Through the mid-1970’s, employers seeking to fund their own employee benefits were required by federal law to meet the same standards as insurance companies: there was no differentiation. This meant, for instance, they had to be licensed, maintain federally mandated reserve levels, and pay premium tax. They also had little choice but to pay a staff of professionals to perform maintenance and administration for the plan (much the way an insurance company would).
As you might guess, only the largest companies could afford to self-fund. This remained the case until 1974, when the federal Employee Retirement Income Security Act (ERISA) declared there was a difference between insurance companies and self-funding businesses. In addition to lining the burdens of companies seeking so self-fund, like licensing and reserving requirements. ERISA also contained a preemption clause stating that it would override any state mandates pertaining to group health insurance.
Despite many challenges to ERISA’s authority, today it continues to make self-funding a viable option for businesses of nearly any size. Employers nationwide have taken advantage of the savings potential and flexibility afforded when they fund their own employee benefit plans. And stop-loss coverage such as that marketed by Assured Benefits Administrators continues to ensure that even smaller companies may do so without asset overexposure.
FULLY INSURED FUNDAMENTALS
We all know how it feels to pay premiums to an insurer. We relinquish our hard-earned dollars to them without any hope of seeing the money again. Regardless of whether we file claims up to the amount of the premiums we’ve paid (indeed, regardless of whether we file ANY claims), the premiums are theirs to keep. This is the concept behind a fully insured employee benefit plan.
The fully insuring employer pays an insurance carrier a flat fee to assume its insurable risk. But there is no reconciliation of funds after the actual claims for the period are tallied. The total cost of the insured plan is fixed: it does not change based on the claims incurred. Fully insured premium may contain numerous component charges over which the employer has no control (excessive administrative fees, mandatory pooling charges, higher overhead and profit margin, etc.).
HOW IS SELF FUNDING DIFFERENT
Self-funding is different because it is the employer’s money which is used to pay employee medical claims, not an insurance company’s. Therefore the employer benefits when funds set aside for claim payment go unused. The majority of the cost of a self-funded plan are VARIABLE. The employer establishes it’s own claim account and may reconcile against future contributions with any unused funds or reserves. And interest earned on the pre-funded claim account is the employer’s to keep, not an insurance company’s.
SELF-FUNDED ADMINISTRATION THROUGH A TPA
With the many advantages of self-funding come the added responsibilities. An insured employer relies upon the insurance company to perform administration for the benefit plan: duties such as member enrollment, claim payment, and preparation of supporting documents. But with self-funding, the employer plays the role of the “insurer”. Therefore it inherits an obligation to see that administration is handled properly.
Rather than facing this challenge themselves and incurring the associated expenses, most self-funded businesses choose to contract a third-party administrator or TPA. TPAs have the personnel, equipment, and expertise to take on these
responsibilities for a reasonable per-head charge.
HOW SELF-FUNDING WORKS
- The employer decides on a plan of employee benefits with the assistance of an agent, broker and/or a third party administrator (TPA).This plan is often similar to the plan, currently provided on an insured basis.
- Stop Loss insurance is arranged so protect the plan against extreme losses. The amount of risk to be insured will be a function of the employer’s size, nature of business, location, plan of benefits, financial resources, prior experience and tolerance for risk.
- A plan document is prepared. The plan document contains all the provisions of the plan, including eligibility, coverage and termination. Employee benefit descriptions, identification cards and other materials necessary to operate the plan are also prepared, usually by the TPA.
- The TPA operates the plan. This includes maintaining proper funds on deposit so that claims can be paid, paying the claims, preparing special claim reports and other required data for the plan and the insurer. The TPA also bills and collects any premiums and other administrative fees for the plan.
SPECIFIC STOP LOSS DEFINED
The self-funded employer can benefit substantially from becoming his or her own “insurer”, it also stands to lose a great deal in the event of large claims. Such is the nature of self-funding and the assumption of risk. With the passage of ERISA. stop-loss coverage evolved to limit this liability, especially for smaller or medium-sized companies.
Basic stop-loss uses dual coverage to cap two different variations of arc risk. The first type of coverage is SPECIFIC stop-loss, which works like an employer’s deductible for each individual participant in the self-funded plan. If the specific level is $20,000, for example, this is the maximum the employer would have to pay on any individual enrollee during the contract period. The stop-loss carrier would reimburse claim dollars above this amount to the employer.
Specific claims are reimbursed to the employer immediately after the deductible is met (not at the end of the contract period). Premium for specific coverage is expressed as a monthly rate for employees and a monthly rate for employees with covered dependents.
Aggregate coverage establishes an overall employer deductible or aggregate level for the entire group, ‘the stop-loss carrier reimburses the group when cumulative claims (up to specific level) exceed this dollar amount.
The underwriter determines a group’s aggregate level by calculating its expected claims during the contract period and adding a risk margin or “corridor” of around 25 percent. Once this is done, the amount is used to calculate monthly aggregate factors for single and family coverage. The group is required to set aside this amount in a trust fund for payment of employee claims. If there are leftover reserves in the fund at the end of the contract period, the group retains this money and may reduce claim reserves by this amount the following year.
Other miscellaneous health benefits such as dental, vision, and prescription drugs may be included under the aggregate coverage.
Specific and aggregate stop-loss coverage technically may be purchased together or separately, according to the needs and risk-bearing ability of the group. Specific coverage is almost always required to be purchased along with the aggregate coverage.
FUNDING THE CLAIM ACCOUNT
Whereas the self-funded group pays traditional premium rates for specific coverage, most of the money paid for aggregate coverage is in the form of contributions to a fund from which the employer pays claims. The stop-loss carrier for the group defines the contributions for both “employee” and “employees plus dependents” participants in the plan. The employer then deposits these amounts monthly to the fund.
The most common funding vehicle used by self-funded employers to pay claims is the 501 ( C ) (9) or VEBA trust. Once a business establishes a 501 ( C ) (9) trust, any investment income the trust earns is tax-exempt. Other self- funded businesses may choose to pay claims out of general corporate assets or using a (non-tax-sheltered) 419A trust.
CONTRACTS TO ENSURE SEAMLESS COVERAGE
Stop-loss coverage is determined on the basis of when an enrollee claim is incurred (when the event actually occurred) and when the employer subsequently paid it to the enrollee. Different stop-loss contracts design different periods during which a claim must have been incurred and/or paid to be covered.
The basic stop-loss contract is the “incurred in 12 months/paid in 12 months or simply the “12/12.” This contract covers those specific stop-loss claims that were incurred and paid during the 12 month contract period. Carriers also offer various other contract configurations.
“12/15” – Covers claims incurred during the 12 month contract period and paid during the 12 month contract period pi us 90 additional days of run-out, but can be extended to 6 months.
“Paid” – Covers all specific claims paid within the 12 month contract period and incurred within the 12 month contract period or the 12 months immediately preceding (24/12).
“Paid with a run-in” – Covers all claims paid within the 12 month contract period and incurred with the 12 month contract period or a specified period preceding the proposed effective dare. This run-in period is limited to normally 90 days but can be extended to 6 months.
CASH FLOW PROTECTION
Aggregate Accommodation is a supplement to the aggregate contract designed to protect the group and improve its cash flow during months when claim activity is unusually high. It is intended to provide a maximum monthly risk exposure when the plan is fully funded. Accommodation provides a quick reimbursement on a monthly basis when claims exceed the greater of the accumulated minimum aggregate (aggregate level set using initial enrollment) or the accumulated true aggregate (aggregate level set using actual month-by month enrollment).
At the end of the plan year. the accumulated paid claims total is again compared to the greater of the minimum aggregate and the true aggregate. If the amount of the yearly reimbursement from aggregate accommodation exceeds the difference between the paid claims figure and the aggregate deductible, the plan must repay this amount.
A carrier’s cash advance or “cash loss limit” provision eases the cash flow burden often created when an employer funds an entire large claim and must wait for reimbursement. from the stop-loss carrier above specific level. This is accomplished through payment of the excess amount for immediate replenishment of the group’s claim account
Once the administrator has submitted documentation of payments made up to the specific, along with bills for amounts in excess, the advance funding process begins. The carrier drafts a check to the employer’s plan for the balance of the claim and sends it to the administrator to deposit in the group’s account.
ADVANTAGES OF SELF-FUNDING
Employers often find the following advantages when operating a self-funded program (many of these benefits overlap, but they all may affect any employer).
- Elimination of most premium tax: In most states, there is no premium tax for the self-funded claim fund; thus, an immediate savings equal 10 the amount of the premium tax (approximately 2% to 3%) is realized.
- Lower cost of operation: Employers frequently find that administrative costs for a self-funded program through a professional TPA are lower than those charged by their previous insurance carrier.
- Carrier profit margin and risk charge eliminated: The profit margin and risk charge of an insurance carrier are eliminated for the bulk of the plan.
- Cost and utilization controls: The TPA may offer a second surgical opinion program, an outpatient surgical program, a hospital bill audit program, a large case management program, access to a preferred provider organization (PPO), and other programs through a variety of sources, rather than the employer being able to use only the insurance company’s in-house programs.
- Cash flow benefit: The employer’s cash flow is improved when money formerly held by the insurance carrier in the form of various reserves, such as for unreported claims and pending claims, is freed for use by the employer.
- Return on investment for reserves: Interest on reserves established by the employer remains under the employer’s control.
- Control of plan design: The self-funded employer has flexibility in the original plan design. The employer may also redesign the plan to eliminate plan abuses if they are encountered.
- Mandatory benefits avoided: State regulations mandating costly benefits are avoided because self-funded programs are subject to ERISA (Employee Retirement Income Security Act).
- Administration tailored to the employer’s needs: The employer usually has a choice of TPA’s, each of whom is interested in providing the employer with flexible services to meet the employer’s needs.
- Risk management effectiveness through Stop Loss insurance: The employer may choose the amount of risk to retain and the amount to be covered by Stop Loss Coverage. An insurance company has set pooling levels allowing little flexibility.
- Return of unused claims dollars: The employer retains the dollars accumulated in the interest bearing account that is unused at the end of the plan year, where insurance companies keep as profit. These dollars can be used to offset premiums at renewal, to increase employee benefits or return to employees in the form of a bonus or premium refund.