’t necessarily have the resources for costly cyber security as a shield for personally protected information or confidential health information. In many cases, he says they have to balance the breadth of coverage with budget constraints, particularly in the area of ancillary risk management/risk mitigation services.
Tipper recalls a conversation he had about three years ago with one vendor that his company was considering to provide cyber security services to its clients. It guaranteed that its firewalls and real-time threat analysis would eliminate any cyber incursions, but the cost of this platinum service was an eye-popping $250,000 a month. He describes the amount as “unfathomable” to smaller businesses which currently must rely on the services of third-party vendors, the commercial equivalent of LifeLock, Norton or McAfee, to provide them with cyber security.
Sandra Fenters Cyber insurance is one of the most expansive policies in the market with at least 10 insuring agreements largely because there are so many disparate areas to address, Fenters surmises. There’s a myriad of subcategories under the cyber-risk umbrella, including computer security and privacy breaches, cyber theft, espionage, extortion and cyber terrorism.
CHAIN REACTION TO CYBERATTACKS
The frightening part is that these episodes bleed into larger business concerns that include loss of revenue, reputational damage, business continuity and supply chain disruption. “It’s a massive exposure that touches the most exposure points I’ve ever seen,” she opines. Countering cyberattacks and data breaches, which have increased exponentially, is a chief concern across all organizations between a deepening global interconnectedness, as well as explosion of mobile devices and social media.
Despite these mounting risks, her client base has been fortunate thus far. The closest any of them have come to a cyberattack was when a distributor of fuel products lost nearly $50,000 in damages stealing from someone stealing credit card information from a gas station pump.
However, newer worries are fast emerging over a related area, which is the uncertain impact of political risks in an increasingly unstable geopolitical environment. She cites several examples that include government confiscation of
property, civil commotion, an inability to convert foreign currency, terrorism and trade embargoes.
“There’s a ton of political risks that we see a lot of our captives writing administrative-action type policies to cover,” Fenters reports.
Supply chain disruptions in an increasingly global economy are another emerging area of mounting concern among smaller American businesses. While politics makes some coverage problematic currently, Tipper’s current firm has worked with its clients to provide a means within a captive insurance vehicle to develop a funding mechanism in the event of trade disputes have to be litigated outside the U.S. in the supplier’s home country’s courts where it can be much more expensive.
In this case, he says many of his clients are following a simple, prudent riskmanagement strategy by choosing a heterogenous group of suppliers or vendors
that’s not limited geographically. “It’s acting in the same way that you don’t put all your investment portfolio into one sector of the economy.” The biggest challenge to the supply chain now is underwriting political risk, he adds.
BRACING FOR HEAVY WEATHER
Captives also help fill coverage gaps for other emerging risks, including the growing category of weather-related concerns. Tipper once ran a Bermudabased company that focused on captives. While there, the firms that create the hurricane models for the insurance industry added a severity component to the computer model that previously just calculated the frequency probability of a hurricane or other catastrophic weather event occurring in a geographic area.
In response, several insurers writing property insurance asked several coastal communities in the Northeast to absorb an increase to their deductibles on their property policies between $25 million and $60 million in the space of just one renewal period because of concerns about climate change and severe weather, he recalls.
“Fortunately with a little bit of work, a captive was used to fund that gap so that they could build up a pool of resources over a period of time that in the event a severe storm came by and inflicted reasonably predicted damage, they would have the funding available to rebuild the community,” according to Tipper.
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Mike Woytowicz
Whereas the cyber area was a unique and highly specialized emerging risk 20 years ago, increasingly severe weather driven in large part by climate change is an emerging space for captive insurance, observes Mike Woytowicz, director of business development for Artex Risk Solutions’ International division. He’s based in Bermuda where hurricanes and Bermuda Triangle folklore are cultural markers.
Woytowicz recently helped incorporate a captive that essentially mirrors the weather derivative contracts available in the market for an energy distribution company to deal with Mother Nature’s wrath. The captive is being used to “de-risk” electric operations and assist weather risk management strategies by allowing the client enough flexibility to increase or decrease the insurance market attachment point (i.e., strike price) for various options available.
The arrangement, which ultimately provides less downside or upside volatility in the company’s operations, serves as a hedge on either side of what’s being bought in the traditional derivative marketplace to guard against soaring gas prices in frigid winters or much higher electricity costs in scorching hot summers.
“If they were buying a put or a call at, let’s say, $50 per kilowatt hour strike price,” Woytowicz explains, “we used the captive to fill that in below that strike which buys that strike down.” The pricing becomes more affordable as carriers move away from the attachment point or strike price in the traditional marketplace because the lower the strike price, the quicker the derivative triggers.
A derivative contract also can be structured as an insurance policy that does not trade on the derivative market. Many organizations do not necessarily think of using insurance or a captive to also supplement or complement the same derivative strategy, according to Woytowicz.
BREAKEVEN POINT
While companies that increasingly use captives to rein in employee benefit costs on the medical stop-loss side can expect dividend payouts in good years, that experience doesn’t translate for weather-related risks. “The weather insurance market, in its current state, is pricing seems basically breakeven,” Woytowicz reports. “No one’s really making or losing money, or not like you see with a traditional insurance policy.”
There are other considerable differences such as a short tail vs. longer-tail nature. For example, he says while medical stop-loss isn’t exactly long tail, employers don’t necessarily know whether or not they’ve hit their aggregate until several months after claims have been sorted out and final bills are sent.
On the weather side, however, Woytowicz notes that the cost of oil or gas can be tracked on a daily basis. “ There are energy transmission organizations that coordinates the movement of wholesale electricity and they monitor and collect the pricing data for every hour of every day,” he says, “and if the price of energy hits the strike on any given day, you know instantly when the contract triggers, so it’s a bit different of an animal.”
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This example is illustrative only and not indicative of actual past or future results. Stop Loss is underwritten by Berkley Life and Health Insurance Company, a member company of W. R. Berkley Corporation and rated A+ (Superior) by A.M. Best, and involves the formation of a group captive insurance program that involves other employers and requires other legal entities. Berkley and its affiliates do not provide tax, legal, or regulatory advice concerning EmCap. You should seek appropriate tax, legal, regulatory, or other counsel regarding the EmCap program, including, but not limited to, counsel in the areas of ERISA, multiple employer welfare arrangements (MEWAs), taxation, and captives. EmCap is not available to all employers or in all states.
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DRONES AND MARIJUANA
Other emerging risks include the use of drones and legalization of marijuana across the U.S. dubbed “the green goldrush.” Fenters has many construction clients, whose industry is known for using drones to track the progress of a large or complex building project, as well as on the agricultural side, which relies on drones to survey crops and make more effective use of the land. Major retailers also are looking to follow Amazon’s lead by testing drones for home deliveries.
But the question is, how businesses can reap the benefits of an unmanned aircraft and protect themselves from the risk of property damage or loss of growth in that area? “Drones do crash,” Fenters says. “If the drone is carrying cargo, what safety features do they have to prevent damage? The FAA is starting to finally come up with requirements for how to operate them and to meet the licensing requirements.” She notes that the Insurance Services Office is currently working on a drone-related product for property coverage.
As for marijuana, she reports that insurance carriers are scrambling to determine the ramifications of driving under the influence and other issues in states that legalize medical marijuana and/or recreational use. Fenters says another area of concern is the impact on workers’ compensation in the event that employees being high in the workplace trigger accidents.
Meanwhile, the way emerging insurance risks are managed in the years ahead will offer an opportunity to break silos that have separated the risk management and insurance teams and more financefocused derivative teams, which are purely focused on hedging. As global companies evolve, Woytowicz believes it is possible that risk managers will be increasing their collaboration with the derivative teams on strategies to minimize potential losses to a company’s balance sheet by either utilizing a captive and derivative combination.
Bruce Shutan is a Portland, Oregon-based freelance writer who has closely covered the employee benefits industry for more than 30 years.
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Q & A ACA, HIPAA AND FEDERAL HEALTH BENEFIT MANDATES: Practical Q & A
The Affordable Care Act (ACA), the Health Insurance Portability and Accountability Act of 1996 (HIPAA) and other federal health benefit mandates (e.g., the Mental Health Parity Act, the Newborns and Mothers Health Protection Act, and the Women’s Health and Cancer Rights Act) dramatically impact the administration of self-insured health plans. This monthly column provides practical answers to administration questions and current guidance on ACA, HIPAA and other federal benefit mandates.
Attorneys John R. Hickman, Ashley Gillihan, and Carolyn Smith provide the answers in this column. Mr. Hickman is partner in charge of the Health Benefits Practice with Alston & Bird, LLP, an Atlanta, New York, Los Angeles, Charlotte, Dallas and Washington, D.C. law firm. Ashley Gillihan and Carolyn Smith are senior members of the Health Benefits Practice. Answers are provided as general guidance on the subjects covered in the question and are not provided as legal advice to the questioner’s situation. Any legal issues should be reviewed by your legal counsel to apply the law to the particular facts of your situation. Readers are encouraged to send questions by E-MAIL to Mr. Hickman at john.hickman@alston.com.
ICYMI 2019 ENDS WITH SIGNIFICANT HEALTH BENEFIT DEVELOPMENTS
By far the biggest news in the health benefits world at the end of 2019 is the repeal of the so-called “Cadillac plan” tax that was enacted as part of the Affordable Care Act (ACA). The Cadillac tax repeal and other health related provisions were included in the end-of-year spending package for fiscal year 2020, enacted on December 20, 2019 (the “FY 2020 Spending Bill”). This article provides a high-level overview of these and other significant 2019 year-end developments.
END-OF-YEAR LEGISLATION
The FY 2020 Spending Bill had some important changes impacting health benefits:
Repeal of the so-called Cadillac plan tax o This was a 40 percent excise tax on the cost of certain employer sponsored health coverage in excess of a specified dollar threshold. Health benefits that would have been affected included major medical coverage, health FSA and HRA coverage and pre-tax funded HSAs. The tax was originally scheduled to go into effect in 2018 but was previously delayed until 2022. Even with the delayed effective date some employers had begun to modify their major medical plans to avoid triggering the tax, such as by increasing deductibles and co-pays. The push for repeal grew as many policy makers increasingly viewed the tax as impacting middle class Americans. Repeal is welcomed by employers and employees alike. Repeal of the health insurance tax (HIT) Beginning in 2021
The HIT is imposed on health insurers and certain self-funded MEWAs based on their relative market share of premiums for major medical plans and certain other health plans. Although the tax is imposed on the health insurance company, it is generally passed through to consumers as part of the premium. The tax went into effect in 2010, and under prior legislation was suspended in 2017, went back into effect in 2018, and was again suspended in 2019. The tax will apply for 2020 and is finally repealed starting in 2021. In less welcome news, the FY 2020 Spending Bill also extended the PatientCentered Outcomes Research Institute (PCORI) fee for 10 years.
This fee is imposed on both self-funded and fully insured health plans as well as HRAs. The fee for a year is equal to the average number of lives covered under the plan multiplied by a dollar amount. The dollar amount was originally set at $1.00 and is indexed for inflation. After the last inflation update, the dollar amount was $2.45. The fee is due once each year, on July 31. This fee was originally effective for plan years ending on or after October 1, 2012, and before October 1, 2019. The FY 2020 Spending Bill moved the end date for the fee, so that it now applies to plan years ending before October 1, 2029. The dollar amount is not yet known but would be slightly higher than $2.45 due to inflation adjustments. The IRS PCORI Fee website has further information, but as of this writing has not yet been updated to reflect the extension of the fee.
In addition to health provisions, the 2020 Spending Bill also includes the SECURE Act, which makes a variety of changes to retirement plan rules.
APPELLATE COURT RULING IN LITIGATION CHALLENGING THE CONSTITUTIONALITY OF THE ACA
In its December 2018 ruling, a federal district court concluded that, since Congress reduced the ACA individual mandate penalty to $0 in 2017, the mandate is unconstitutional and, therefore, the entire ACA is invalid.
The decision was appealed and, in a ruling issued in December 2019, the federal court of appeals agreed that the individual mandate is now unconstitutional but did not agree with the cursory opinion that the entire ACA must necessarily fall.
The appellate court sent the case back to the district court for a thorough analysis of which, if any, parts of the ACA are now unconstitutional. In the meantime, the law continues to remain in effect. Ultimately, this issue is expected to reach the Supreme Court, but a final decision will take some time.
Note: The effective elimination of the ACA individual mandate has prompted some states to pass individual mandate laws that also require reporting by coverage providers, including employers who sponsor group health plans.
To date, the following states have passed such laws: New Jersey, Washington D.C., Vermont, Rhode Island, and California. New Jersey and D.C.’s laws are effective in 2019, which means reporting will be due in 2020. The others become effective in 2020 with reporting to commence in 2021 (for 2020). Insurers and plan sponsors that cover residents in these states should ensure compliance with these requirements.
IRS DELAYS SOME ACA REPORTING
The IRS has issued some IRS Form 1095 reporting relief for certain ACA reporting requirements. While Form 1095 generally applies to health insurers, it may also apply to employers with self-funded plans. Notice 2019-63:
Delays the due date for furnishing 2019 Form 1095 to covered individual recipients until March 2, 2020.
Provides that no penalties will be assessed for failing to furnish a Form 1095-B or a Form 1095-C to recipients if prominent notice is placed on website that a copy may be requested and a copy of the notice is provided within 30 days of the request. NOTE: These provisions do NOT extend to forms required to be filed with the IRS.
Extends good faith relief to all ACA 2019 forms.
LOOKING AHEAD
A lot happened in 2019, including dramatic tax changes in the end-of-year legislation. 2020 looks to be a busy year as well. The agencies may raise the limit on permissible health FSA carryovers and possible guidance on whether certain expenses, such as direct primary care arrangements and health sharing ministries, qualify as a medical expense. We might see some Congressional developments as well, such as surprise billing legislation which was under discussion for possible inclusion in the spending bill but was not quite ready.
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