An Underwriter’s Guide to Financing Employer Sponsored Health Plans

With healthcare inflation on the rise and escalating pressure to deliver competitive benefit packages, employers are searching for alternatives to traditional funding arrangements. This guide offers a framework to evaluate which arrangement is right for your organization.

Is Self-Funding Right For Your Organization?

A number of factors influence the strategy for financing an employee health plan. As an underwriter, I ask questions of plan sponsors that address the predictability and volatility of the employee population and, in turn, the volume of claims. Those questions include the following considerations:

• Group size and scale
• Employee turnover
• Desired plan and quality of benefits
• Geography
• State of the economy
• Employer’s risk appetite

Group Size

The size of your organization, in terms of eligible and enrolled plan participants, has a direct impact on claim volume in a given year. In general, a higher claim volume creates lower volatility in costs over time, making the evaluation and forecasting of future claim risk more predictable. The availability of these metrics means that larger group sizes (250+ enrolled employees) are more likely to be candidates for self-funding than those with fewer employees.

Employee Turnover

Employee turnover rates impact annual claim fluctuation. Higher turnover rates – those in excess of 25% per year – create greater fluctuation through less predictable employee demographics and higher likelihood for unfavorable risk selection. Different industries have different norms for employee turnover. Taking into account your industry and average turnover may influence financing choices.

Desired Plan & Quality of Benefits

The high priority of attracting and retaining qualified, motivated employees through benefit offerings, while also containing healthcare benefits costs, is an ongoing task. I am often involved in conversations with human resources, financial, and operational leaders regarding the importance of keeping a competitive benefits package for their employees while keeping costs in check. Over the years, carriers have attempted to streamline fully insured benefit offerings and save administrative dollars in the process. As such, the necessity of keeping a high quality benefit plan while holding costs at bay require creativity, scrutiny, and regular attention such that self-funded options may fit the need more so than fully-insured for benefit design.

Geography

An employer’s primary state of domicile also factors into benefit plan funding options. Some states have more competing carriers that have the ability to write a fully-insured contract than others. For those states, competition among insurance companies can keep costs down. For states with fewer fully-insured options, and consequently less price competitive options, you may be able to negotiate a health plan that includes self-funding options.

State of the Economy

The economic climate impacts all aspects of an employer’s business. Because the ability to accurately forecast claims and cash flow is of high importance, a steadily growing business may have the ability to consider all funding types whereas a business facing difficult economic headwinds and declining employee enrollment may need the security and budget planning that a fixed fully-insured premium can offer. These needs may change over the years given the varying state of the economy.

Employer’s Risk Appetite

Any conversation regarding healthcare funding should factor in the employer’s risk tolerance. Over the years, I have worked with large, stable, low turnover businesses that enjoy the stability and security of fixed-premium financing. Conversely, some much smaller, higher turnover, newer businesses with higher risk appetites prefer self-funding. I have found good results in both scenarios. The decision about funding structure is driven by the risk appetite and expectations of the business. Fortunately, the degree to which the funding can be tailored to the risk appetite of the customer is high in today’s marketplace.

A Spectrum of Healthcare Funding Options

Following a thorough examination of the employer dynamics, we need to develop an understanding of the funding alternatives commonly available in today’s health insurance marketplace. These alternatives range from the fixed-premium financing of fully-insured health plans to self-funded health plans that take on some degree of risk and claims volatility. Available funding mechanisms include:

• Fully-Insured Plans
• Minimum Premium Plans
• Level-Funded Plans
• Self-Funded Plans
• Partially Self-Funded Plans with a Captive
• Self-Funded Plans and Reference Based Pricing

Fully-Insured Plans

The most well-known and understood method of financing an employee health plan is through a fixed-premium fully-insured contract. These offer security with a fixed monthly rate for at least a year and sometimes more depending on the carrier and contract design. The insurance company accepts the risk fully within the contract terms in exchange for a pre-defined invoiced premium rate per enrolled employee tier. Standard fully-insured contracts are generally a non-participating contract, meaning there are no settlements at the termination of the contract. Conversely, participating contracts allow for additional risk acceptance on the employer’s part by incorporating a potential premium return based on claims performance.

Minimum Premium Plans

Minimum premium plans are a type of participating contract in that final results are dependent upon a year-end accounting of a pre-defined claim fund. The minimum premium only holds if an employer performs at or better than the initially projected claim fund rates. Otherwise, additional funds may be due or deficits accumulated to future years. Minimum premium plans feature a maximum cost that limits the employer’s liability in a given year. These can be useful vehicles for accepting slightly more risk so long as the mechanics are well understood, and the opportunity reasonably exists to outperform other financing alternatives without too much downside risk being pushed upon the employer.

Level-Funded Plans

Level-funded financing is an entry-level self-funded product that operates similarly to the minimum premium product in that it is essentially divided into two parts: the claim fund and fixed costs. Employers are billed a maximum rate and a settlement occurs at the end of the contract to determine if some portion of the claim fund may be recouped by the employer. Effectively, it is a self-funded product that operates like a fully-insured billed premium: set monthly costs with an opportunity for a return at the end. As with the minimum premium plans, reasonable opportunity for returns must exist without excessively high initial costs. For small to mid-size employers (between 75 and 250 enrolled employees) these can be reasonable alternatives to conventional fully-insured contracts with a good understanding of the mechanics and pricing involved.

Self-Funded Plans

As health plans grow in membership, and the claims experience develops more credibility and predictability, it is more common to migrate to a self-funded arrangement. The self-funding model can offer many benefits, including:

• Access to the employer’s specific claims and utilization data that allows the plan to make well informed and strategic decisions relating to the development and management of their health plan
• Improved cash flow, as the plan funds claims when they are incurred
• Reduced premium taxes – only paid on stop loss insurance (catastrophic risk insurance)
• Reduced carrier profits – targeted carrier profits based on percentage of premium rates. Because stop loss insurance is a fraction of the cost of fully-insured premiums, rates may be only 10% - 12% of the fully–insured rate.
• Appropriate risk margin
• A self-funded plan allows for appropriate risk selection and insurance to match the employer’s tolerance level. Fully-insured rates include significant margin to account for missing the projected claims amount (typically called risk margin).
• Customized benefit design
• Employers holding their own reserves rather than prepaying to the insurance company with little or no opportunity for return

Self-Funded Plans with a Captive Risk Pool

An emerging trend in the health insurance market is the use of captive risk pools, which allows self-funded groups to share in the risk assumed by stop loss reinsurers. The primary idea of a captive is to improve the risk pool, lower claim cost, and control the carrier profits. The number of captive risk pools has grown in recent years, promoting more competitive pricing in the marketplace.

Self-Funded Plans and Reference-Based Pricing

Reference-based pricing is a more aggressive approach to self-funding. This strategy attempts to make claim payments using the providers’ cost basis per service as the reference, and reimbursing the providers with a predefined margin on the top of the list cost. While significant savings may be realized through reference-based pricing, it is infrequently chosen due to the potential for members to experience disruption in their health care options. Even with increased reference-based pricing vendors and provider community familiarity, this approach is best reserved for employers who are facing significant cost increases who are experienced with self-funding.

The decision to consider a self-funded health plan rather than a conventional fully-insured option cannot be met with a one size fits all answer. Suitability of each of the alternatives is dependent on an employer’s unique circumstances. Thoughtful assessment of employer dynamics, paired with an appropriate funding vehicle to match your risk appetite, can lead to long-term success in developing and providing a comprehensive and competitive health plan to your employees.