I support the goal of quality health care for all Americans, including the 38% of workers employed by businesses with between 3 and 199 workers, according to the Kaiser Family Foundation.
Unfortunately, under the Affordable Care Act, better known as Obamacare, starting this year employers with at least 50 full-time-equivalent workers must offer health insurance to at least 95% of employees and their dependents, or face stiff penalties.
That, I believe, will encourage many small companies to self-fund their health benefits plans. And that poses a problem.
Under self-funding, companies themselves collect premiums from employees, administer the health care program, and pay workers’ medical bills, rather than buy health care coverage from a traditional insurer.
Most of America’s large companies, those with more than 3,000 employees, engage in self-funding. Until now, relatively few small companies have done so. In 2014, 15% of small firms (under 200 employees) were self-funded. There was a slight uptick to 17% in 2015. But I expect that number will grow significantly in 2016 as small companies adapt to the new ACA rules.
According to Kaiser, in 2015 only 56% of small firms offered health care, vs. 98% of those with 200 or more employees. Among that group, those with 50 to 199 employees will be subject to the employer mandate for the first time. Those are the ones most likely to take the risk of launching a self-funded plan.
For small businesses subject to the employer mandate, self-funding offers both great advantages and some treacherous disadvantages.
On the plus side, beginning this year or next, many such businesses can effectively sidestep several ACA requirements by self-funding their health care plans. For instance, they can avoid the community rating requirements that restrict how much insurers may vary premiums based on factors like age and smoking status.
Small businesses can also avoid the medical loss ratio requirement, under which at least 80% of premiums collected by traditional insurers must be spent on health care activities, as opposed to administrative functions. And they can likely avoid the Essential Health Benefit requirement, which stipulates minimum coverage in 10 health care categories.
Companies that self-fund also tend to incur lower costs (absent a big claim) because insurers build in a risk premium and a profit margin. All self-funded plans are also exempt from the ACA’s new federal tax of 2% on healthcare premiums, as well as state taxes on health care premiums, which average 1.75% of premiums.
But a big company has a diversified employee base and the financial resources to absorb any overruns in health care expenses. A small company has neither. As a result, one unusually big claim can significantly damage or even wipe out a small self-insured company.
In order to limit the potential downside risk, small companies often purchase stop-loss insurance, which kicks in when an employee incurs unusually high medical expenses. But that strategy still presents problems.
The handful of large reinsurers that sell stop-loss insurance evaluate a firm’s employee base and self-funding program, and then charge whatever the market will bear. Since stop-loss policies are issued on an annual basis without guaranteed renewal, an unexpected rise in the health care costs at a small firm can lead to much higher premiums the following year or an abrupt cancellation of the policy altogether.
A potentially crippling scenario for a small business is not far-fetched. Say an employee is diagnosed with an obscure type of cancer. He needs intensive therapy for two to three years at a cost of millions of dollars. The stop-loss insurer may pay for his care for one year then decline to renew the contract. No other reinsurer will take on the policy, so the employer gets stuck with the bill. For many small businesses, that would be financially devastating.
With Congress gridlocked, it’s not politically feasible to pass amendments to the ACA, so it’s up to the states to act to protect small business. Although states are not permitted to regulate employer-sponsored health care plans, they are able to regulate stop-loss insurers.
In a bid to discourage self-funding by small companies, some states have prohibited insurers from offering stop-loss policies to businesses with fewer than a specified number of employees, while others have banned stop-loss policies with very low deductibles.
Those steps make for a good start, but financial incentives for better alternatives will be needed to limit self-funding to appropriate firms. Otherwise, the dream of affordable health care will turn into a nightmare for too many small businesses.
Robert C. Pozen, the former chairman of MFS Investment Management, is a senior lecturer at the MIT Sloan School of Management.