Over half the United States’ non-elderly population — some 150 million people — receive health benefits coverage through an employer-based healthcare plan. Despite being covered by either partially or fully self-funded healthcare plans (61%) of those 150 million people, many people are still unfamiliar with the term.
It’s clear that a large number of people are already enrolled in self-funded healthcare plans. Understanding its principles is important as it may help you to find cost-containment options. We’ll explore the benefits of self-funded health coverage over fully insured “traditional” plans and whether everyone can make that transition.
What is a Self-Funded Health Plan and How Does It Work?
The same principle applies to both fully insured and self-funded health plans. The money is collected and used for medical expenses. The terms and extent of coverage are detailed in the policy or plan document. The fund’s ability to pay for catastrophic expenses or “high-dollar” emergencies will increase the more people who contribute to it (the risk pool).
Fully insured health plans pay a fixed amount (premium), to take financial risk for medical expenses. The applicable insurance carrier pays the medical bills with their own assets. If the premium collected exceeds claims paid, the carrier retains the balance. However, if claims paid exceed premium collected, the carrier is responsible for the loss. However, self-funded plans do not transfer that responsibility to a third party. This model allows a self-funded company plan to pay claims using the plan sponsor’s assets. The employer is often the plan sponsor and the employees are the ones contributing to the plan. These payments are similar to insurance, but from the perspective of the participants. They draw from an established medical trust that has been built up from contributions from employees and/or direct company funds. However, if the claims paid exceed the contributions, the employer and employees retain the surplus and do not lose the funds to a carrier.
Let’s make this comparison even more simple.
What is a traditional fully insured health plan?
Many people believe they have traditional, fully-insured health insurance. This is because of two reasons. The first is that almost everyone has direct insurance. This includes auto insurance, homeowner’s and renter’s insurance. Individuals who purchase insurance use a fully insured model. Self-funding is only popular in the area of health benefits. Employers provide group coverage for health benefits, which is different from automobiles and houses. This means that plan participants (the employees) don’t know how their health benefits are funded. They only know that their employer set them up. They assume that their health insurance is funded in the same way they fund their car and home. The network is the next step in self-funded plans. It can be a PPO, HMO or other. These networks can be rented from well-respected insurance companies such as Blue Cross, United, Cigna, Aetna and United. These carriers’ logos are found on plan documents and ID cards for health plans, leading people to believe they have insurance with the carrier, not access to their network.
However, even though you have access to the same network, being self-funded can be very different. Fixed premiums are the basis of fully insured health plans. Fixed premiums are paid by enrollees to their carriers in fixed increments. Carrier rates are determined largely by the number of people covered under a policy as well as their expected claim expenses. The cost of this whole healthcare package, which includes the profit margins and operating expenses of the carrier, has traditionally been passed on to employees who have very little control over prices and coverage.
The carrier then manages claims and administers coverage. However, they keep any money leftover from the year (i.e. premiums less actual claims paid). To tilt the balance in their favor, carriers use the following method to calculate the premiums for fully insured plans:
- Projections for Claims: The estimated monetary amount of healthcare reimbursements that the carrier will issue to insureds within one year.
- The pooling charges are used to reduce volatility and liability of the carriers, as they assume greater and greater risks for policyholders and cover more people.
- Administrative fees: Prescriptions include administrative costs for claims processing, medical management, facility usage, and prescription network usage.
- Taxes: Each state has specific health insurance regulations, compliance requirements and medical policies it must adhere to. Insurance premiums may also be subject to taxes, which can be added onto final rates by carriers.
- Carrier’s Profit: Carriers need to make a profit in order to remain in business. To help meet this goal, they convert profit margins into premiums.
This model allows health insurance companies to increase premiums regardless the year’s actual claims amounts and their expenses. They also get any profit that is left over as pure profit. Their profit margin will be high if eligible claims are low that year. However, employers and employees do not get any “refund” and may still see rate increases the next year.
What makes self-funded health insurance different?
The self-funded health benefits plans pay claims and have incremental payments to handle. However, these payments are now handled by the insured entity (the carrier) and not a third-party (a carrier). Employers would collect contributions and store them in an interest-earning account. They also hire a third-party administrator (TPA), who will pay claims using your assets. You can also create and revise the plan to suit your specific population’s needs. You have more control over the design of your plan and choosing the best networks and coverage for your employees if you are self-funded. You get:
- There is no pooling risk. Self-funded policies are covered under the federal Employee Retirement Income Security Act (ERISA) and do not need to account for the same kind of pooling volatility, since their “risk” pool is limited to their own enrolled participants. Your plan won’t have to pay more to absorb risk from other, more expensive plans.
- There is no profit margin: Even better, there are no premium payments that make a profit for the carrier. Any money you have left over can be used to lower your contribution rates or to increase coverage.
- Lower administrative fees: Self-funded plans will still pay for claims processing, stop-loss insurance coverage and network contract drafting, either done in-house or through the assistance of a third-party administrator (TPA). However, these administrative fees are usually lower than those for fully insured plans.
Top Reasons Why Employers Switch to Self-Funded Health Plans
Nearly all the major health insurers in the United States now offer some form of self-funded healthcare coverage, either through an administrative services only (“ASO”) contract, or, through a TPA they own. There are also many independent TPAs available. Self-funding is a large part of the health insurance market. However, it is still growing. Major carriers, which in the past had a competitive offering and provided a self-funded option, are now investing more resources towards their self-funded businesses. This is a sign that the market is huge and growing. These are just a few of the reasons companies have made the switch.
1.Pay Claims as They Occur
Self-funded health plans have the advantage of “pay-as you-go” claims. Companies that self-fund do not have to make large premium payments or set up costly premium installments. Instead, they simply reimburse claims as needed. Claims costs can vary from month to month. They are primarily affected by the care received by covered individuals, not hypotheticals or projections.
2. Choose the most beneficial plan and network
Employers who choose to self-fund their plans can customize them to meet their specific needs. You can monitor claims using claims analysis software. Coverage adjustments can be made for your employees the next year to better address their data-backed healthcare realities.
3. Enjoy the benefits of your own savings
Your plan and your participants will benefit if claims fall below what was expected for the month. You can even earn interest on healthcare reserves when stored in the right account type, further incentivizing money saved.
Here are some key points to consider when making the switch
It takes dedication and time to transition from a fully-insured health plan to one that is self-funded. This transition comes with risk.
Shock claims refer to “catastrophic”, large-scale claims that essentially deplete the self-funding reserves meant for your entire employee pool. Shock claims can potentially cause chaos in the self-funding model. The innate advantage of self-funding is to avoid paying excessive premiums. This is the biggest risk for this type of healthcare coverage. However, there are industry solutions to minimize this risk.
There are two main solutions addressing shock claims:
- Individual Stop Loss (ISL),: ISL protects individuals against large claims by establishing a payment threshold or “specific deductable”. If any claim exceeds that threshold, ISL will reimburse the plan for claims that were paid over the deductible.
- Aggregate Loss Limit (ASL),: ASL offers the same protection as ISL but for smaller claims that add up over a threshold instead of a few extreme ones. Once the aggregate of claims exceeds the predetermined threshold, the aggregate stop loss is activated. After that, claims paid by the plan above the threshold are reimbursed.
Many factors affect the viability of self-funded healthcare for your company. These factors include, but are not limited to: the size of your participants (depth of risk pool), the demographic makeup and healthcare market in which your company operates.
Stop-loss “reinsurance” carriers are working hard for self-funding to be more accessible to a wider range of employers. To expand self-funded plans to smaller markets and organizations, innovative new programs are being created. Plans can be tailored to fit smaller businesses and institutions by using models that consider the financial discipline of each business, employees’ health, and overall risk tolerance. This allows for smaller companies to reap the benefits of this model.
Fiduciary issues for self-funded plans
Private self-funded benefit plans that are funded by private funds are exempted from state insurance laws under the Employee Retirement Income Security Act of 1975 (“ERISA”). These plans must adhere to Federal law but may avoid burdensome State-based laws. ERISA imposes additional duties in addition to these benefits. Employers with self-funded health plans are required to appoint people with discretionary authority to manage the plan and its assets. These individuals must be identified in the plan document. They are responsible for managing and overseeing the institution’s self funding policies.
These individuals are called fiduciaries. They must follow the following responsibilities.
- Only act in the best interests of plan participants (i.e. covered persons).
- Follow the guidelines and provisions of the company’s self-funded plan as described in its core plan documents.
- Responsible for the management and preservation of plan assets in reserve funds.
- Be responsible for your plan expenses.
- Following general fiduciary codes and standards of conduct.
Employers can appoint both in-house and outside fiduciaries, if the TPA is open to it.
Tax considerations for Self-Funded Plans
Fully insured and self-funded plans are subject to overlapping tax considerations. These similarities include employee contributions, company contributions, and claims paid. However, self-funding organizations are still subject to tax and legal consequences.
1. State Premium Taxes
Self-funded programs are not subject to state premium taxes, unlike traditional fully insured coverage. These taxes are usually between 2 and 3 percentage points of the premium’s value. Many employees are unaware that they are paying this tax since most carriers include it in their annual premium quotes.
2. State-Mandated Benefits and Fees
Self-funded plans can avoid premium taxes and are exempted from most state insurance laws. Organizations can customize their coverage and are exempt from compliance audits and associated fees. This includes the Health Insurance Marketplace User fee. Businesses that opt for this route will benefit from exemptions from state-mandated benefits, which tend to lower both the cost and complexity of providing coverage.
3. Internal Revenue Codes (IRC).
More commonly known as the IRS Tax Codes, the IRC includes taxation parameters on healthcare coverage programs. If they are found operating discriminatory coverage strategies under IRCSS105(h), self-funded plans must comply with IRCSS104, 105 and 106.
4. Death Benefits and Taxes
Self-funded healthcare plans have different tax rates for death benefits. More specifically, IRC SS 101 (b) does not apply to self-funded plans, meaning an employee’s death benefit transfers to beneficiaries may qualify under a different tax rate.
Compliance for Fully Insured vs. Self-Funded Plans
All laws that apply to self-funded health plans are applicable:
- Health Insurance Portability and Accountability Act, (HIPAA).
- Employee Retirement Income Security Act, (ERISA).
- Americans with Disabilities Act
- Pregnancy Discrimination Act
- Age Discrimination in Employment Act
- Economic Recovery Tax Act (ERTA).
- Tax Equity and Fiscal Responsibility Act, (TEFRA).
- Deficit Reduction Act (DEFRA)
- Consolidated Omnibus Budget Reconciliation Act, (COBRA).
Compliance takes place at the federal level, and not at the state-audited level. It is managed by an in-house employee or a TPA, legal counsel, who acts as the plan administrator, fiduciary, and a TPA. This is not a complete list.
Documentation for Fully Insured Plans vs. Self-Funded Plans
It is also relatively easy to create proper documentation for a self funded health plan. The following documents are essential for compliant programs:
- Plan Documents: An in-house appointee or self-funded TPA must create and maintain a formal document or set if written documents that outline the entire self-funded plan. A self-funded plan may use a well-written Summary Plan Description (SPD), which reduces the plan to one.
- Summary of Benefits & Coverage (SBC), and Summary Plan Description(SPD): This summary must include a glossary and information about network and terms. These documents are provided to the covered person along with a certificate of insurance.
- These policies can be purchased through a stop loss provider.
- Form 5500: Self-funded organizations do not need to file a Schedule under ERISA annual reports. However, they have other filing requirements.
- Affordable Care Act (ACA), Reporting and Tax Returns. Self-funded plans must file the ACA’s 1094B and 1095B series to maintain compliance. They can also file tax-exemption applications under VEBA status.
Transitions to a Self-Funded plan
It takes time to switch from a fully-insured policy to a self funded plan. On average, it takes two years of preparation. Organisations that are fully committed and have the resources to carry out all steps of the transition can reduce this time by six to twelve months. To ensure that you are addressing the following issues, conduct a self-funded assessment of your health plan.
- Make an Action Plan. Describe your timeline and contact all parties involved to start drafting core policies and planning documents.
- Coordination and Contract Involved Parties for Drafting the Plan Document: This will at the minimum include a third party administrator or another party contracted to help with the formal SBC, SPD and partner fiduciaries.
- Finalize the Plan Policies and Coverage. This ensures that ERISA, HIPAA, and other regulatory mandates can be met. The new plan will also maintain full federal compliance.
- Purchase Stop-Loss Insurance: To reduce risk and protect your company in the event that you are sued,
- Draft Administrative Service Agreements: Designing and outlining the duties for an administrator of in-house plans or a contract with TPA.
- Publish SBCs & SPDs: All employees and covered persons.
- Fiduciary Liability Insurance and ERISA Bonds are two options. These policies can be used to protect your reputation and assets in the event that any administrative agent is negligent, fraudulent, or violates federal laws.
For Self-Funded Health Plan Consulting, contact The Phia Group LLC
This transition can be complicated and come with both new risks as well as rewards. Since its inception, The Phia Group is dedicated to making health benefits more affordable for both employees and employers. We offer cost-containment solutions that are tailored to our clients’ needs.