FUNDING YOUR HEALTH PLAN
Do you know the best way for your company?
There are a variety of mechanisms available to fund health insurance programs. Below is a summary of the basic concepts involved in each type of funding.
The most familiar funding design is the “fully insured” plan. In this design the employer pays a premium to an insurance carrier each month and in return the carrier pays eligible claims. The premium is due the first day of each month and represents the insurer’s projection of all the plan charges. These charges include the carrier’s expenses for doing business (including premium taxes), claims and reserves for expected future claims. Premiums are easy to budget because the employer is dealing with a level guaranteed cost. If charges exceed the premium, the carrier covers the additional charges. At the end of the contract year, deficits are recaptured in the form a rate increase. By transferring from one insurance company to another, the employer can avoid this deficit recoupment.
The major weakness of this type of program is the inherent loss of financial control. While in an adverse year the insurance company will attempt to recoup any deficit, in a favorable claims year the insurer may or may not pay a dividend, but only after extracting its profit and altering reserves to cover its termination responsibilities. The employer, because he is pre-paying future claims, is unable to utilize any of the cash-flow advantages caused by claim-lag and the initial claim run-off. In addition, since the insurance company is holding the reserves, the employer cannot earn interest on his money.
Minimum Premium Plans
One way to take advantage of this cash-flow, while still maintaining the security offered in traditionally funded plans is using a partially self-funded or “minimum premium” plan.
These types of plans combine the limited liability of a fully insured plan with the improved cash flow and reduced premium tax of a self-funded plan. The employer pays the insurance carrier a smaller monthly premium for the administrative and insurance expenses, while funding the claims as they are paid until a certain maximum is reached. If the actual claims are less than the claims projected at the beginning of the year, the employer can hold and earn interest on the amount of money not needed to pay claims. If actual claims exceed projected claims, the insurer pays the additional amount until there are extra funds available in the future (for example: if in one month the claims exceed the threshold and in another month they are below it, the carrier will recoup the amount above the threshold from that month). The employer does not have to pay more than the premium and claims projected at the beginning of the year. In addition, the employer holds the reserves for claims that are expected in the future and pays state premium tax only on the monthly premium paid to the insurance carrier.
Typically, minimum premium plans offer very attractive first year savings. This is because the insurer’s claim projections in this year reflect only nine months of claims instead of twelve. The reason for this is that the carrier anticipates that during the first three months the plan is in force, most claims submitted will be run-off claims that the prior carrier will be responsible for. In addition, there is a certain amount of start-up time involved before claims are paid in the new plan.
In the second year, the renewal increase will be more substantial than in future years. This is because the claims projections will be increased from nine months to twelve months (25%) to account for a full year of claims. Also, medical cost trends increase at approximately 15% to 20% per year. And then there are the usual factors such as profit margins and inflation that contribute to rate increases. Some of the increased costs can be reduced by negotiation and plan changes.
It is also important to consider what occurs when one of these plans is terminated because the employer is responsible for the “terminal liability”. Terminal liability is the payment of the “run-out” claims, claims that would have been covered under the plan but were not submitted until after the termination date. Some minimum premium plans do not make provisions for terminal liability and the employer will be responsible for administering claims after the termination date.
In plans that include a terminal liability, the funding can be throughout the life of the contract by the employer creating a sinking fund or with the use of a letter of credit , or lump sum deposited with the carrier. In some cases, if the employer has strong financials, the carrier may waive this requirement.
Self Insured Plans
At the other end of the spectrum, are self-funded plans. These are appropriate for employers with over 100 employees. Here, the employer is responsible for all the claims and holds the reserves for expected claims. Claims are paid directly from corporate assets or via a funded trust. A stop-loss policy is purchased to cover claims above a certain threshold and a third-party administrator is contracted to adjudicate claims as they are submitted. In larger organizations (over 3,000 employees) the administration is typically done in-house.
Employers utilize this concept to improve cash flow, save premium taxes, increase freedom of plan design, and maintain tighter financial and administrative control over their programs. Cash flow improves by paying for claims when incurred and processed as opposed to prepaying them via a monthly premium. The time lag on submitting and processing claims in conjunction with the absence of established reserves, enables the employer to improve cash flow within the employee benefit program. In addition, if actual claims are less than the expected claims, the employer can reap the benefit of less expenditure in the benefit program. And since he is holding the money, interest can be earned on amounts not needed to pay claims. Secondly, premium taxes are saved because they are only applicable to the stop-loss insurance premiums.
Improved control over the program is possible since all elements –administration, aggregate stop-loss, specific stop-loss, and basic claim responsibility are examined and purchased separately.
If actual claims exceed projected claims, the employer is liable for the additional claims. However, the employer’s liability can be limited by purchasing specific and aggregate stop-loss policies which will pay claims above a certain ceiling.
If the plan is terminated, the responsibility for claims incurred before but paid after termination is the employers. It is possible to purchase an “incurred claim” stop-loss contract, but this increases the employer’s liability even if the plan is terminated. Some third-party administrators offer riders, which can minimize this liability.
Pros and Cons of Self Insurance
- You only pay for benefits that were utilized
- Employer holds part of the reserve and can invest it to earn additional money
- Greater plan design flexibility since the plan is only required to meet ERISA requirements
- Premium taxes are reduced or disappear completely
- Employer is only responsible for 9 months of claims during the first year, allowing him to fund the reserve and take advantage of the use of his money
- Stop Loss insurance can be utilized to reduce employer liability
- Unbundling benefits gives the employer greater negotiating ability. If he likes the network but not the administrator, he can change the administrator without disrupting the employees’ relationships with their physicians. If the stop loss insurance increases, it can be changed without disrupting the plan
- If stop loss contracts are properly designed the carrier cannot recoup deficits
- Plan cost can fluctuate
- Employer must make sure the reserve is sufficient to pay termination costs if the plan is cancelled
- If the employer reduces benefits, the employees may feel the plan is not as generous
- Second year rate increases are significant because they include the full 12 months of expected claims
- Stop Loss contracts can be tricky. They must be carefully negotiated and designed
- Employee assumes liability for claims payments
- Too many variables can be confusing
- Deficit recoupment