A crash course in self-funded small-group health insurance

"Another 20% increase? If this keeps up, I won't be able to offer insurance."

Small groups are regularly stomaching double-digit rate increases. But, many see this as a budget burden that could threaten their employer-sponsored health insurance (and, potentially, your paycheck).  And so, some are exploring self-funded options to reduce costs. What do small groups – and health insurance agents interested in this market – need to know?

Self-funded vs. fully insured: who bears the risk?

Insurance is all about risk. To understand the difference between self-funded and fully insured approaches, you need to know who shoulders the risk in each case.

For most small groups, plain old, fully insured health insurance has been the default choice. In this arrangement, the employer transfers the risk of loss – the costs of doctor bills, surgeries, prescription drugs, etc. – to an insurer. In exchange for assuming that risk, the insurer charges a monthly premium. 

Premiums are determined by a variety of factors. In the small-group market (assuming the group chooses Affordable Care Act-compliant plans), premiums are determined by the group’s rating area, the age of each subscriber and dependent, the tobacco status of each subscriber and dependent, and the number of subscribers and dependents enrolled. Non-ACA-compliant plans may use other factors, including previous health history, to determine their rates.

In a self-funded arrangement, the employer assumes the risk of loss. They’ll pay their share of doctor bills, surgeries, prescription drugs, and other services. And instead of paying premiums to an insurer, they’ll generally charge employees a premium to participate in the plan – pooling their money to help pay each other’s claims.

Limiting an employer’s risk in self-funded plans

You’re probably wondering – doesn’t that get expensive? How can employers –especially small ones --afford to pay the hospital bills if baby fever runs through the workplace? Or, worse, what if a plan member needs intense cancer therapy?
Enter stop-loss coverage. These policies do what they say they will – they stop the medical losses a group could be liable for in a given term,  generally a year. These policies also require a premium payment – no one takes on risk for free.
A group will need to consider three types of stop-loss coverage: Individual (or specific) stop-loss, aggregate-stop less, and specific run-out stop-loss. Underwriting policies and/or stop-loss insurer’s pricing models require specific attachment points for each type of coverage – that is, the dollar amount at which the coverage will kick in for the covered contract, or group.

Individual stop-loss attaches to individual contracts within the group. For example, an individual stop-loss policy might attach to a given contract after $20,000 of medical expenses – the employer is on the hook for that family’s first $20,000 in medical bills (employee cost-sharing notwithstanding). Beginning with the 20,001st dollar, the stop-loss carrier will pay for any additional claims on that contract for the remainder of the term. However, the employer is still responsible for claims from other employees.

That kind of expense can strangle a budget, so many employers also invest in aggregate stop-loss to mitigate risk for covering the entire group. For these policies, stop-loss insurers often look back at the employer’s past medical expenses to estimate what a group is expected to spend each year. Then, depending on the plan design, the aggregate stop loss pays for any losses above a specific threshold. For example, suppose a group was estimated to have $100,000 in medical expenses per year, with an aggregate stop-loss policy attaching at 120% of that figure. The group would be responsible for that entire first $120,000, but the stop-loss carrier would cover any other medical claims from the group that year.

But what if a group decides that self-funding is no longer the right solution? Or, what if the business grows so large (like, over 1,000 employees) that stop-loss coverage is no longer necessary? Groups can purchase individual (or specific) run-out coverage that covers claims filed after the self-funding arrangement ends. Run-out coverage is in place for a specific period, generally for two years after the end of the arrangement. This protects from providers filing claims in an untimely fashion, or if an episode of care (hospital stay, cancer treatment) stretches beyond the self-funded plan’s end date.

Simplifying the self-funded experience

If paying claims, collecting premiums, and managing stop-loss coverage sounds like too much for a small group to handle, you’re probably right. Many groups contract with third-party administrators to coordinate all these details on the employer’s behalf.

Some vendors, including many big-name insurers, also offer level-funded products. In these arrangements, the vendor bundles the estimated costs of claims,  stop-loss coverage, and administration into a single monthly payment.
That might look, sound, and feel a lot like a fully insured plan, but remember, the employer has assumed the financial risk in this case. In a year with fewer claims, unspent cash can be returned to the employer’s budget. And in years where baby fever takes hold? The upper limit of what the group will spend is known since stop-loss coverage is embedded in the plan.

What could agent compensation look like?

Carriers use a variety of models to compensate agents for self-funded small groups. Generally, you'll see two camps. Some carriers will pay you based on a percentage of the sold stop-loss premium. Others will pay on a flat per-employee-per-month basis. We haven't found many that pay on a per-member-per-month basis, so there may not be an advantage in placing a group with many dependents on this type of coverage. 

Pros and cons of self-funding for small groups

There are, undoubtedly, some significant benefits for small groups going the self-funded route. First and foremost, there is a potential for cost savings, so long as the group doesn’t seek medical care often. And because this is a fee-for-service model, they only pay for the care they use – they’re not shouldering responsibility for an insurer’s other subscribers. Depending on how the plan is constructed, the group may choose to contract with provider and pharmacy networks of their choice. 

But, there are also some significant concerns. First of all, this is a time-and-labor-intensive endeavor, even with the support of a third-party administrator. Administering your own health plan also brings on a slew of compliance requirements fully insured groups aren’t accustomed to taking on: compliance with ERISA, HIPAA, COBRA, the ADA, and the Affordable Care Act’s tax filings for starters. And because costs do fluctuate, these arrangements might not be a good fit for groups without a stable cash flow.

What’s the right call?

After dealing with high single or double-digit increases every year over the past decade, small groups can’t be blamed for exploring other avenues to secure health coverage. Self-funding could be a good fit. However, taking on that risk is an enormous responsibility – one that could easily sink a growing business. Careful consultation will be needed to see if they have the will and wherewithal to make it work.