Small and midsize employers continue to struggle to manage their ever-increasing health plan costs. Since 2005, the average family’s premium has increased 61%, and the upward trend will almost surely continue. Employers’ choices are shifting more costs to workers, bearing the increasing costs themselves, or a mix of the two.
Faced with this challenge, CFOs of midsized and smaller companies are increasingly looking to implement best practices that historically have been prevalent only at the largest companies. One such practice is moving from an insured health plan to a partially or fully self-insured one. This article outlines that general principles of self-funding for small and midsize employers, addresses potential challenges employers might face, and provides tips to help CFOs assess self-funding.
In a traditional medical plan insurance contract, the employer pays predetermined rates (premiums) to the insurance carrier, and in exchange the insurance carrier takes on all claims risk for one year. In a self-insured arrangement, the employer, as plan sponsor, hires a company to administer the plan, but the administrator draws on the employer’s general assets to pay the doctors and hospitals.
Under a self-funded arrangement, there is tremendous risk to the employer of a member having a large claim. To mitigate this risk, the employer typically purchases stop-loss insurance.
There are two major types of stop-loss insurance: specific (or individual) and aggregate. Under the former, once a single member’s claims reach a predetermined annual amount (for example, $50,000 or $100,000), the stop-loss carrier reimburses the employer for the rest of the member’s claims costs. Under aggregate stop-loss policies, the employer is reimbursed for the amount of claims (excluding any that are reimbursed under the specific policy) that exceed a predetermined amount for the year.
Self-funding is not a new or cutting-edge idea. In fact, 94% of employers with 5,000 or more workers do it, according to 2015 research by the Kaiser Family Foundation. Among those with 200-999 workers, 56% self-fund. It’s far less common where there are fewer than 200 workers, with 17% of such employers self-funding, but that’s up from 12% in 2008.
Why are more employers choosing to self-fund?
Reduced Taxes and Fees: States typically tax insurance premiums. When you self-insure, the majority of such premiums are removed. Moreover, the Affordable Care Act introduced new taxes on insurance carriers, who pass along increased expense to employers. While self-funded plans are subject to some ACA taxes, the tab is less than with an insured plan. Finally, self-insuring removes some carrier risk charges.
Plan Design Flexibility/Control: It seems that each year brings increased restrictions on plan designs. With self-funding, as long as the employer complies with certain rules, it can customize a plan that works best for the organization and its employees.
Increased Cost Transparency: When receiving that double digit health plan renewal each year, employers often wonder whether it truly is a fair renewal. When you self-insure, you see very clearly where your dollars are spent.
Given these advantages, why don’t all employers self-insure?
State-Imposed Limitations: Some states regulate or disallow sales of stop-loss insurance to smaller groups. For example, a New York state law prohibits the sale of stop-loss insurances to groups of 100 workers or fewer. If a smaller employer cannot protect itself with stop-loss insurance, self-insurance is just too risky.
Lack of Claims Data: It’s difficult to assess the viability of self-funding if you cannot access historical claims from your insurance carrier or if the data set is too small to make credible predictions. Those are common challenges for smaller employers.
Claims Spikes: Even with the protection of stop-loss insurance, claims still fluctuate, and the fluctuations are more pronounced with smaller groups. A small handful of hospitalizations, or even just one, can impact claims totals.
Additional Administration: When a company self-insures, it must become much more involved in the health plan, particularly regarding banking arrangements, compliance requirements, and managing plan design.
Is Self-Funding Right for Your Company?
If an employer determines that it wants to explore self-funding, what are some prudent steps to take? The following tips should help get you on your way:
Evaluate Your Claims History: Look at your claims for the last few years. Have you had many large claims (say, more than $50,000 or $100,000)? Model it out and see what your costs would have been if you had hired a third-party administrator and paid for stop loss during those years. A rule of thumb is that you’ll have a high claims year every five years, but you want to track savings over time.
Assess Your Tolerance for Risk: If you don’t have strong cash flow or if you sometimes struggle to make payroll, self-funding is probably not for you. If you envision being worried about an impending large claim throughout the year, it may not be worth the angst.
Consider TPAs in Addition to Insurance Carriers: Many of the nation’s top insurance carriers own their own third-party administrators (TPAs), which cater to smaller employers. They offer fewer bells and whistles than their parent companies, and their services are typically unbundled. However, they typically can run a self-insured plan for lower administrative costs and they often offer the same broad network of doctors and hospitals as the carriers at the same discounted rates. [Editor’s note: Summit Financial Corp., the author’s employer, does not offer TPA services for health benefits plans.]
As small and midsize employers continue to grapple with health care costs and regulatory requirements, they will increasingly look to best practices used by larger companies. While self-funding is not necessarily a good fit for every company, as small and midsize organizations assess their options, we expect they will continue to consider joining those who have been self-funding their medical plans for years.
Eric Gulko is a vice president and consultant in the Summit Benefit Solutions division of Summit Financial Corp.