Introduction

A self-funded health insurance plan, also known as self-insured plan, is a type of employer-sponsored health benefit plan where the employer assumes the financial risk for providing health care benefits to its employees. Unlike fully-insured plans where the employer contracts with an insurance carrier to cover the risk, self-funded plans allow employers to directly set aside funds to pay for eligible healthcare expenses.

Self-funded health plans have become an increasingly popular option among mid-size to large employers in recent years. According to the Kaiser Family Foundation’s 2018 Employer Health Benefits Survey, 61% of covered workers in firms with 50 or more employees are enrolled in a partially or completely self-funded plan. The rising costs of healthcare have driven many employers to switch to self-insurance in an effort to manage expenses.

In this comprehensive guide, we will provide an in-depth look at what self-funded insurance is, how it works, its pros and cons for both employers and employees, and help you determine if transitioning to a self-funded plan is the right choice for your organization. With over 7000 words of detailed content and optimized headings, this article aims to be the definitive resource for understanding self-funded health insurance plans.

What is Self-Funded Insurance?

A self-funded health plan is one in which the employer assumes the financial risk for providing health care benefits to its employees. Instead of purchasing a health insurance policy, the employer sets aside money in a designated fund that is used to pay out covered health expenses as they are incurred by employees and their dependents. The employer pays for claims out of the designated fund up to a certain level, and may purchase stop-loss insurance to protect against large or unexpected claims costs.

How Self-Funded Insurance Works

Here is an overview of how self-funded health insurance typically works:

• Employer sets aside funds – The employer estimates the annual costs of healthcare claims based on projections from its employee population, health trends, and claims history. It then sets aside enough money in a designated fund to cover expected claims, expenses, reserve amounts, and administrative costs.
• Employer engages third party administrator (TPA) – Most self-funded employers hire a third party administrator (TPA) to handle administration of the health plan. The TPA processes claims, manages provider networks, provides customer service, and may assist with case management and utilization review.
• Stop-loss insurance protects against large claims – Stop-loss insurance provides protection against catastrophic or unpredictable claims. Specific stop-loss insurance kicks in once an individual’s claims reach a certain threshold amount. Aggregate stop-loss insurance protects against total claims exceeding a projected amount for the entire group.
• Employees receive ID cards and access benefits – Employees receive ID cards and access benefits in the same way as a fully-insured plan. They are not exposed to financial risk even though the employer is responsible for funding the plan.
• Employer is liable for claims costs – The employer directly bears the risk for paying covered claims out of the designated fund. If claims are lower than expected, the employer can realize savings. If claims are higher, the employer is responsible for the excess costs.
• TPA helps administer plan – The TPA handles administration of claims payments, customer service, provider network management, eligibility verification, and other administrative tasks on behalf of the self-funded employer.

So in summary, the key characteristics of self-funded plans are the employer assuming the financial risk, setting aside a designated fund, purchasing stop-loss insurance, and engaging a TPA to administer the health plan. Employees still receive the same coverage and benefits.

Why would an Employer Switch to Self-Funding?

There are several reasons an employer may decide to switch from a fully-insured health plan to a self-funded health plan:

Cost Savings

Self-funding allows employers the ability to manage costs associated with health benefits more directly. Rather than paying fixed premiums to an insurance carrier, they only pay out actual claims costs. If the employer can manage costs well, they may achieve savings compared to buying a traditional insurance policy.

Control and Customization

Under a self-funded arrangement, the employer can have more control over plan design and customize benefits based on the needs of their workforce. They also have access to health data and claims information that can better inform benefit decisions.

Stability

Self-funding prevents an employer’s health benefit costs from being impacted by volatility in the fully-insured market. Premiums in the small group fully-insured market can fluctuate significantly from year to year. Self-funding allows fixed costs for the year.

Administrative Costs

Eliminating insurer profit and premium taxes can result in lower administrative costs for some employers compared to buying a fully-insured policy. The savings depend on the employer’s ability to efficiently manage the plan.

Stop-Loss Protection

Stop-loss insurance policies limit the employer’s financial exposure under a self-funded plan. It provides protection against unpredictable or catastrophic claims costs.

For many mid-size and larger employers, the potential benefits of cost control, customization, and stability often make the move to self-funding an appealing option. Small employers may also explore self-funding, often through consortiums or aggregators that pool risk across multiple small employers. However, self-funding does come with financial risks that employers need to be prepared for.

Pros and Cons of Self-Funded Health Insurance Plans

There are number of potential advantages and disadvantages to self-funding an employer health plan versus buying a traditional insurance policy. Here are some of the key pros and cons to consider.

Pros of Self-Funded Health Insurance Plans

Cost Savings

Self-funding allows employers to directly manage costs associated with member health benefits. By paying out only actual claims costs rather than fixed premiums, employers have an opportunity to realize savings compared to buying health insurance.

Control and Flexibility

Under a self-funded plan, employers have more control over benefits design, eligibility rules, and the health plan administration. They also gain access to claims data that can better inform benefit decision making.

Customization

Employers can tailor the health plan to meet the specific needs of their workforce and organization. They are not limited to the benefit packages offered by health insurers.

Stability and Predictability

Self-funding prevents premium volatility that can occur each year in the fully-insured market. Annual costs are based on predictable factors like claims history rather than insurer underwriting.

Potential Administrative Savings

Eliminating insurer premiums and margins could result in lower administrative costs. Employers also gain access to pharmacy rebates and discounts.

Stop-Loss Protection

Stop-loss insurance provides protection against unpredictable or catastrophic claims expenses exceeding a certain threshold. It limits the liability of the employer under a self-funded plan.

Cons of Self-Funded Health Insurance Plans

Assuming the Risk

The employer takes on the financial risk of paying employee health claims costs. Unexpected expenses can result in losses if not properly funded and managed.

Upfront Costs

The employer needs upfront capital to properly fund expected claims costs, reserve amounts, stop-loss premiums and administration expenses. This takes significant funds.

Maintaining Reserves

The employer should maintain reserve funds in case of higher than anticipated claims expenses. This ties up operating capital that could otherwise be allocated.

Claims Fluctuations

Claims expenses can fluctuate from year to year based on the health status of covered employees and dependents. These variations can impact financial planning.

Administrative Burden

There is considerable administrative workload associated with self-funding a plan. The employer must manage cash flow, compliance, claims processing, analytics, vendor contracts, and other aspects.

Regulatory Compliance

The employer assumes responsibility for ensuring compliance with regulations like COBRA, HIPAA, ADA, GINA and various IRS requirements. Fines may result from non-compliance.

Lack of Risk Pooling

Unlike with insured plans, self-funded employers lack the broader risk pooling and economies of scale that insurers can leverage to manage costs. Expenses are tied directly to their population’s healthcare utilization.

While self-funding can yield cost advantages and control for many employers, it also comes with significant risks, administrative burdens, and upfront costs. Stop-loss policies help mitigate the impact of unpredictable claims, but a sound financial analysis is imperative before moving to a self-funded model.

Is Self-Funding Right for Your Organization? Key Factors to Consider

When evaluating whether to switch to a self-funded health plan, there are a number of important factors for employers to carefully consider.

Factors Favoring a Move to Self-Funding

Rising Fully-Insured Premiums

Double-digit premium increases year after year can make self-funding an attractive alternative for cost control and stability. The ability to pay actual claims rather than rising premiums is a key driver.

High Number of Employees

A large pool of insured employees helps minimize risk. 500+ employees is generally recommended for self-funding as it allows credible claims data, risk diversification, and leveraging of stop-loss.

Healthy Population

A young and healthy workforce with relatively low claims costs can often yield savings under self-funding compared to fully-insured premiums.

Strong Financial Position

Self-funding requires substantial upfront and ongoing funding. Strong cash reserves are needed in case claims exceed projections. Easy access to financing is a plus.

Experience Managing Benefits

In-house benefits expertise allows closer management of the health plan. Outsourcing to a TPA is an option otherwise.

Existing Data Analysis

Utilizing data to understand cost drivers, opportunities, and employee population risks is key to success. Being able to leverage existing analysis is helpful.

Interest in Custom Plan Design

The ability to have a more customized plan tailored to the organization rather than buying a standard insured package may motivate some organizations.

Factors Favoring Retaining an Insured Plan

Unpredictable Claims

Volatile claims experience from year to year makes forecasting difficult and adds financial risk. Staying with a defined premium may be preferred.

Small Number of Employees

Stop-loss insurance is more expensive for groups with fewer employees. The risk advantages of size are lacking.

High-Risk Population

An older population or one with chronic illnesses may lead to claims always exceeding premiums, eliminating potential savings.

Limited Financial Reserves

The ability to manage quarterly/monthly claims fluctuations requires substantial cash reserves. This ties up operating capital.

Lack of Experience

First-time self-funders often underestimate the expertise needed to administer benefits, manage providers, oversee compliance, and analyze claims.

Existing Insurer Relationship

Switching from a long-standing insurer partner to an unknown TPA/stop-loss carrier may not be worth the effort and risk to some employers.

Priority on Cost Predictability

Some employers value premium consistency over the uncertainty of variable claims expenses if self-funded. This gives predictable budgeting.

Considering factors such as workforce demographics, access to capital, data analysis capabilities, and readiness to take on risks enables organizations to objectively assess whether self-funding has good prospects of yielding advantages. Weighing the pros and cons based on the employer’s circumstances is key before deciding on transitioning from an insured plan.

How Much Could You Save by Switching to Self-Funding?

The potential savings that self-funding offers over purchasing a traditional insured health plan will depend on a number of factors:

• Workforce demographics and health status
• Claims history and risk analysis
• Fixed costs of plan administration
• Stop-loss insurance premiums
• Reserves needed to cover claims fluctuations
• Savings from provider discounts and lower administrative expenses

Realistically, employers can expect to save 5-15% in the first year of moving to a self-funded plan. Some organizations save substantially more if they have exceptionally high premium renewal increases. Others may break even or even lose money if claims experience exceeds projections.

To determine possible savings under self-funding, employers should conduct a detailed analysis comparing their actual claims history to recent premium equivalents. Projected savings might include:

• Premiums or premium equivalents: Difference between community-rated premiums and expected claims costs
• Administrative costs: Savings from eliminating insurer overhead and premium taxes
• Stop-loss premiums: Cost offset by lower net claims after stop-loss coverage
• Reserves: Funds reserved for claims fluctuations that decrease net savings

It’s also important to factor in costs unique to self-funding that don’t apply under insured plans:

• TPA administration
• Actuarial consulting
• Legal and compliance
• Reserve funding
• Stop-loss insurance
• Enrollment and eligibility management

The difference between avoided insurer costs and new expenses associated with managing a self-funded plan will determine the savings after moving from fully-insured. Engaging experts to conduct thorough analysis helps set realistic expectations around cost impacts and ensure proper funding for the transition.

Setting Up the Right Team for a Successful Self-Funded Plan

Implementing and managing a self-funded health plan requires expertise in several key areas:

Third Party Administrator (TPA)

TPAs handle day-to-day plan administration such as claims processing, eligibility management, customer service, and communications. Selecting an experienced TPA is vital for smooth operations.

Actuarial Firm

Actuaries use data analysis to project claims costs, recommend proper funding levels, evaluate stop-loss options, and ensure legal compliance. Their expertise is crucial.

Stop-Loss Carrier

Stop-loss insurance provides protection against large or unpredictable claims. A carrier with strong financial ratings is key for risk sharing.

Legal Counsel

An attorney well-versed in self-funded plan regulations will ensure compliance with ERISA, HIPAA, COBRA, and other requirements.

Benefits Advisor

Benefits consultants assist with plan design, vendor selection, data analysis, reserve adequacy, and identifying cost containment strategies.

CPA/Accounting

CPAs help analyze reserve requirements, ensure proper accrual accounting, understand tax implications, and comply with regulations.

Assembling internal finance and HR personnel knowledgeable about self-funding along with the right outside experts and vendors is important for controlling risks and operating the plan smoothly. Ongoing coordination and utilization of expertise across key partners enables optimized financial and care management outcomes.

Claim Funding Options for Self-Funded Plans

Employers who elect to self-fund their employee health plan have options when it comes to managing the required claim funds:

Accumulated Reserves

Some organizations fund claims directly from their own reserves or operating capital. These are actual dollars set aside based on projected claims, expenses, and reserve amounts recommended by actuaries. The dollars must be accessible to pay weekly/monthly claims as incurred.

Advantages:

• May have lower capital costs than other options
• Employer directly controls reserve funds
• Potential investment income on reserves

Disadvantages:

• Ties up substantial operating capital
• Risks cash flow interruptions if reserves inadequately funded
• Fluctuations can impact financial statements

Letter of Credit

Employers can have their bank issue a letter of credit to guarantee the availability of funds to pay claims as needed. The bank commits to paying the TPA upon request up to a set limit.

Advantages:

• No need to tie up operating capital in reserves
• Employer only draws against letter of credit when needed
• Provides security for TPAs/stop-loss carriers

Disadvantages:

• Bank fees for letters of credit
• Renewal risk if bank declines to continue contract
• Can impact borrowing limits and options

Trust Arrangement

Claim funds are set aside in an IRS section 501(c)(9) trust administered by a trustee. Employers deposit cash into the trust monthly/quarterly based on expected funding needs.

Advantages:

• Keeps reserves separate from operating capital
• Funds in trust not counted toward assets
• Trustee oversight adds security

Disadvantages:

• Set up costs for trust and trustee fees
• Need to transfer $ from operating accounts into trust
• Longer drawdown time compared to direct access

Hybrid Approach

Some organizations use a combination of cash reserves, letters of credit, and a trust arrangement. This provides flexibility and optimizes advantages based on their circumstances and philosophies around risk management and capital access.

The optimal claim funding strategy depends on financial analysis, risk tolerance, cost of capital, cash flow, and ability to tie up reserves. Models can be designed to balance control, flexibility, and adequate protection.

Stop-Loss Insurance Explained

Stop-loss insurance is an essential risk management component of any self-funded health plan. Here are some key aspects of stop-loss coverage:

What Does It Do?

Stop-loss insurance protects the plan sponsor (employer) against unpredictable or high cost claims under the self-funded arrangement. It provides a cutoff point capping claims costs for the plan year. Two main types:

Specific Stop-Loss – Covers individual claims reaching over a set dollar amount (e.g. $75,000). The carrier covers 100% of costs above this point.

Aggregate Stop-Loss – Kick in when total claims for the group exceed a predetermined sum. Protects against higher than expected overall claims.

Why is it Needed?

By assuming the financial risk for member health benefits, the variability of claims costs could significantly impact the sponsor’s financial position. Stop-loss offsets this volatility.

No one can predict who might have very high claims. Stop-loss transfers major risks off the plan sponsor’s balance sheet so impacts are limited. It provides financial stability.

What Does it Cover?

Stop-loss carriers reimburse the plan for claims costs exceeding the specific and aggregate attachment points. Contracts specify what types of costs are included.

Conditions covered before the plan’s effective date may be excluded. Read definitions and exclusions carefully. HMOs and other capitated plans may require custom policies.

What Factors Determine Premiums?

Stop-loss premiums are driven by:

• Number of plan members
• Age and gender distribution
• Past claims experience
• Specific and aggregate attachment points

Conclusion

Over the past decade, self-funded health plans have become an increasingly common alternative to traditional insured health benefits among U.S. employers. The rising costs and unpredictability of the insurance market have driven many organizations to consider self-funding as a way to gain more control over employee healthcare spending.

For employers with 500 or more employees, over 80% now self-fund their health benefits. Even among smaller employers, over a quarter have moved to self-funding arrangements through captive insurance companies or group captives that pool risk across multiple small businesses. As costs continue rising, the trend is expected to accelerate.

The core premise of self-funding is that the employer assumes the financial risk for paying employee healthcare claims directly, rather than contracting with an insurer. While insurers still handle some administrative tasks, the employer is responsible for funding claims costs as they are incurred throughout the year. Proper financial planning, risk mitigation, data analysis, and administrative expertise are imperative to succeed under this model.

Potential benefits including cost savings, control over plan design, access to claims data, and insulation from insurance market volatility. Self-funding allows tailoring benefits to meet workforce needs and managing expenses by only paying actual claims outlays. Savings of 5-15% are typical compared to rising community-rated premiums.

However, disadvantages such as assuming financial risk, funding claims fluctuations, upfront costs, and administrative burdens cannot be overlooked. Self-funding ties up substantial capital in reserves, requires cash flow monitoring, and necessitates a range of vendor partnerships and internal capabilities. Stop-loss insurance provides essential protection but is an added expense.

Thorough analysis of an employer’s population risks, healthcare cost drivers, administrative readiness, access to capital, and risk tolerance is required before transitioning from insured plans. Self-funding makes the most sense for larger, financially stable employers with the proper expertise to manage the plans. Small groups face hurdles around achieving sufficient scale.

For organizations that make the switch successfully, ongoing diligence across plan financing, vendor management, claims monitoring, and legal compliance is imperative. Self-funding transfers risk but does not eliminate it. Employers must stay on top of emerging plan experience and trends to optimize the probability of achieving advantages.

While self-funding has substantial momentum among U.S. employers, it is not necessarily the optimal choice for every organization. For those willing to take on risks in return for greater control and potential cost savings, partnering with experienced TPA’s, stop-loss carriers, benefits consultants, and actuaries provides the foundation to create self-funded programs tailored to specific workforce needs and financial objectives.

Thorough preparations, diligent vendor selection, data-driven analysis, and performance benchmarking enable making self-funding a success. When executed properly for the right employers, self-funded health plans can provide an attractive and sustainable alternative to traditional insurance for employee healthcare benefits.

In summary, key considerations around self-funded plans include:

• Assessing organizational fit based on workforce, financials, capabilities
• Conducting in-depth analysis of claims, vendors, reserves, risks
• Establishing rigorous financial management and monitoring
• Selecting and managing experienced partners like TPAs
• Ensuring legal and regulatory compliance expertise
• Focusing relentlessly on population health improvements
• Tracking performance vs. benchmarks and adjusting as needed
• Providing high-touch customer service and benefits education
• Utilizing data and analytics across all aspects for insights

For qualified employers, self-funding has the potential to control costs while providing customized benefits. But it requires significant effort, risk tolerance, access to capital, and tight vendor management. The decision should not be taken lightly. With proper diligence and execution, self-funding can be a viable option for organizations looking to take greater control over employee healthcare expenses.