A4: Regulatory Considerations for Stop Loss Captive Programs

A4:

Regulatory

Considerations

for

Stop

‐

Loss

Captive

Programs

Panelists

Mike Ferguson

President & CEO Self‐Insurance Institute of America, Inc.

Tess Ferrera

Partner Schiff Hardin

Lisa Kaderabek

Partner McDermott Will & Emery LLP

David F. Provost, CFE

Deputy Commissioner, Captive Insurance Vermont Department of Financial Regulation

Moderator: 

Sean B. Rider

Managing Director ‐Sales and Consulting, Willis Global Captive Practice Willis North America Inc.

Regulatory Considerations for

Stop-Loss Captive Programs

INTRODUCTION

– Numerous regulatory concerns that must

be considered when launching a captive.

– Specific topics to be covered during this

session will include:

• ERISA Concerns;

• Securities Law Concerns; and

ERISA Stop Loss Captive

Considerations

• If captive is deemed to be an

“employee benefit plan, ERISA

fiduciary concerns trigger?

– Is stop loss an employee benefit within

the meaning of ERISA?

– Does the captive contain “plan” assets.

• As a rule, stop loss is not thought to be

an employee benefit.

– Stop-loss coverage is not a benefit

described in ERISA § 3(1).

– DOL Advisory Opinion 92-02A letter to

SIIA concluded, based on the specific

facts presented that stop-loss coverage

an ERISA plan.

• In AO 92-02(A), the DOL decided that the stop loss policy was not a “plan asset” because, for among other reasons,

– the insurance proceeds were payable only to the employer,

who was the named insured under the policy;

– the employer had all rights of ownership under the policy;

– the policy was subject to the claims of the employer's

creditors; and

– neither the plan nor any participant or beneficiary of the

plan had any preferential claim against the policy or any beneficial interest in the policy.

• Is it possible for a stop loss policy to be

deemed an employee benefit plan?

• Employee vs. employer contributions

• The owner of the policy

• Rights of plan participants to any recourse

against the policy.

–

Patelco

Credit

Union

v.

Sahni

,

262

F.3d

897,

909

(9th

Cir.

2001)

(checks

issued

to

employer

from

stop

‐

loss

carrier

were

plan

assets

where

employer

had

exclusive

control

over

plan

account

and

could

use

assets

to

benefit).

Low

• If the stop loss coverage in the captive

is not a “plan asset,” NO ERISA

concerns.

• If the stop loss coverage is deemed to

be ERISA covered, lots of ERISA

concerns.

• If arrangement provides coverage to

multiple employers, Multiple Employer

Welfare Arrangement (“MEWA”)

concerns.

– What is a MEWA?

– ERISA’s MEWA preemption provision

would apply. In general, state law not

preempted.

– States think the term MEWA is a

four-letter word.

• ERISA’s standards of fiduciary care

and loyalty apply.

• ERISA’s prohibited transaction

provisions trigger.

BREAK

Regulatory

Issues

for

Captives

Securities

Laws

Presented by: Lisa M. Kaderabek

McDermott Will & Emery LLP

11

What is a Security?

•

Statutory

Definitions

•

Court

Cases

•

Application

to

Common

Captive

Statutory Definitions

participation, profit‐sharing agreement, transferable 

share, voting trust certificate, certificate of deposit, put, 

call, option, warrant, etc.”

• Definitions alone are not enough:

‐your “note” for your home mortgage is not regulated as a security

‐con‐men can call a penny stock a 

fluffy bunny (“Prime Bank Investments”)

‐country club and condo and co‐op 

ownership “interests” regulated but not necessarily as securities

‐trade and social group memberships

‐health care: PHOs and other physician 

membership networks (state no action letters based on “not a security” analyses)

45426425v1 13

Court Cases

• 2 Seminal Supreme Court Cases

United States Housing Foundation, Inc. v. Forman 

• 5 characteristics of a security

1.  Right to receive dividends/apportionment 

of profits

2.  Negotiability (realize value) 3.  Ability to pledge or transfer

4.  Voting rights proportionate to number of shares 

owned

5.  Potential for appreciation in value

Court Cases (continued)

• An investment of money

• In a common enterprise

• In the reasonable expectation of receiving profits from the significant managerial efforts of others

45426425v1 15

Application to Captive Structures

(Not dependent on type of captive risk (stop

‐

loss, etc.))

‐

Ask these questions:

From Forman

•

Do the shares/interests pay dividends?

•

Are the shares/interests transferable?

•

Can the shares/interests be pledged?

•

Are

voting

rights

tied

to

number

of

shares/interests

owned?

Application to Captives

(continued)

From Howey

•

Is there an “investment” or is the capital better

viewed as a payment to participate in/gain access to

an Insurance Program?

•

Is there a profit expected from the managerial

efforts of others (not tied to owner’s loss

experience)?

45426425 17

Application to Captives

(continued)

Other

Factors

(from

other

cases)

•

Do

marketing

efforts

focus

on

return

on

investment?

•

Do

brokers

(securities

brokers)

get

commissions?

•

Is

there

a

market

for

instruments?

•

Can

the

general

public

(not

industry

insureds)

purchase/own

investments?

Typical Captive Feature Mix May

Include

• Non-transferable/pledgable • Only insureds may own

• Dividends (v. policyholder distributions) based on owner’s loss experience

• No market/no broad-based marketing

• 1-owner, 1 vote (notwithstanding number of shares) • Shares may not appreciate in value

• Redemption payments tied to owner-specific account based on loss experience or return of initial capital • Self-management of insurance company operations

(board consists of representatives of insureds/all insureds are represented on the board)

45426425 19

Conclusion

Depending

on

this

mix

of

Factors,

interests

in

a

Captive

may or

may

not be

securities:

•

Draft

terms

of

all

documents

to

support

this

argument

Substance Over Names

Naming a relationship:

•

“participation agreement”

•

funded account

•

collateralized interest

Lots of reasons these may not be securities 

(based on particular characteristics) but name 

alone does not complete the analysis

What to do with Uncertainty?

Federal Exemptions:

• “Not a public offering” ‐ ‐Section 4(2) of Securities Act of 1933

• Defined in Reg D

‐limited number of purchasers

‐accredited investor definition

‐no general solicitation or advertising    • Anti‐Fraud

‐Provide disclosure (should do this in any event due to 

complicated programs and to maintain good relationships)

State Exemptions

“They sold us a piece of the clear blue sky”

‐ All states must have a Reg D‐conforming exemptions (although a filing and  fee may be required)

‐ Exemptions based on limited numbers of in‐State purchasers are also often  available

45426425 23

Special Problems:

California Insurance Code

you may have found an exemption):

“An insurer shall not sell in this state…or offer for sale, negotiate 

for the sale of, or take subscriptions for any security of its own 

issue until it shall have first applied for and secured from the 

[insurance] commissioner a permit authorizing it so to do.”

• holding company structure

• get permit

• lack of enforcement/rely on “not a security” position

Where is the interest “sold”?

‐

Offshore signatures/no onshore 

meetings, marketing, etc. (often required 

for tax compliance purposes anyway if an 

onshore 953(d) election is not made)

‐

Power of attorney for offshore execution

‐

Signing offshore may be a supportive 

factor in the mix, but US laws generally 

look to location of principal 

office/residence for locus in applying 

securities laws

Is Registration as a

Broker-Dealer Required?

• Generally, an Issuer of securities (the Insurance Company) is exempt  from broker‐dealer (and agent) registration if the Issuer itself offers  the interests through actions of its officers (and does not charge a  commission)

‐ documents should come from Issuer’s email ‐ issue for sponsors

‐ ministerial acts by insurance manager at direction of Issuer  okay

• Insurance broker should not

‐ take a commission on the sale of the interest (commissions  on the insurance placed are okay)

‐ actively market interests for Issuer

‐ Grey area:  can advise clients on insurance coverage  provided by an Insurance Program (is this effectively acting  as a broker‐dealer for the sale of interests if they are  securities?  If there is no securities commission paid?)

What if Captive Gets it Wrong?

‐

tolerance for risk/scrutiny 

‐

long‐term relationships with insureds v. many 

exits and entrances

‐

number of insureds

‐

amount of contribution

‐

rescission as most likely remedy (but not the 

only possibility ‐ ‐

see “tolerance for risk”)

BREAK

Regulatory Issues & Concerns

•

Regulators at many levels have concerns 

about stop loss insurance

–

Is

it

stop

‐

loss

or

just

a

high

deductible?

–

Cash

flow

–

Small

employers’

resources

–

“Lasering”

–

Adverse

selection

–

Appearance

of

insurance

when

TPA

is

state

‐

regulated

insurer

–

Avoidance

of

state

‐

mandated

health

benefits

Regulatory Issues & Concerns

•Stop loss coverage with very low attachment points acts like 

insurance

31

Regulatory Issues & Concerns

Regulatory Issues & Concerns

33

“Lasering”:

the

practice

of

carving

out

expensive

employees

from

the

excess

coverage,

leaving

the

employer

responsible.

Regulatory Issues & Concerns

•Small employers with young, healthy employees will self‐

insure, leaving the older employees to the exchanges…

34

…

but

DOL

statistics

show

employers,

large

&

small,

tend

to

have

representative

Stop Loss Regulation

•

The NAIC developed a Stop Loss Insurance 

Model Act in 1995, amended in 1999.  The 

act:

–

Prevents

insurer

from

avoiding

regulation

by

selling

at

very

low

attachment

points

(gaming

the

system)

–

Makes

self

‐

insured

plans

retain

significant

risk

–

Established

minimum

attachment

points

35

Stop Loss Regulation

•

Per the NAIC Stop Loss Insurance Model, 

insurer may not issue a stop loss policy to a 

small group (50 or fewer employees) that 

attaches at less than:

–

$20,000

per

individual

per

year;

–

Has

an

aggregate

attachment

point

of

the

greater

of:

–

$4,000

times

the

number

of

members

–

120%

of

expected

claims

Stop Loss Regulation

•

For large groups (51 or more employees), 

the policy may not attach at less than:

–

$20,000

per

individual

per

year;

or

–

110%

of

expected

claims

in

the

aggregate

•

In no case may stop loss provide direct 

coverage of health care expenses of an 

individual

•

States may index the dollar thresholds for 

inflation

Stop Loss Regulation

•

An

NAIC

working

group

is

reviewing

the

model.

The

WG

and

a

number

of

states

are

considering

such

changes

as:

–

Increasing

the

minimum

attachment

point

to

$60,000

or

more;

–

Requiring

stop

loss

insurers

to

cover

IBNR

after

plan

termination

–

Prohibiting

“lasering”

of

claims