Saving on Health Benefit Costs With Self-Insured Plans

There is a move among employers to self-insure health benefits, but if employers don’t act like insurers, they are missing out on the total cost-saving potential.

To combat rising health costs, many companies have turned to self-insurance—covering their workers’ health expenses directly.

Get more!  Sign up for PLANSPONSOR newsletters.

Philadelphia-based Andrew Cavenagh, founder and managing director of Pareto Captive Services, a firm that helps midsize businesses self-insure, says his firm targets employers with between 50 and 500 employees. He notes that, traditionally, employers of this size have not self-insured because they fear volatility and risk. Pareto creates what is called a “captive,” in which employers fund a pool of money, and, if they have a bad claim, the captive will pay it out. “This makes it less risky and volatile,” Cavenagh says.

He adds that self-insuring is becoming popular because it can save employers—and employees—considerable money. For example, fully insured carrier premium taxes in some states are half a percent or more; state taxes are paid at a different rate for self-insured plans.

Cavenagh also says premium payments will be different. If an employer is fully insured using a health insurance provider, it may pay that provider $1 million in premiums. If the employer moves to self-insure, it won’t pay such a large premium to an insurance provider, but it will buy a catastrophic stop-loss policy to cover catastrophic claims. Cavenagh likens fully insured to buying an automobile insurance policy that covers all maintenance for auto care—oil changes, tire rotation, etc.—but people want to pay the small stuff themselves and leave the large and unknown claims to the insurer—which would be akin to self-insured plans.

He notes, however, that self-insured employers can also buy an aggregate stop-loss policy for paying smaller claims.

Cavenagh says employers that have been with Pareto for four years have an annual trend of less than 3%. For clients with the firm for five years, the annual trend is flat or negative.

These cost savings are one win for employers, but, Cavenagh says, an even better one is gaining control to create bigger cost savings. For example, employers can become more creative with their pharmacy benefit format, or they can offer employees incentives to go to high-value providers.

Acting Like the Insurer

Rob Piazza, product manager, analytics, at Benefitfocus in Charleston, South Carolina, says many employers fail to realize the cost savings they could because they overlook this opportunity. “Although they’re taking over the role of ‘insurer,’ few employers are acting like one, and they’re likely losing millions because of it,” he says.

According to Piazza, now that employers have taken on the risk of payers—i.e., insurance companies—they need to adopt the sound management strategies of payers, and there are three areas of focus: administrative management, cost control and benefit plan design.

Administrative management involves working with a third-party administrator (TPA) for claims administration, working with an insurance broker and using stop-loss insurance to help with high-cost claimants. “What scares me is how often you hear that employers have no idea what their medical trend is or their cost-target, and many say their broker handles that,” Piazza says. “If partners don’t show the medical trend in the right way or don’t know how spend is going up, employers need to shop around. They need to know their numbers.” He adds that employers don’t know how to manage pharmacy costs but their pharmacy benefit manager (PBM) should. If an employer is paying for a service and trends are still going up, it needs to shop around, he says.

One way to control costs is to establish a wellness program, but employers need more than that, Piazza says. “Many times employers working with a wellness vendor may be paying $100 per employee but only getting a risk assessment. They really need to work with a disease management vendor,” he explains. He says 5% of employees account for 50% of the employer’s cost, and generally the reason is six out of 10 Americans have at least one chronic condition; four out of 10 have more. Disease management programs use metrics to see who is taking medicine, having regular screenings and seeing their doctors. Piazza cites Rand research that found the return on investment (ROI) for disease management programs is $3.8 to $4 per dollar in costs, while wellness program ROI is 50 cents on a dollar.

“If employers have enough money do both a wellness and disease management program, that’s great, but, if they don’t, disease management is better,” he says. “You know which members need help and can make an outreach to avoid inpatient hospital admissions and, even more so, readmissions.”

Cavenagh notes that employers may use cancer screenings, and one Pareto client contracted with a local radiology and imaging center so that co-pays and deductibles were waived for employees who went to this high-value provider.

Pareto is also starting a series of shared primary care clinics. “We are actually trying to spend twice as much on primary care to save money on specialists, and we’re establishing it collectively so our clients can use it,” Cavenagh says.

As for plan design, Piazza says it shocks him that many self-insured employers still don’t charge more for smokers. “Many say they want to offer a rich benefit plan for families, but they don’t have to keep the extra money, they can reinvest it into a wellness program or health savings account [HSA] contributions,” he observes.

In addition, adding a spousal surcharge for spouses that have access to insurance elsewhere makes sense, according to Piazza. However, he says, the policy needs to be explained because it sounds bad to be charged more for having the family covered on the plan. “Employees need to understand that if their spouse is a homemaker, there is no surcharge, but if [that person] is offered benefits from another employer, it makes sense to [add the charge],” he says. “That’s one of the key drivers of ‘per employee, per year,’ costs.” According to Piazza, employers that generally pay about $12,000 per employee per year have 2.7 members per employee, but those paying $9,000 per employee per year have a member-per-employee ratio that is lower. Just like the smoking surcharge, he says, the spousal surcharge can be reinvested to make health benefits even richer.

“Self-insured employers have a balancing act between wanting to offer a rich package to attract and retain talent and controlling cost,” Piazza says. “Cutting cost is not restricting benefits but [includes] investing more intelligently to improve member outcomes to ultimately contain cost for employees and employers.”

As Cavenagh observes, there is no one plan design that is effective for every employer. Plans need to be designed individually based on employers’ needs.

A Few Tested Factors Can Explain Most Risks and Returns

The rapid move of big data has created many factor-based investment products, but institutional investors need to focus on only a few.

“In factor-based investing, institutional investors look at the sources of risk and return behind securities’ prices—what are the true drivers of risk and return?” explains Don Robinson, CEO and chief investment officer (CIO) of Palladiem LLC, an investment management firm that serves the adviser community.

 

For more stories like this, sign up for the PLANSPONSOR NEWSDash daily newsletter.

For example, for bonds, factors that may influence return include inflation expectation, short-term insulation based on federal policy, interest rates, interest rate spreads, performance over Treasury yield, credit risk and default risk. Robinson says there are fewer factor-based products for bonds, but he believes the industry will see more.

 

For equities, Robinson says, factors contributing to risk and returns have been explained by academic research. Factors include value; how a stock is priced today vs. in the next five to 10 years. He says if the stock is very expensive today, it will most likely revert to fair value over 10 years, and vice versa. Additionally, there is momentum, which covers irrational behavior such as investor reaction to news and chasing of performance—this consistently extends 10 to 16 months, then reverts back, he says. Quality is a measure of profitability for companies; more profitable companies generate higher returns. Low volatility is another factor; sometimes an equity has low volatility because it has been neglected. And the size factor is based on the theory that investing in risky smaller companies can pay off.

 

“Today, because of the rapid move of big data and technology, investors can slice and dice factors,” Robinson says. “There is way too much product and a lot of confusion.”

 

Matt Peron, managing director of global equity at Northern Trust in Chicago, says, years ago there were many institutional investors who needed help with active management and found that smart beta wasn’t working as they had expected. Northern Trust offered services to review data and found people generally had an expensive index fund because of over-diversification. “If they had 20 active managers, in theory they canceled each other out,” he says. “This led to lots of unintended risks and impure implementation of factor exposure.”

 

According to Robinson, rigorous application over 45 years has found that value, momentum, quality, low volatility and size will explain more than 95% of performance and risk. “Anything else is just noise; redundant application,” he says.

 

He notes a common frustration among portfolio managers is that most investors are uneducated about what factors are and how they are managed in a portfolio. “Our charge is to educate,” he says.

 

Applying Factor-Based Investing

 

Robinson says some products use a single factor, but the investor has to determine how much to weight that investment and how to manage changes that come over time. He recommends looking at a multi-factor exchange-traded fund (ETF) or strategy that embraces common factors. Plan sponsors should study the prospectus to determine the fund’s methodology.

 

Peron observes that plan sponsors don’t want to just take five factor managers and slam them together and hope for the best; they have to thoughtfully construct a program. “Start by working backward from objectives: risk tolerance, return, time horizon. Identifying these then allows for development of a factor program and the factor profile you need to be successful,” he says.

 

With factor investing, plan sponsors are trying to intelligently capture risk factors and be rewarded, Robinson says. He notes they can do that with technology, and should be able to cheaply, though not as cheaply as if buying in the regular market. However, he adds, the industry is seeing many providers reducing fees on smart beta design, which, according to Peron, is similar in design.

 

“Price is important. Methodology of execution is important. With technology and big data, factor investing can be done a lot cheaper,” Robinson says.

 

Peron acknowledges current low forecasts for equity returns, but says if plan sponsors consider value, they’ll find a good part of the market trading at seven times or 10 times earnings. “Value is quite cheap in this way,” he says.

 

According to Robinson, one of the attractive features of factor investing is that the main factors tend to be diversifiers together. For example, value tends to do well in bad conditions as opposed to momentum. However, he warns, investors should not try to time factors, but have some exposure to all factors. “Some are pro-cyclical—quality tends to do well when the market is slowing down, value does better when the market improves or comes out of recession,” he says.

 

Northern Trust evaluates what it calls the FER—factor efficiency ratio. Specifically, this computes a factor efficiency ratio that measures the percent of active risk coming from desired factor exposure. For example, if an index is value-oriented, how much active risk is coming from the value factor? When comparing multiple value indices, this metric provides an unambiguous interpretation of how efficient each index is at acquiring exposure to a given factor.

 

“In the coming five years, if returns become more muted, as some are expecting, the extra basis points [bps] that you might be able to achieve using careful factor investing strategies become that much more important,” Peron concludes.

«