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 Domicile Licensure Requirements Concerns. 1
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. 2
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 specific attachment point. 3
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 fourletter word. 4
ERISA s standards of fiduciary care and loyalty apply. ERISA s prohibited transaction provisions trigger. BREAK 45426425 10 5
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 Situations 45426425v1 12 6
Statutory Definitions Note, stock, bond, debenture, certificate of interest or 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 Characteristics of Securities 2 Seminal Supreme Court Cases 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 45426425v1 14 7
Court Cases (continued) SEC v. W.J. Howey Co. 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? Can shares/interests increase in value? 45426425v1 16 8
From Howey Application to Captives (continued) 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? 45426425 18 9
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 Operate to support this argument 45426425 20 10
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 45426425 21 What to do with Uncertainty? Comply with Exemptions from Securities Laws 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) 45426425 22 11
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 California Insurance Code (separate from CA securities law where 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 change the law! 45426425 24 12
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 45426425 25 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?) 45426425 26 13
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 ) 45426425 27 BREAK 45426425 28 14
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 stateregulated insurer Avoidance of state mandated health benefits 30 15
Regulatory Issues & Concerns Stop loss coverage with very low attachment points acts like insurance 31 Regulatory Issues & Concerns Cash Flow! 32 16
Regulatory Issues & Concerns Lasering : the practice of carving out expensive employees from the excess coverage, leaving the employer responsible. 33 Regulatory Issues & Concerns Small employers with young, healthy employees will selfinsure, leaving the older employees to the exchanges but DOL statistics show employers, large & small, tend to have representative populations 34 17
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 $20,000 36 18
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 37 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 38 19
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