Self-Funding Health Benefits Another Cost-Saving Strategy

“Self-insured” means employers pay health care claims of employees out of their own pockets rather than paying premiums for “fully-insured” plans offered by insurance companies. David Ross, executive vice president and director of Underwriting Services at Hays Companies in Minneapolis, Minnesota, tells PLANSPONSOR there are actually few employers that go completely self-insured; most buy some insurance for very high risk, or high cost, employees.

Ross used to be a strategist for a health insurance provider, so he has the inside scoop about why offering a “fully-insured” health benefit program may be more costly to employers. “The reason employers may want to partially self-insure is it costs less on average over time,” Ross says. He stresses that “on average over time” is important for employers to understand. “You are accepting some risk, volatility and variability. With fully-insured plans, you know exactly the price tag, but with a self-insured plan, you don’t know the price tag in any given period.”

However, Ross explains, employers can know their costs over time using actuarial science. “In 50% of the years, the underwriter’s projection will be too high, in the other 50%, it will be too low. There will be ups and downs, but as long as employers have the right cash flow, they can handle it, and it could be a tremendous advantage,” to self-insure, he notes.

Basically, the workings and administration of self-insured plans are the same as fully-insured plans; there are effectively only three components that differ and make self-insured plans less expensive over time, according to Ross.

He explains that self-insured plans are Employee Retirement Income Security Act (ERISA) plans and must follow all federal laws regarding employer-sponsored health plans, but they are not bound by state regulations regarding employer-sponsored health plans. States have high-risk pools paid for by taxes that, by law, are pulled from fully-insured products in that state. Once an insurer files a plan, the state evaluates how much it will need from that plan for the high-risk pool and will tax the plan. Self-insured plans are not taxed by states, and depending on which state employers are in, this could equal a 2% to 6% savings, Ross says.

Secondly, there is a risk margin in fully-insured products because the group of employees a given product is insuring is quite variable. Insurers will project a risk cost for each employer. “They feel justified in charging a risk margin, because the risk could be high for the group of employees of a particular employer, but that’s a theoretical risk,” Ross explains. “In application, there’s negligible risk because all insured employees of each employer are pooled. This pool is enormous, so it has statistics going for it.” He contends the risk margin charged to employers is really more of a profit. Self-insured plans will not be paying this profit to insurers.

Another component of fully-insured plan costs that self-insured plans do not have to worry about is terminal lag. Ross explains that when a group leaves an insurer’s plan, there are still outstanding claims it will have to pay for—this is called terminal lag. The factor used in fully-insured plans to anticipate that lag is always based off older information when the lag was slower—over time the amount of lagging claims decreases—so what insurers charge employers for terminal lag is really too much.

“Those three components make self-insured plans always on average over time cheaper,” Ross states.

Going forward, there is a fourth component employers need to consider, according to Ross—the health care reform impact on plan costs. “Depending on which insurer is selling you a fully-insured product, it may bundle that with insurance the insurer sells to individuals—the same plans now being sold on public health exchanges,” he explains. Some of the previously uninsured that can now get coverage through an exchange are higher risk individuals. “When higher risk folks go into the pool, anyone sharing in the pool gets inflationary risk added to the premium.”

Employers may have not considered self-insuring health benefits before because of some admonitions that employers with less than a certain number of employees should not do so, but Ross says the industry is wrong. The decision should not be based off the number of employees, but should be based on whether employers have enough cash on hand to handle claims. “If they always have enough cash on hand, an employer of any size would benefit from a self-insured model. If they have a small cash margin, even if they’re a large employer, they should not be self-insured,” he says.

In addition, some employers may not have considered self-insuring because they use a benefits broker. Ross contends brokers are typically ill-equipped, especially smaller ones, to understand the nuances of self-insuring. It’s easy to compare rates of fully-insured plans, and brokers are more adept at consulting about fully-insured plans.

“There’s a lot of misunderstanding around self-insured, but now largely because of health care reform, employers are having to take a longer, harder look at it,” Ross says. Traditionally, employers may save 8% to 12% on health benefit costs by using self-insured plans, and with some projecting health care reform could add 6% to 10% to premiums for fully-insured plans, moving to a partially self-insured model could offer more savings opportunity for employers.