Is Self-Funding the Right Choice?

Does going Self-Funded really save your money, or does it just sound good…

No matter how big or small a company is, there are always questions about how to handle health insurance for its employees. There are many ways to structure and fund an employer sponsored health plan, but what is the right way for your company? For most smaller sized companies, it is a question of offering health insurance or not. For most small to mid-sized companies, it is a question of how much of the healthcare burden to cover for the employee and their dependents. Should it all be paid by the company, how should it be shared, and what additional coverages should be offered (i.e., dental vision, etc.)? Lastly, for some companies (both large and small) the conversation becomes not only the items above but also how should the plan be funded and administered. Can the company afford to assume some or all of the risk on the population? Are the savings large enough to be overcome the risk involved? When an employer considers alternative funding structures, like self-funding, they are essentially deciding whether or not they are willing to take some financial risk at the hope of saving some money.

A fully-insured health plan is the most common way to structure an employer sponsored health plan. When fully-insured, the company seeking insurance pays a premium to a health insurance company and in return employees have the option to participate as part of the group. The premium covers both the cost of the claims and the cost of the administration. Most of the time fully-insured premiums are set once a year and remain in effect for a period of 12 months. Insurers oftentimes vary premiums to distinct groups based on the size of the group and the group’s past claims experience. When fully-insured, the health insurance company accepts the premium payment and is responsible to pay claims on behalf of the members. Covered members have predefined cost sharing benefits such as deductibles and copays, but all other costs are the responsibility of the insurance company. If an insurance company under prices the group they have to accept the outcome, if they overprice the group they either have to refund the group or risk losing them to another carrier.

When fully-insured, the company seeking insurance pays a premium to a health insurance company and in return employees have the option to participate as part of the group.

Below are five advantages to being fully insured. There are other advantages, but these are the most prevalent in the market.

Five Advantages of being Fully Insured:

• Not at full risk for bad claims experience
• Administrative burden of running a plan are built into the premium paid
• Budgeting for health insurance costs are static for set periods of time
• Ability to concentrate on what you are good at and allow Insurance companies to do what they are good at
• Increased ability to price shop for insurance rates from year to year

When an employer decides to offer a self-funded health plan, or often called self-Insured health plan, the company is acting as its own health insurer and is at risk to pay its own claims. There are different arrangements of who writes the checks and holds the reserves, but in the end the company is at risk for the payments that need to be made on behalf of its members. Under a self-insured plan there are both upside and downside risks to the employer. In the good years when lower claim activity occurs, the company could be saving money. In the years that experience is not as good, the company would be paying more claims and thus the cost of the plan may be more expensive. To help limit the fluctuations in cost most self-insured companies choose to purchase stop-loss insurance either for the entire group (aggregate) or per member (specific). These coverages help limit the downside risk of being self-insured, but also eat into the potential savings that could be found when becoming self-insured, especially in the good years.

Most people that are part of the self-insured health plan would not even know or notice a difference from being a part of a fully-insured plan. Members still pay premiums out of their paychecks and carry a card that allows them to go to the doctor. Oftentimes a member would not know they are part of a self-funded group because most of the time a major health insurance company is administering the plan. The medical card in the wallet of the member looks no different than other cards, it is just funded differently. In many occasions the same insurance company that had taken full risk on the group will be the administrator for the self-funded group and the health card in your wallet will not have any differentiation.

There are many different costs associated with being self-funded, with some being variable like the actual claims payments, and others being fixed like claims administration, stop-loss insurance, and other administrative costs. The variable costs fluctuate by month (like claim payments), while the fixed costs are charged either to the entire population or on a PMPM (per member per month) basis. Though this article does not dive deep into the cost and expertise needed to administer a self-funded plan, it is important to remember it is very time intensive and encompasses a lot more than just writing checks.

5 Reason many companies choose to Self-Fund their Medical Benefits

1. When self-funding medical coverage, companies have increased flexibility in benefits and other legislative issues. This increased freedom allows the company more flexibility in what they offer, and what they may choose not to offer. Self-funded plans are required to act under ERISA¹ rules, but even under these there is a lot more flexibility to do what you want. ERISA rules help protect both the company and the members in the plan. Self-funded groups also have increased legislative flexibility because they are not subject to risk adjustment, risk pools, age curves, and many essential health benefit restrictions.
2. When you offer a self-funded plan you no longer pay premium tax. This savings can be substantial when the group is large. For example, in California the current premium tax is about 2%. For a group of 1,000 members, paying $500 a month, that would equate to a total savings of about $120,000.
3. Manage your own cash flow. Under a self-funded plan, you can retain the full benefit of cash flow. If you can invest the cash flow at a reasonable return the benefits can be significant. Reserves are required to be held and are substantial in nature. Being able to hold your own reserves represents a potential investment income increase as reserves are substantial in nature. Under the traditional fully-insured approach the carrier retains excess funds and may or may not credit the employer with cash flow savings.
4. Some plans choose to become self-insured to eliminate the cost of insurance companies profit margin. It is true that insurance companies have profit built into their rates, but this is a bit of a slippery slope as a reason to become self-insured. Unlike popular belief, most insurance company profit margins are not very big. They make most of their money on quantity of members, not on the sheer profit on each member. Most major Blue Cross/Blue Shield plans limit their profit at about 2-2.5%, there are years that they make more or less than that. In the years that the profit is more many Blue plans require it be returned to the policyholder. The profit margins decrease as the size of the group increases. The groups most likely to consider self-funding are the largest groups where the margins are much smaller than the average stated above.
5. Companies like to feel like they are in control. Many companies like to be in control and thus becoming self-funded allows them to feel like they are in more control. By writing the checks and making final insurance related decisions many companies feel they are better serving their members/employees. Companies seeking to be in more control should remember that most self-funded groups still contract with a TPA or an Insurer to administrate their plan and thus are not completely independent. Self-funded employers have the ability to choose the amount of administration that they would like. They can choose to either do more themselves or pass on more of the responsibility to the administrator. Many time groups are paying for services in their fully insured premium that they either do not use or do not know about.

Not all companies are ready to take the leap to become self-funded, and more often than not companies choose to be fully insured until they are pressured into a change either by costs or by other representation. Before making that decision, we recommend reaching out to not only your insurance broker, but also an actuary to look at your options. We at Axene Health Partners, regularly assess the viability of companies becoming self-insured. This is done through thorough analysis of past claims experience, projecting future medical costs, and doing projected future savings and cash flow testing.

The most frequently asked question about self-funding that we get is “how big should our group be in order to consider self-funding?” The answer to that question is not as easy as it might seem. There is no magic number that makes it work. Groups of all sizes can thrive being self-funded, it just depends on the risk appetite of the company. If you are risk averse I would avoid self-funding, but if you are a risk taker and have the cash on hand to cover the risk I would consider it. For data and planning sake we would normally not advise a group of less than 1,000 total members covered (employees + dependents) to be consider self-funding. When there are less than 1,000 members it can often be hard to decipher noise from actual data trends. This does not mean that groups smaller than that cannot consider it, they just need to understand the additional volatility that might be present in the population.

All funding options should be explored including hybrid options of being partially self-funded. The transition to becoming self-funded often takes years and can be done by taking small steps towards full self-funding. This can be done through many options including lower stop-loss levels (i.e. lowering your risk of unpleasant experience), increasing member deductibles and partially funding the cost under the deductible, and various other Value Based Arrangements.

Every business has unique needs and wants, and it is important to remember there is always risk involved in making changes to health insurance. To date we have seen groups that have saved a lot of money by becoming self-insured and others that should have never made the transition. There are potential savings available, but they need to be looked at with sober eyes to see if the savings are worth the risk. Proper planning and assessment needs to be completed to have the highest possible chance of succeeding under a self-funded program. Making the decision to become self-funded is only the beginning of the decision. Once you are self-funded there are bevy of other things to be considered like who to contract with (TPA, Stop-loss, Care Management…), what to charge your members (Premium Equivalent Rates), and how much surplus/IBNR to hold. Future articles will be written to explore these topics and please do hesitate to reach out to us if you need help deciding on a future funding path for your plan.

¹The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that sets minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in these plans.

Joshua W. Axene, FSA, FCA, MAAA, is a consulting Actuary at Axene Health Partners, LLC and is based in AHP’s Temecula, CA office.