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.

Robert Pozen

Robert Pozen

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.

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13 responses to “Self-Funding Health Benefits Could Kill Your Company”

  1. Self-funded health plans and stop loss policies are complicated. But if a company works with a experienced broker/consultant that understands this market, the employer can be protected from your examples of how things can go wrong. There are some bad contracts that set a small employer up for disaster. But there are good contracts that protect the employer and health plan from unknown risk. You bring up good points but are missing a lot of detail on how these plans are a good option for many small employers.

  2. The problem with proselytizing for more regulations on small group self-funded plans is that you have to first understand how they work. The author of this article makes good points as it pertains to LARGE group self-funded plans. But it’s clear that he has no experience working in the small group arena. The majority of self-funded products available to small groups have protections from many of the risks the author mentions. Working with an experienced advisor (broker, agent, consultant, specialist) is recommended for ANY small business. Going it alone is risky. Avoid 12/12 contracts, companies who LASER, excess loss policies without monthly accommodation, early termination penalties and understand your minimum attachment point. Just as I would never recommend a business owner fumble through a tax audit without the help of a professional, said business owner should not enter into a self-funded contract without first consulting a professional in the industry.

  3. This is a very misleading article and politically driven – there’s a new way to self fund, called level funding which is basically a risk free way for an SME to self fund

  4. Russ – in what way is this article politically driven? Are you saying that because “level funding” is the basis of a product that you’re selling?

    • Democrats don’t want SMBs to know that self ‘ level’ funding is appropriate and more AFFORDABLE for 50% of the CFOs / SMBs in the marketplace and the reason is because if too many small businesses choose NOT to buy traditional small group health insurance then the ACA’s community rating / small group health pools – which are already a DISASTER — get EVEN WORSE. I don’t care if SMBs buy from us. BUT they NEED to know that LEVEL FUNDING is 10-40% cheaper than buying traditional health insurance if they employ a fairly healthy population. Why should SMBs be penalized by the ACA and big business?! THEY NEED TO KNOW AND DESERVE TO KNOW THE TRUTH

  5. Pozen works for a left leaning think tank – so not surprised that this debate has gotten political. CFOs don’t care about politics. They care about knowing the facts and figures – right now the media is withholding the facts and figures because they are pro ACA. Not a shocker here.

  6. Just so everyone is on the same page, please note that Russ Carpel has a company that sells level-funded benefits options to employers.

    • CFOs deserve to know this option is available – whether they come to us for guidance or go to a competitor, is totally fine by me. But I am disgusted by the politics here and lack of clarity

      • Russ, there’s nothing political about facts. The “level funding” arrangements are the worst of both worlds. You either go self funding or you don’t, the in between hybrid approaches are useless. As a consultant, the first consideration is my client’s financial situation, if they can handle the risk, then we will pursue self funding. You don’t half ass anything, especially a line item as large as group health insurance. You conveniently haven’t discussed the downside of level funding arrangements (higher admin than true self insurance, higher SL premium because it’s packaged vs. competitively marketed, loss of plan design flexibility, etc.)

  7. While I have no doubt that Mr. Pozen’s article carries a definite political whiff, I am more concerned with the use of erroneous nomenclature and questionable sources being quoted for statistical support. For example, the referenced KFF study, which has been going on for several years now, is sorely lacking in accuracy at the lower end of the employer size tier. I have analyzed the wording of the questions used for their survey, and because I am also aware of the knowledge base of the persons who are the most likely to respond to those surveys on behalf of employers, and the tiny, tiny sample of their category of “small” employers used, all lead to misleading answers to questions relating to self-insurance, the types and extent of stop-loss used, etc. In further example of lack of basic understanding of the subject, Mr. Pozen refers to “premiums” in a self-insured environment, which is totally incorrect – employers do not “collect premiums” from their employees, if they did, they would have to pay premium tax – and they rarely administer health insurance plans or pay medical bills themselves (they either utilize a major insurance entity via an administrative services contract, or if they are smart, they utilize an independent professional Third Party Administrator to avoid the inherent conflicts of interest when an insurer acts as the administrator, stop-loss insurance carrier, provider network, and PBM to manage Rx claims). Education is the linchpin of a successfully implemented self-insurance program, and as other comments have pointed out, the package of stop-loss protection features, contract parameters, and the flexibility of plan design that comes from being free from plan benefit requirements make the option of self-insurance a viable alternative for employers at size levels previously considered “too small,” mostly because brokers advised them so, but not for valid reasons. Instead, “you’re too small” was a euphemism for the no-value-added vested interest of brokers who would be denied the ability to collect outlandish commissions from insurance premium products instead. I am a health insurance/benefits actuary with 40 years of experience in alternative benefits, delivery systems, and financing. I was designing, rating, underwriting, and paying claims on employer groups down to 20 employee as long ago as the early 80’s. Have there ever been any problems arise? Of course, but not at higher clip than occurs at 200 life, or 500 life, or 1000 life cases, so long as transparency in information and concept are hallmarks of the process for establishing an educated self-insured client relationship, and due diligence is performed at each step of the way. Is self-insurance always the best answer for any employer group, of any size? Of course not, but it should not be discounted on the basis of the self-evident questionable expertise demonstrated in this article. Self-insurance and its moving parts are a somewhat technical minefield when compared with the relatively “simple” aspects of plain old traditional health insurance, and should be discussed and explained by knowledgeable specialists.

  8. Mr. Pozen,
    Thank you for your article and at least bringing up the issue of self-funding for small groups.
    What I find both interesting and concerning is how you state there are advantages and “some treacherous disadvantages” to self-funding, but only one real objection is presented. And you fail to even discuss the numerous methods available to address the “treacherous disadvantage”. So let’s do that right here:
    1. A group can always go back to the highly overpriced ACA, especially now for groups under 100 employees – the price is the price, so there is no Risk for Self-Funding if under 100 employees if the plan is designed correctly. Why NOT save all the money possible until you have to go back to the ACA?
    2. If you group “qualifies”, look at some of the level funded products noted by some of the commentaries – these can be excellent stepping stones or permanent locations for some employers, but with less of the full advantages of true self-funded plans.
    3. Participate in a program that shares the risk through a pooled captive arrangement (groups 50 and up).
    4. Purchase “carve-out” policies that address some of the larger “risks” scenarios – like organ transplants, kidney dialysis, etc. or pre-arranged alternatives for care in high cost medical events.
    5. Design plans that hold insurance companies and health care providers accountable through real time claim management and integrity (not the excessive markup and errors hidden by the current ineffective and antiquated system).
    6. And there are even better options and ideas…
    Our firm has many small self-funded clients (20 to 100 employees) and every few years, upon review, traditional insurance may be an alternative due to an on-going major medical expense, but the vast majority save millions of dollars due to self-funding. Some of these employers have plans that pay 100% of their employees’ healthcare premiums for the workers and their families with little or no deductibles! There is no comparison on the quality and benefit to those employers and employees, in comparison, if they were thrown to the ACA.
    Thank you

  9. My employer uses a self funded plan admisistered and stop lossed with Aetna, using their network. My deductible is High, individual($2750),Family, ($11,000), with a 70/30 plan. My premium is still the same as it was on Aetna’s non self funded plan. My emploer does not disclose the price of my premium, or the policy terms. I feel as though I am getting ripped off, and not having the terms of my policy makes me anxious about his right to stop covering me if I had a major illness, or his right to just not pay the amount for certain illnesses. Is this legal?

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