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The Pros and Cons of Self-Funding Your Health Care Plan


HR Wire
Health Care Plans 04/17/2007

Maureen Minehan

Think self-funding your organization's health care plan would reduce costs and improve service? You're not alone. More than half of U.S. employers already have made the switch.

Still, self-funding may not be right for every organization. Employers considering a switch from fully-funded to self-funded health plans should carefully consider the pros and cons before making the leap.

Definition of a self-funded plan

According to the Self-Insurance Institute of America, Inc., a self-funded group health plan is one in which the employer assumes the risk for providing health care benefits to its employees. Instead of paying a fixed premium to an insurance carrier, self-funded employers pay employee health care claims out of their own pockets as the claims are incurred.

Employers can be partially or fully self-funded. Employers that partially self-fund, might, for example, continue third party coverage of mental health or prescription benefits, while shifting to self-funding for all other medical claims.

According to the 2006 Kaiser Family Foundation Employer Health Benefits Survey, more than half (55 percent) of U.S. companies partially or completely self-fund their health care plans. The practice is almost de rigueur among companies with 5000 or more workers, with 89 percent self-funding at least part of their health benefits plan. Self-funding is less common among employers with under 200 employees, with only 13 percent opting to partially or fully self-fund.

David C. Parker, a senior vice president at Meritain, a provider of self-funded plans, says small employers shouldn't avoid self-funding just because it's uncommon among their peers. He believes employers with the financial and administrative means to pursue self-funding can succeed no matter what their size. "I've seen employers with 25-30 employees do very well," he tells HRWire.

Benefits of self-funded plans

Why are self-funded plans appealing to many employers? One significant draw is the elimination of many Employee Retirement Income Security Act (ERISA) and other requirements for self-funded plans. Employers who self-insure are exempt not only from ERISA rules, but typically also from state health benefits regulations and taxes.

Exemption from such regulations means self-insured employers have more control over the types of benefits they cover and the levels of coverage they offer. Self-insured employers in California that don't want to cover birth control, for example, can exclude contraceptives from their plans even though state law mandates such coverage for fully funded plans. For multi-state employers, self-funding can help create national consistency by eliminating the need for state-by-state compliance.

Cost savings are another big lure. Employers typically save some money immediately by eliminating state premium taxes. They also often save by eliminating overhead and other fees paid to their former insurers. And, if they successfully reduce claims costs, they save some more.

"In addition to paying premiums, [fully-]insured companies pay premium taxes to the state, broker and insurance commissions, reserves and, of course, profit for the shareholders of the insurance provider. Self-insured companies don't have to pay," Sue Conway, a partner at Warner Norcross & Judd LLP in Michigan, explains.

Disadvantages of self-funded plans

The biggest disadvantage of self-funding is the assumption of greater risk. A year that brings large, unanticipated medical claims can be devastating to employers with poor cash flow. Self-funding also can make budgeting more difficult because health care outlays will vary from year to year and throughout each year. In contrast, fully-funded employers know the amount they'll need to pay out over a specified period of time.

Another obstacle to self-funding is the need for strong administrative skills. While many self-insured organizations use third-party administrators or enter into "administrative services only" arrangements with an insurance company, self-funded employers must still have strong oversight. According to AV International, a self-insurance consulting services firm, the U.S. Department of Labor (DOL) has interpreted the failure of self-funded employers to implement an efficient administrative system as a breach of fiduciary duty.

Strategies for success

Employers that think the pros of self-funding may outweigh the cons for their organizations need to take several steps to ensure their self-funding strategy is appropriate and effective, including:

Perform claims and demographic analyses. Understanding the volume and nature of employee health claims is essential. Examples of questions to ask include: In the past five years, what was the annual total dollar value of claims? What percentage was due to one-time incidents vs. chronic or catastrophic illness? Does the workforce profile skew old (anticipate more chronic illnesses) or young (anticipate more recreational injuries)? The information gleaned from the analyses can help project likely costs over the short-to-medium term.

Understand cash flow. Because self-funded employers must have money available to make timely claims payments, organizations perennially short on cash should think twice about self-funding. "Self-funded plans aren't great for companies with difficult cash flow," Parker says. They do work well, however, for companies with strong cash flows or reserves.

Evaluate stop-loss insurance options. Most self-funded employers purchase stop-loss insurance that provides protection against costly claims. Stop-loss coverage can be triggered by either a high dollar claim or by surpassing a predetermined aggregate claim amount, depending on the type. Under the first, an employer may buy a policy that shifts responsibility for a claim to the insurer once it exceeds a certain dollar amount, such as $10,000 or $20,000. Under the second, the insurer assumes responsibility once the total amount of claims for all employees reaches a specific threshold. Employers need to determine their comfort with different levels of risk and purchase stop-loss insurance accordingly.

Assess administrative options. Employers also need to assess their administrative strengths and weaknesses and decide whether to administer the plan in-house or through a third party. For those considering a third party, AV International recommends evaluating administrators based on their efficiency, contacts with other service providers such as stop-loss carriers, cost management skills, customer service record and financial solvency. The fees paid to administrative providers must be factored in to the decision to self-fund.

Determine benefits coverage preferences. Examples of issues that must be decided include employee eligibility for the plan, covered benefits and exclusions, employee cost-sharing, policy limits and retiree benefits. AV International reminds employers that self-funded plans must still comply with certain ERISA rules, the U.S. tax code and federal anti-discrimination laws such as the Americans with Disabilities Act (ADA), the Mental Health Parity Act, the Health Insurance Portability and Accountability Act, the Pregnancy Discrimination Act, the Newborn's and Mothers' Health Protection Act and the Women's Health and Cancer Rights Act.

Create a plan for monitoring. Finally, employers need to decide at the outset how they will monitor performance of the self-funded plan. Parker says contracting with third party administrators that provide exhaustive electronic data is important; armed with information on utilization, costs, service satisfaction and other issues, employers can better assess whether self-funding is the best choice they can make.

Parker also says employers should plan stay with self-funded plans for at least three to five years to reap benefits. "Organizations approaching self-funding with a long-term perspective are more likely to do well with self-funding. Because claims are cyclical, they need to make a three-to-five year commitment to see savings."

The bottom line

Judging by the more than half of U.S. employers already self-funding part of their health care benefits, self-insurance is an important option for employers to consider. By carefully analyzing claims, cash flow, administrative capabilities and coverage goals, organizations can better determine whether the switch to self-funding makes sense.



Resources:

Self-Insurance Institute of America: http://www.siia.org  

Kaiser Family Foundation 2006 Employer Benefits Survey: http://www.kff.org/insurance/7527/index.cfm  

AV International: http://www.avinternational.net  

Sue Conway, partner, Warner Norcross & Judd: http://www.wnj.com  

David C. Parker, senior vice president, Meritain Health: http://www.meritain.com