by Dan Freeman
As healthcare costs continue their uphill march, many employers who are fully insured are feeling the squeeze between offering attractive, affordable health insurance and preventing their health plan costs from eroding operating margins.
Further, the possibility of a catastrophic claim has long dissuaded these employers from using a standalone self-insured plan to manage their healthcare costs. For many, the thought of one large medical claim dealing a crashing blow to a plan budget makes self-insurance seem less attractive than the reality of steady increases in fully insured health insurance premiums.
However, when taking a long-term view of a self-insured strategy, as well as an active risk management approach to self-insured costs, the pain of fully insured premium costs outweighs the additional risk stemming from self-funding.
Fully Insured coverage
To understand the savings borne by a self-insured strategy, one must first gain an understanding of fully insured premium development for group health coverage. Fully-insured carriers will typically reflect all expected costs associated with providing healthcare benefits to employees and their dependents. These costs are comprised of three main components: benefits or claims paid to covered lives, internal expenses or costs to run the plan, and external, mandated expenses that need to be passed through to the customer. The carriers will update their cost estimates for the upcoming plan year in the form of an annual premium renewal report. It is important to note these premiums are developed to cover costs after any employee out-of-pocket costs. In addition, the claims costs are typically based on a traditional, fee-for-service reimbursement premise.
Before we compare fully insured costs and trends to self-insurance, we first must define self-insured coverage.
Self-Insured Programs defined
Cost, capacity, control: The three pillars of self-insurance. For years, these goals have eluded employers in their search for lower health care costs. The leap from a fully insured plan to a self-insured arrangement was much too great a stretch, but as fully insured premiums are consistently outpacing other employer expenses, many see self-funded arrangements as a reasonable strategy to temper this rising expense, while still providing high value, affordable health benefits.
Cost: A self-funded program can be thought of as having three main layers: the primary employer layer where the employer is responsible for payment of its claims and benefits up to a certain retention point (more on that later). The second layer is the fixed expense layer, which is required to administer the health plan. The third layer, or stop-loss layer, is where a stop loss carrier pays claims that have exceeded a certain annual claims limit, $75,000 for example. In the next section, we will demonstrate how these layers of cost can remain consistently below fully insured premiums.
Capacity. Many have felt they need to be extremely large employers, with as many as 1,000 enrolled employees, to reap the benefits of a self-insured strategy.
While the law of large numbers does play a part in a self-insured structure, it is not a strict requirement to enter this space. With the right amount of stop loss protection, and active management of costs, a relatively smaller employer, as low as 50-75 lives, can outperform fully insured costs over the long term with a reasonable level of predictability.
For example, a mid-size employer considering moving to stand-alone self-insured arrangement could seek to retain a typical stop loss level of $75,000 per claimant. This means that the group is self-insured up to $75,000 per year per plan enrollee. The stop loss carrier would absorb any paid claims above this level. Being able to cap losses at lower attachment points is crucial for smaller employers to operate under a self-funded arrangement.
It is important to note that there are other self-insured arrangements available for employers who may not have the risk tolerance to be a stand-alone self-insured entity. Options such as health captives and self-insured MEWAs are also a viable option. However, for purposes of this article, we will focus on self-insurance for stand-alone employer group.
Control. Similarly, self-insured plans offer their members more choice in plan designs and networks compared with the offerings of a traditional insurer. Benefit plans can be tailored to the needs of an employee population. In addition, because self-insured plans are governed under ERISA, these health plans are typically exempt from state laws, which often mandate certain benefits.
Further, a self-insured group can opt to enter into networks or cost containment programs that actively manage and control provider reimbursement levels that they cannot access with a fully insured carrier. An effective program, such as collaborating with providers that belong to the Free Market Medical Association (FMMA), can reduce the level and volatility of claims on a consistent basis.
Making the case
When making the decision to self-insure, a feasibility study is crucial to the process. This study will list and analyze the advantages and disadvantages for both funding arrangements. The study should also lay out a high-level strategy for the employer group, regardless of their decision of whether to go self-funded or fully insured.
A good feasibility analysis should also show the three main layers of self-funded costs, and then compare to what the fully insured equivalent would be for the same health plan coverage. This will give the decision-makers enough knowledge and comfort to take the appropriate course of action to meet their specific needs. A summary of a typical feasibility study is shown in Figure 1. This is based on a hypothetical 350 employee life company. The figures shown below are represented on a Per Employee per Member (PEPM) basis:
As is evident in Figure 1, self-insurance saves employers on many different levels. For one, state premium taxes are charged in a fully insured plan, but not under a self-insured plan. Further, an employer group can avoid the (potential) new taxes that fully insured plans pass along to employers under the Patient Protection and Affordable Care Act (ACA). These taxes typically amount to approximately 5% of premium in a fully insured plan, costs that are avoided under a self—funded arrangement.
Self-insured groups can also avoid frictional costs such as a broker commission and the profit or risk load that an insurer builds into its premium charge. These charges are typically calculated as a percent of premium, rather than a flat PEPM. This tends to create a disincentive to effectively manage premium levels, since higher premiums equate to higher profit loads and higher commissions.
Additionally, a self-insured group that actively manages claims can see a discount to their stop-loss premiums, relative to a self-insured group that would rely on a traditional carrier to manage and adjudicate their claims. A program such as FMMA could lead to not only lower stop-loss reimbursements, but also lower incidence of claims that actually would breach their stop-loss deductible.
While the main advantage of fully insured coverage is predictability, the main disadvantage is cost, and not just for the upcoming plan year, but also each successive year of coverage. Not only are there more cost components in fully insured coverage versus self-insured, the annual trend increase in these costs are typically higher than self-insured. This is why longer-term projection is necessary in the feasibility study.
It starts with an analysis of the employer’s fully insured plan – its premiums and historical and projected renewal trends – which are used to develop a baseline of future cash flows for the next five years. Using commonly accepted actuarial methods such as examining an employer’s actual trend experience, expected losses are projected for the employer at the three self-insured layers. Figure 2 shows an example of a five-year projection of self-insured costs versus fully insured costs. It is important to note that self-insured claims are assumed to increase at a lower trend level than fully insured rate increases, due to the active management of costs. Utilizing cost control measures, such as the FMMA, has been shown to reduce costs even further on an annually consistent basis. The three trend lines shown are based on typical premium increases for a fully insured group, a self-insured group in a traditional, discounted fee-for-service arrangement, and a self-insured group that has partnered with FMMA providers. Overall, as Figure 2 shows, self-insured costs will be significantly lower in the long run.
An appetite for risk?
The volatility of self-insured costs needs to be measured and communicated to the employer before they can make any decisions around a risk management strategy. For many, it will depend on what they consider an acceptable level of risk. While no one number can completely pinpoint that risk, a feasibility study lends objectivity and support to the decision making process by outlining both the short and long term expected outcomes.
The feasibility study also develops a range of possible loss scenarios and an expected loss at different risk tolerance percentiles. There is always going to be some month-to-month variability around the expected loss percentile, but this figure gives an employer a point of reference for weighing its risk.
The chart below show the probability of actual claims outcomes, with a stop-loss retention point of $75,000, for a 350-life group (Figure 3). This chart is the result of Monte Carlo simulations performed for a typical 350-life employer group, ran for 10,000 simulated plan years.
While a larger employee pool reduces volatility and increases predictability, an additional risk load could still be budgeted by the employer. For example, in Figure 3, an employer could price at a level close to the 75th percentile, so a 5% load to premium would be sufficient.
Also shown in the chart is where a typical fully-insured carrier would price their premiums; usually around the 75th to 85th percentile. Again, a self-insured employer could budget their costs at the same level as the fully insured charge, if so desired. When the losses are lower than expected, employers rather than the carrier receives the benefit, typically in the form of a fund surplus.
The decision to move to a self-funded structure requires more than a willingness to accept some degree of claims variability. It also requires a company-wide buy-in to the decision from all departments, especially from human resources and finance. A group will need to transition from a “set-it-and-forget-it” mentality of a fully insured plan to a commitment to be actively engaged in a range of activities. Activities from monitoring claims activity to reviewing periodic claims reports to understanding the impact of incurred but not reported (IBNR) liabilities are essential.
In addition, as other employees move in and out of the group plan, an employer, with some actuarial support, periodically needs to understand how its risk profile matches up against the budgeted costs every year. Assessing the issue requires a step up in risk management that would not be necessary under a fully insured plan.
With self-insurance, an employer can…
- Avoid state and federal premium taxes
- Eliminate the cost of broker commissions and insurer’s profit load
- Gain control over plan design
- Have a wider choice of services and networks
- Realize savings from potentially lower claims
- Collaborate with their plan advisors on employee benefits/risk management issues surrounding their health plans
But the employer also must….
- Accept claims variability
- Be more involved in overseeing claims activity
- Accept a greater administrative role
⇐ Before the decision is made to move to a self-funded arrangement, the group will need to consider if the advantages outweigh the additional burdens.
⇐ Much of the success or failure of self-insurance depends on the employer and its confidence in its decision and its understanding of the risks involved. This confidence and understanding can be gained through a comprehensive feasibility study.
⇐ Self-insurance is certainly not for the faint of heart, but for those that can weather the occasional wide swing in claims and not panic, self-funding can achieve lower health care costs over the long term and still offer comprehensive health benefits.
DAN FREEMAN is a Consulting Actuary with the Employee Benefits Health and Welfare practice in Omaha, Nebraska. As a credentialed actuary, Dan is responsible for actuarial reports and analysis for medical, dental, life, disability, paid time off, and other ancillary plans.
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