The Mechanics of Self-Funding

Overview

With healthcare costs trending at higher rates and changes through Health Care Reform, many organizations are dedicating more time to evaluating how their group benefit programs are funded. Understanding the mechanics of self-funding, can be challenging if you are unfamiliar with the basics.

The majority of group benefit plans are “fully insured,” where an organization pays a monthly premium to the insurance company who “fully” owns the risk. Regardless of whether the premium covers the insurance company’s expenses, they are responsible for paying.

This option is popular, because it’s perceived as less risky due to the fixed monthly cost. There is a misnomer that being insured keeps you at arm’s length from plan decisions and potential human resource nightmares. Some also argue that the administrative responsibilities also decrease when fully insured—perhaps. Yet, that would mean you have a complete understanding of the mechanics of self-funding, the other platform available.

Many employers simply shy away from self-funding because it appears complex. Our goal is to take the mystery out of self-funding.

The Pros & Cons of Self-Funding

Self-funding is an alternative funding platform, where an organization assumes the financial risk associated with group benefit programs. The organization typically partners with a plan administrator, often referred to as a third-party administrator (TPA), which in some cases might be an insurance company. The key difference is the organization uses its own money, including the monies collected from employees through payroll deduction to cover the healthcare expenses incurred and administrative costs. There are clear pros and cons to choosing a self-funded plan arrangement over the fully insured platform.

Pros

  1. With a self-funded health plan, you are in control of the plan design and are often able to avoid state-mandated plan provisions that are otherwise without input.
  2. When claims expenses are low, the organization reaps the reward of the cash savings versus fully insured, where the insurance company wins.
  3. You control the overall risk management with what is known as “stop loss” insurance. This safeguards your organization in the event a claims expenditure exceeds a predetermined threshold, ensuring your cash flow is protected and avoiding unforeseen expenses from depleting the company assets.
  4. Financial advantages of self-funding include the elimination of a 2% premium tax and having full transparency in the administrative costs paid to the plan administrator for claims and customer service responsibilities.

Cons

  1. The insurance company reaps the benefits under a fully insured contract, which typically comes in two forms. One being the lower claims expenses for a period of time, and second, by way of contracted discounts with providers. In some cases, being self-funded means the network savings you have access to through the TPA is less than the discounts achieved by insurance carriers.
  2. For self-funded plans, there can be unpredictability in cash flow. Since your organization is paying claims expenses rather than a fixed monthly premium, the expenses can fluctuate from month to month and even year to year, especially if your group is unhealthy.
  3. There is also what is known as a “lag” between when the expense is incurred by a plan participant and when the expense hits your books. If the expense
    is high dollar and eligible for reimbursement from your stop loss insurance, there may be a delay to you in recouping the money from the carrier. Continue reading to learn more about stop loss insurance.

Stop Loss 101

Stop loss insurance protects organizations against catastrophic risk associated with medical expenses. The plan will reimburse the organization at a certain threshold of expenses, which is predetermined each year or thereabouts.
There are two types of stop loss programs. Specific stop loss protects the organization from a catastrophic claim incurred by a single plan participant, while aggregate stop loss protects the organization against claims exceeding a total dollar amount for a given time period, regardless of whether the expenses are catastrophic in nature or not.

Example Specific Stop Loss Coverage

Example Specific Stop Loss Coverage

*The risk is owned by the organization and is not transferred to the stop loss carrier. This is an important consideration in terms of the deductible amount your organization is comfortable with.

Example Aggregate Stop Loss Coverage

Example Aggregate Stop Loss Coverage

* Any and all claim expenses that exceed this aggregate attachment point are now reimbursed by the stop loss company and are no longer a risk to the organization.

Contract Considerations

With the stop loss contract, there will be additional decisions to make, such as the deductible, shown in the Specific Stop Loss example on the previous page. You will also have to consider the conditions of the agreement in terms of what makes an expense eligible. Two primary factors are the incurred date of the claim and the paid date of the claim.
Most stop loss insurance carriers offer four types of contracts:

  1. Incurred in 12, paid in 12. This contract provides coverage for claims that are incurred and paid during the same 12-month policy year.
  2. Incurred in 12, paid in 15. This type of contract, also referred to as a run-out policy, provides coverage for claims that were incurred in the 12-month contract period and paid within the following three months of the contract.
  3. Incurred in 15, paid in 12. Also known as a run-in policy, this protects against claims incurred in the 12-month contract period, as well as the three months prior to the contract period.
  4. 24/12 or “paid” policy. This is typically only offered as a renewal option when staying with the same stop loss carrier from one year to the next. Essentially, the policy offers seamless protection from one year to the next regardless of when the expense was incurred or paid.

It’s also important to consider the laser provision, which sets a specific stop loss attachment point at a higher level for some individuals than others. For example, if John Doe has historically incurred $250,000 in claims, the stop loss carrier may insist that a higher specific or aggregate attachment point be placed on him.

Choosing a Plan Administrator

If you have chosen to use a self-funding arrangement, you must determine the plan administrator—either a TPA or an insurance carrier. Both are viable options. Simply being self-funded, regardless of who administers the plan, offers great flexibility; however, there are a few advantages to selecting an insurance carrier as the plan administrator, including:

  • Greatest savings potential through contracted network discounts
  • Proactive case management eliminating potentially excessive expenses
  • Stop loss protection factored into the contract for administrative ease and decreased risk in cash flow mishaps

In Summary

There is no one-size-fits-all solution to benefits. As you develop and refine your health and benefits strategy, be sure it is aligned with your organization’s strategic goals and objectives. Talk to a trusted advisor to see what funding option makes sense for you.

The Mechanics of Self-Funding

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