The Benefits And Risks Of Self Funding Your Employee Health Benefit Plan

What Is Self Funding?

An employer who operates a self funded health plan assumes the financial risk for providing health care benefits for its employees. Self funded plans differ from fully insured plans in that employers do not pay monthly premiums for health care that employees might be given, the employers, rather, pay only those claims that employees actually receive.

To limit their liability most employers purchase stop-loss insurance. The stop-loss insurer agrees to reimburse the employer for health care costs that reach a certain threshold (usually $25,000-$100,000) in exchange for premium payments. Generally, the lower the threshold amount the higher the premium.

For example, assume a stop-loss threshold set at $25,000. The employer will pay employee health care claims up to and exceeding $25,000. However, the employer will be reimbursed for those paid claims over and above $25,000. The stop-loss insurer does, however, put annual and lifetime limits on coverage and will adjust premium costs accordingly. The higher the annual and lifetime max the more premium will be demanded.

The employer’s money may solely be used to pay claims or, alternately, it may be a shared expense with employees making some contribution. The money is typically placed in a trust account that is then debited to pay claims as they are incurred.

What Are the Benefits of Self Funding?

Typically, employers automatically save money in the first 12 months while self-funding. This occurs because claims payments are not processed until the second or third month. In the first year, employers have 12 months worth of money set aside to pay claims but they will only be paying 10 or 11 months worth of claims because of the time lag.

Employers also experience savings on direct costs that are included in fully insured medical insurance premiums such as overhead, taxes, profits and commissions. Most self funded plans use a third party administrator (“TPA”) to process and pay medical claims. Most TPA’s administration costs are significantly lower than those included in the premium by an insurer or HMO. And the premiums paid to a stop-loss insurer are usually much lower than those paid to an insurer for a fully insured plan.

Self funded employers also save on premium taxes that they would ordinarily pay if fully insured as they merely hold money in trust to pay for health claims. Self funded plans are not required to pay to the 2-3% premium taxes applicable to fully insured plans.

Mandatory benefits imposed by state law are also not applicable to most self funded plans, as federal law governs regulations of most self funded plans. These state mandated benefits are oftentimes expensive and cutting them out removes added expense.

Self funding provides employers the flexibility to design their health benefit plans. And they have greater control of the distribution of benefits as compared to a fully insured plan. In a self funded plan, employers have access to the money in the claims fund that is being used to pay current claims. This money produces interest income that can be added to the fund that would not otherwise exist in a fully insured plan.

What Are The Risks of Self Funding?

Despite these important benefits there are several risks that must be considered before the decision to self fund is made. The biggest issue in self-funding is the potential financial exposure.

Catastrophic events and high utilization by employees can lead to exorbitant claims costs. This can mitigated, as discussed above, by purchasing stop-loss insurance. But proper analysis of your company’s potential risk is essential when trying to determine the attachment points for stop-loss coverage.

Your company also must be aware of potential legal exposure. As a self funded plan you remain ultimately liable for claims decisions errors. In addition, labor relations problems could arise with employees in event that employee medical claims are paid late and this could lead to unrest, job dissatisfaction or a decrease in productivity. Both of these risks make choosing a qualified, competent TPA absolutely essential.

Finally, there are many legal complexities that impact self funded plans. Most self funded plans are regulated by the Department of Labor and are subject to federal law, specifically the Employee Retirement Income Security Act (“ERISA”). And there are several important tax law considerations that must be accounted for as well. Developing a relationship with an ERISA attorney well versed in self funding can save you time, money, and the headache of employee lawsuits.

Is Self Funding Right For Your Company?

In general, the decision whether to self fund is much easier for those employers with more than 200 employees. In fact, self funding is not widespread among small employers, only 12% of those with just 3 to 199 employees self fund their health plans, according to the 2007 Kaiser Family Foundation Survey of Employer Health Plans. The more employees you have the easier it is spread the risk. Medical claims tend to be quite volatile and smaller employers oftentimes cannot maintain the cash-flow necessary to fund those months where costs are excessive.

To determine whether self funding is the right option for your company, you should perform a risk analysis and cash-flow analysis, then examine employee demographics and covered dependents. You should also review the claims history of your company. You must know the age and distribution of the claims submitted by your employers in order to determine the risk that you will be accepting by self funding.

With this information you will have an idea about the general age of your employees and be able to identify what their aggregate health claims reveal. For example, if your employee population is older the data may reveal expensive conditions of age such as heart disease or cancer. Or perhaps your employees are disproportionately overweight, then you may see more diabetes claims or at least be put on notice that these types of claims are likely. On the other hand, if your employees are young they may have very little utilization but may be susceptible to sport injuries. At this point, you must review utilization rates for the last 3 to 5 years.

With this data in hand you should be able to determine whether you can reasonably afford self funding. Be realistic, however, about your company’s cash-flow. Claims do not arrive in an orderly fashion over a 12 month calendar period. Some months are more expensive than others. You cannot postpone claims payments you must have adequate cash-flow and enough reserves to immediately pay claims. The assistance of a qualified TPA, insurance broker, and/or ERISA attorney is essential at this point and a competent professional will be able to assist you to determine whether self funding is a viable option.

What Impact Will ERISA & Other Laws Have On Your Self Funded Plan?

Most self funded plans are subject to ERISA and the comprehensive bundle of regulations associated with this statutory scheme. ERISA, however, preempts state insurance laws including reserve requirements, mandated benefits, premium taxes, and consumer protection regulations. Self funding provides more freedom to create plans free from state mandates, which can result in substantial savings versus fully insured plans.

However, in addition to ERISA there are other federal laws that definitely impact your self funded plan including:

1. Health Insurance Portability and Accountability Act (“HIPAA”);
2. Consolidated Omnibus Budget Reconciliation Act (“COBRA”);
3. Americans with Disabilities Act (“ADA”);
4. Pregnancy Discrimination Act;
5. Age Discrimination in Employment Act;
6. Civil Rights Act;
7. Internal Revenue Code (“IRC”);
8. Tax Equity & Fiscal Responsibility Act;
9. Deficit Reduction Act; and
10. Economic Recovery Tax Act.

While this is no inconsequential list, a good TPA will be able to handle the administration and compliance with the most onerous of the statutes listed above including ERISA, HIPAA, and COBRA. However, be aware that while TPAs will provide compliance service they may not accept liability for violations of these laws (other than for gross negligence), which will rest squarely on the shoulders of you the employer.

Who Will Administer Your Self Funded Plan?

As you can see, choosing the right TPA is one of the most important if not the most important decision when deciding to self fund. A TPA can help with the cash-flow analysis and risk analysis and can administer much of the compliance requirements of a self funded plan.

Here are 10 steps to take when seeking a qualified TPA:

1. Look for a TPA that is capable of providing a customized health plan specific to your company’s needs;

a. Your chosen TPA should be flexible enough to create a plan that fits your demographics. Working with your TPA to customize coverage will cut costs and improve employees’ satisfaction with the benefits provided.

2. Check references from some of the TPA’s larger clients.

a. Ask for a list of the TPA’s larger clients then contact the clients to independently verify the client’s satisfaction with the TPA.

3. Make sure that the TPA uses and provides accurate legal information.

a. Look for a TPA that is communicative and up to date on changing regulations. It is essential that your TPA maintains a close relationship or employs an ERISA attorney due to the complexity and interplay of federal ERISA and state insurance regulation.

4. Understand how a provider (physician/hospital) network (PPO) figures into the equation.

a. TPA’s oftentimes have relationships with provider networks and can negotiate on your behalf.

5. Investigate how the TPA manages your funds.

a. ERISA requires self funded plans to prudently safeguard their assets. While not required by law, TPAs generally recommend that employers set up a trust account for their plans. This step fulfills the prudence requirement of ERISA. Many TPAs also offer client audit reports to verify that their financial practices prevent fraud and abuse.

6. Ask whether the TPA processes COBRA and HIPAA documentation.

a. COBRA and HIPAA, two federal laws, have several notification and compliance aspects that most TPAs will happily administer for you. Just ensure that your contract states that the TPA will be liable for COBRA and HIPAA administration errors and that the TPAs errors and omissions policy covers COBRA and HIPAA errors.

7. Learn all you can about the TPA’s cost-containment programs.

a. Ask how the TPA handles pre-authorizations, large case management, utilization review, and provider network evaluations.

b. Also determine how the TPA manages catastrophic claims. A good TPA is usually proactive: Detecting catastrophic claims early allows the TPA to reduce your costs without diminishing quality of care.

8. Find out how the TPA trains its claims analysts.

a. In addition to finding out how analysts are trained, inquiring about turnover rate is good idea as well.

9. Make sure that the TPA practices good management reporting.

a. Your chosen TPA should make available periodic reports explaining plan status. Reports should detail finances, number of employees served, medical costs, use of medical services, and savings realized from network providers.

b. These reports are invaluable and will provide you with the information you need to decide which services to add and whether you need to increase or decrease contributions from employees and put you on notice regarding other necessary changes or alterations.

10. Review bids from stop-loss insurance providers.

a. After you have chosen your TPA, it can contract for stop-loss insurance on your behalf. Be cognizant, however, that self funded plans are required by ERISA to obtain several bids.
b. Ensure that you are able to easily review the bids and make sure that you do some due diligence checking on the stop-loss carrier. You may not want to deal with a new company that is unfamiliar with the business and is inexperienced.

c. Lastly, ask your TPA their procedure when renewing or changing stop-loss carriers. A good TPA is aware and will put you on notice that the renewal procedures and claims definitions are often complex. These complexities are purposefully drafted by the stop-loss carrier to avoid claims liability.

d. A quality TPA will ensure that you are made aware of these complexities and will make sure that you are not left holding the bag with thousands of dollars of unpaid claims.

Conclusion

For those employers who have the size and available cash-flow, a self funded health plan can result in substantial medical claims savings. A self funded plan offers the flexibility to design customized benefit plans and provides much more control over plan benefits than the typical fully insured medical plan.

However, there are numerous risks and potential pitfalls including legal and compliance hazards, human resource and employee relation headaches, and potential liability for mishandling claims. Most large companies find that these risks can successfully mitigated with the help of a qualified, competent TPA.

Implementing a self funded health plan is not to be undertaken lightly, but failing to do so may mean wasting thousands of dollars every year on fully insured premiums. Performing the cash-flow analysis and risk analysis detailed above will give you a good idea whether your company is ready to self fund. At that point if you believe self funding is a viable option, contact a qualified TPA or ERISA attorney and with the assistance of a competent professional you can design a self funded plan that not only meets the needs of your employees but also bolsters your bottom line.