One of them is International Paper Co., the world's largest paper and forest products manufacturer with 100,000 employees, operations in 50 countries and revenues of $25 billion last year. Like SCA, Stamford, Conn.-based IP has also applied for a Labor Department exemption from ERISA rules, hoping to use a captive to finance its U.S.-based employee life insurance, disability and medical benefits. The company declined comment until its application is approved.

SCA is more forthcoming. Tesfazion anticipates the exemption will be approved before the end of the year. If it is, SCA expects to save 10% to 15% annually in premiums and other costs using a captive for the life and disability benefits versus buying traditional insurance. The plan is for Aetna Casualty & Surety, a licensed insurer, to "front" for the captive, i.e., underwrite the life and disability insurance for a fee though it will not bear any real risk. "Aetna will cede the entire risk to the captive once we form it, and then the captive will purchase reinsurance to spread this risk at a cost that is substantially less than buying traditional commercial insurance," Tesfazion says. The reinsurance market, she explains, is more cost-effective at the moment than the primary insurance market.

There are other savings attributed to the strategy. "We remove the frictional costs that commercial insurers charge to cover their overhead and profit, plus we increase our cash flow by keeping the premium within the subsidiary captive," Tesfazion notes. "We also advantage the investment income potential of this premium, as opposed to the insurer advantaging it."

The downside to the captive strategy, of course, is that the captive bears corporate risk not ceded to reinsurers, a percentage that SCA would not divulge. "This is not a one-size-fits-all-companies proposition," says Cole. "Whether or not you use a captive for employee benefits depends on many factors–if the company is cash rich or is interested in finding savings wherever possible, if it needs enhanced control over benefits rate-setting and reserve-setting or if it needs to fashion unique coverages like war risk insurance, where employees outside the U.S. are, in theory, exposed to dangerous situations and don't have insurance protection through life insurance. There are many situations that are very idiosyncratic to a company that may or may not make this a good idea. In some cases, the liabilities aren't deemed to be significant enough, or they've already been addressed through significant design changes so that financing the liabilities through a captive doesn't add that much value. This is really a very case-by-case decision."

SCA figures it knows its risks better than any third-party insurer ever could, Tesfazion asserts. "A captive gives us greater control over managing our risks since they are our risks to begin with, sinking to our bottom line when claims are filed," she adds. "That's pure incentive to control losses. And once we control these losses, the captive can charge a lower premium than a traditional insurance company would."

It makes sense: Commercial insurers generally base their premiums on industry loss averages, thus a company with loss experience lower than the norm will pay a premium that takes into account the higher industry average. Conversely, when a company insures via a captive, its loss experience can be viewed in isolation, generating a premium that is more closely aligned with its actual risk. "We expect a captive for employee benefits will be just as cost-effective as a captive for other corporate risks," Tesfazion says.

Once the captive is formed, SCA plans to have it insure U.S.-based property and casualty exposures, such as workers compensation, in addition to employee life and disability benefits. While Tesfazion would not comment on the potential tax advantages that would accrue to SCA in this regard, accountants say they are significant. "Given the right circumstances, employee benefits can provide sufficient risk distribution to qualify a captive as an insurance company for federal income tax purposes," says Jim Mannello, tax partner and CPA at accounting firm KPMG LLP in Stamford, Conn.

The Internal Revenue Service allows tax deductions for federal income tax purposes for premiums paid to transfer corporate risks to commercial insurers. When it comes to premiums paid to a corporate-owned captive insurance company, the IRS wants evidence that the captive is more than just a corporate subsidiary. Various tax court rulings over the years indicate that if a company can demonstrate that its captive either insures the risks of other companies or contains a sufficient distribution of its own varied risks, the tax deduction may be allowable. "Putting employee benefits risks in a captive that currently insures property and casualty exposures definitely gives the owner greater ammunition to argue a premium tax deduction," Mannello says.

"But there is never anything clear with the IRS. It's always a matter of interpretation," he says. "Still, we expect an explosion of companies in the next couple years seeking to put employee benefit-type coverages in their captives to avail potential tax benefits. That alone will prompt the IRS to finally clarify the premium tax issue, bringing this to a head."

Some companies, like New York-based, $67-billion Verizon Communications Inc., with employee benefits that fall outside the ERISA prohibitions, already are adding employee-benefit risks to their captives to avail themselves of potential tax advantages. "We offer a program to our retirees and employees where they can buy auto and homeowners insurance through three different insurance companies–Travelers, Liberty Mutual and Metropolitan," says Sheila Small, Verizon's assistant treasurer. "We then reinsure 30% of these risks through our captive to substantiate the premium tax deduction. We want to make the captive feel, taste and operate like a real insurance company."

Verizon's captive, Exchange Indemnity, insures a portion of the company's liability, workers compensation, property, employment practices liability and other risks. By reinsuring the auto and homeowners risks of its employees, the captive achieves what Small believes is sufficient risk distribution and third-party insurance business to qualify it as a bona fide insurer for federal income tax purposes. "This is not like the Eighties where captives would absorb third-party risks they knew nothing about just to get the tax deduction," she adds. "We know these risks because they are our employees."

Verizon is considering using its captive to fund those employee benefits currently deemed prohibited transactions under ERISA, as are a host of other companies. "ADM opened the door to all companies doing this and, consequently, we are seeing extraordinary interest," says Jill Husbands, a managing director at insurance broker Marsh Inc. in Bermuda, who specializes in captives. "We've held two conferences on the subject, each attended by close to 300 clients."

Alcon Inc., a Swiss health products company with $3 billion in 2002 revenues, is intrigued by the concept. "We're waiting to see what happens when other companies apply for the exemption," says Dave Spence, director of global risk management and insurance in the company's Fort Worth, Texas office. Alcon currently employs its Bermuda-based captive, Trinity River Insurance Co., to reinsure its non-U.S. employees' life insurance, disability and health coverage benefits, which are pooled together across the 180 countries in which it operates and insured by Generali Group, a Milan, Italy-based insurer.

Financing employee benefits outside the U.S. through a captive is a cottage industry. According to a study by Marsh, nearly one in three captive owners expect to use their captives to reinsure the multinational pooling agreements they have in place with insurers to absorb non-U.S. employee benefit programs. "By reinsuring the employee benefits, captives that are absorbing increasing amounts of property and casualty exposures in the current hard market can diversify their risk portfolios, thereby reducing overall risk," Husbands says.

Alcon would like to do in the U.S. what it already does in the rest of the world, says Spence. "Evidently, the key to obtaining the ERISA exemption is to match your plans very explicitly to what Columbia Energy and ADM did," he adds. "It is a very involved process." Both Columbia Energy and ADM declined comment for this article, but Ted Scallet, a partner at Washington-based Groom Law Group, offered a blueprint to obtain not only the ERISA exemption, but an expedited one. Scallet is representing both IP and SCA in their petitions to the Department of Labor and had worked on the Columbia Energy application at another law firm.

"The Labor Department about eight years ago formalized what I call the 'cookie cutter' concept to receive an exemption," Scallet says. "Basically, if two exemptions are granted that are substantially similar to each other and to what your company wants to do, then the department will provide a streamlined approval process, taking no more than 75 days upon receiving the initial application."

That's a substantial improvement from the time it took Columbia Energy to receive its exemption–two years–not to mention the six months it took ADM. But the expedited approval is viable only if the application matches the ones filed by Columbia Energy and ADM, what Scallet calls a "check the box" application. The first apparent requirement is to make sure the captive is licensed in a U.S. state, as opposed to an offshore domicile, which the Labor Department evidently is uncomfortable about given its lack of regulatory control outside U.S. boundaries. "You also need to have a captive that has been in business for at least a year, in order to demonstrate some kind of track record," Scallet says. "The Labor Department in both Columbia Energy and ADM wanted audited financials preceding the year in which the captive would handle the U.S. employee benefits."

Another requirement is to apprise the department how employees will benefit by the captive strategy. "DOL wants to understand that the captive will be financially advantageous not only to the corporate owner but also to employees," Scallet says. "Companies must show how the captive will provide employees either with an increase in benefits they're provided or lower costs to purchase those benefits–more benefits, same buck or same benefits, less buck."

These need not be onerous improvements, he notes. "As the person who negotiated the Columbia Energy deal, I can attest that DOL isn't looking for such significant improvements that they would eat up whatever savings are expected to accrue from the captive strategy," Scallet says. "You could argue that letting employees buy three times their salary in life insurance, rather than two times, or adding free accidental death and dismemberment coverages to the benefits provided, are demonstrable benefit plan improvements."

All in all, observers predict the Labor Department will be inundated with applications for ERISA exemptions and that employee benefits will soon be as common a risk in a captive as liability insurance. "There is no question that the regulatory climate has improved markedly and overcoming the required hurdles is not as seemingly insurmountable as it once appeared," says Cole from Towers Perrin, which is consulting to both IP and SCA. "Given the pressures in many companies to attract and retain top talent, a captive is now another avenue worth exploring."