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November 25, 2013 | Retirement Plans
Health plan costs rank among the highest concerns of U.S. employers, and with good reason, since health care cost increases have outpaced inflation for years. As shown in the chart below, average health plan costs increased dramatically over the past decade1.
Many factors have contributed to these increases, including:
Regardless of the reasons behind the increases, most employers are not able to absorb increases of that magnitude over the long term, particularly in the current economy. Employers pay the vast majority of health plan expenses for their employees, averaging 82% of the cost of single coverage and 71% of the cost of family coverage in 20131. Faced with this necessary cost of attracting and retaining talent, employers have a multitude of decisions to make in designing a health plan that is both valued by employees and sustainable in terms of employer costs.
Among these decisions are:
This paper focuses primarily on funding employer health plans and reviews the many intricacies involved in selecting the appropriate funding method, as well as the advantages and disadvantages of different funding methods.
The main decision an employer faces on health plan funding is whether to purchase insurance to cover claims and other expenses, or to self-insure the plan.
If a plan is insured, the employer contracts with an insurance company to assume the risk of all health plan costs. The employer pays a monthly premium to the insurance company to cover claims and administration costs, and the insurance company bears the full responsibility for paying all incurred claims. Within the fully insured category, health plans can be community-rated or experience-rated.
With a self-insured (or self-funded) plan, the employer bears the risk of all costs incurred under the plan for claims and administration. The employer can pay claims either from general assets or through a trust established for funding claims.
The employer typically hires a third party administrator (TPA), or an insurance company on an administrative services only (ASO) basis, who will process claims under the plan and give access to their network of physicians and other health care providers.
Some employers choose to partially self-fund (e.g., carve out prescription drug benefits and self-fund through a pharmacy benefits manager firm, while continuing to insure the medical portion). Options such as partial self-funding, or other hybrid funding options, are not explored in this paper.
There are many variables which would make one type of funding arrangement more appropriate for any given employer. Insured and self-insured plans differ in who bears the risk and who maintains control over the reserves. When moving from insured to self-insured, the risk and control, as well as the advantages and disadvantages that accompany them, are shifted from the insurance company to the employer. The main advantages and disadvantages of each funding arrangement are detailed below.
On the positive side, an insured funding arrangement means the insurance company bears all the risk of unexpectedly high claims. At least for the time period spelled out in the employer’s rate agreement, the monthly premiums will not be affected by high claims. Upon renewal, the insurance company underwriters will include recent claims experience, either good or bad, in determining rates for the next period, but employers do not have to experience the highs and lows of claims variability throughout the year, and they can reasonably budget their expenses.
One of the downfalls of an insured arrangement is the insurer’s fixed costs that are built into their monthly premiums. This includes costs such as administration, overhead, state premium taxes (average 2% to 4% of premiums), and reserve levels that insurance companies are required to meet. Another point against an insured arrangement is an employer typically has less flexibility in plan design since they are choosing among the insurer’s “off the shelf” products.
In a self-insured health plan, an employer will reap the benefits of good claims experience, since their costs are not impacted by the experience of an insurance company’s pool. Thus, any successful efforts an employer makes to control claim costs will not be diluted by poor claims experience of other groups in the pool. Employers who self-fund will have greater flexibility in plan design since they are not limited to the insurance company’s offerings, and they are generally not subject to state benefit mandates. State benefit mandates can add significant cost to health plans, particularly in states with a long list of mandated benefits that insured plans must cover. Some examples of state benefit mandates are dependent age limits that are higher than the age 26 federal mandate, and COBRA continuation coverage requirements that are more generous than the federal requirements. Self-funded plans are still required to comply with federal benefit mandates, such as the health care reform legislation passed in 2010, the Patient Protection and Affordable Care Act (PPACA).
In addition to the potential for lower claim costs due to fewer plan design mandates, self-funded health plans also offer lower costs in other areas, such as:
Another significant advantage of a self-funded health plan is greater availability of claims utilization data. This allows an employer to make more informed decisions regarding plan design based on a better understanding of how claims dollars are being spent. Employers should be aware of the implications of having access to protected health information under the Health Insurance Portability and Accountability Act (HIPAA) and should ensure all HIPAA-required documentation is in place (e.g., policies, procedures, business associate agreements, and staff training). Employers may want to consult with an attorney specializing in HIPAA to ensure compliance.
The employer bears the risk of all costs under a self-insured health plan. While some of this risk can be mitigated by purchasing stop-loss coverage, there is still potential for wide variability in payments throughout the year. Employers who choose to self-insure must be able to meet claim expenses as they arise. Even claims above the stop-loss threshold will be initially funded by the employer until they are reimbursed by the stop-loss carrier.
As the number of employees increases, the prevalence of self-funding also increases. Since 1999, the percentage of employers self-funding their health plans increased from 44% to 60%, as shown in the chart below1. As health plan costs continue to escalate, more employers are realizing the potential for savings in a self-funded arrangement.
The largest component of cost in a health plan, either insured or self-insured, is the actual claims expense. Claims typically make up 88% to 92% of total costs, while other expenses account for only 8% to 12%2. In calculating costs (premium rate for an insured plan and premium equivalent rate for a self-insured plan), both insured and self-insured plans begin with actual claims and add expected medical trend to arrive at projected claims for the following year. To account for the full cost of the plan, other expenses need to be factored in, such as administration fees and network access fees charged by the third party administrator, and stop-loss insurance premiums. On the self-insured side, employers avoid some of the insurance company’s added expenses and also maintain control of reserves.
When considering self-insuring, it is important to note any additional programs that an employer may have been receiving as part of their insured premium. As these programs may not be included in the administrative fees charged by a third party administrator, or they may be offered for an additional fee, the employer will need to add these costs into the calculation of the health plan budget and premium equivalent rates. Listed below are a few examples of these programs.
An employer may choose to purchase stop-loss insurance to protect against catastrophic claims. Stop-loss insurance is available in two forms:
An employer may purchase either specific or aggregate stop-loss, or both. In any case, the employer pays premiums to the stop-loss carrier for this protection, and the stop-loss carrier reimburses the employer for expenses in excess of the specified threshold amounts. Employers will need to evaluate their risk tolerance and strike an appropriate balance between the premium for the stop-loss coverage and the deductible/attachment point that represents a comfortable level of risk.
Stop-loss policies are written as covering claims incurred and paid within a specified time period. Examples of possible options include the following (the
Employers need to carefully weigh these options and select the one that makes sense for the current coverage period. For example, a newly self-funded plan would not need to be concerned with covering claims incurred prior to the start of the policy period since those claims would be covered by the prior insurance company. However, employers need to ensure the ability to select a different option upon renewal with their stop-loss carrier. Also, with the health care reform legislation’s changes to the allowed maximum dollar limits on health plan coverage, employers should carefully review their stop-loss policies to ensure there are no gaps in coverage.
Employers must also ensure their administrator’s ability and willingness to coordinate claims reporting to the selected stop-loss carrier. Many stop-loss carriers will request to be alerted to claims likely to exceed the deductible once they reach the half-way point (e.g., on a stop-loss policy with a $100,000 deductible, the stop-loss carrier may request to be notified when a claim reaches $50,000 and is expected to continue), or they may need to be alerted to claims with a specific diagnosis, regardless of the dollar amount.
Some stop-loss carriers will be actively involved in managing high cost claims, and early notice facilitates this process and can ultimately lower the overall cost of the claim. Failure to provide timely notice can negatively impact the stop-loss carrier’s ability to manage claims, which will directly impact the employer’s premiums upon renewal. Some administrators will charge an additional fee to coordinate with an outside stop-loss carrier, so employers should confirm the coordination process before finalizing carrier selection and should include coordination details in their contract with the administrator.
While self-insuring a health plan has the potential for cost savings over an insured premium, there are several considerations employers need to be mindful of to ensure a successful transition.
Calculation of premium equivalents and adequate reserves – Employers may want to work with an actuary or underwriter to calculate projected costs. The administrator or stop-loss provider may be able to assist with these projections. This step is critical to ensure adequate budgeting and calculation of employee contributions.
Risk tolerance – Employers will need to be prepared for the variability in costs associated with a self-funded health plan. Claim expenses can vary widely from month to month due to high utilization or a catastrophic claim. Claims can be funded through general assets, or through a trust established for funding claims. In either case, adequate reserves must be available to pay claims as they arise throughout the year.
Claims data (utilization, benchmarking, prescription pricing) – Employers will need to select vendors who are able to provide the necessary reporting and data to allow them to make informed decisions regarding plan design changes and to evaluate any cost control measures in place.
Non-discrimination testing – Self-insured plans are subject to non-discrimination testing. (NOTE: This testing was included in the PPACA legislation as a new requirement for insured plans beginning in 2012, but it has been delayed indefinitely.) If the administrator does not provide this service, employers will need to engage another vendor or train internal staff to conduct the testing.
Administrator services – An employer with a self-funded health plan will need to select certain vendors to partner with in the management of the plan. Most employers will hire a third party administrator (TPA), or an insurer on an administrative services only (ASO) basis, to adjudicate claims. At a minimum, the selected administrator should be able to provide the following services and products:
Consultant/broker services – If an employer is working with a consultant or broker on health plan design and management and selection of vendors, they should be asking questions to determine their ability to assist with successfully managing the plan. In particular, employers should be looking for consultants/brokers with experience in the following areas, or with the ability to assess and select vendors to perform these services on behalf of the employer.
Since employers bear the full risk of costs under a self-insured plan, cost containment measures are of critical importance. When making the transition to a self-funded health plan, employers will need to confirm with all vendors involved in managing the plan that the appropriate cost containment measures are in place. Listed below are some of the more prevalent programs in use today.
Of the many decisions an employer faces regarding health plan design, the decision to insure or self-insure is fundamental. There are many considerations to explore before and after choosing the appropriate funding method. Continual cost control efforts are critical once an employer takes on the risk of claims expense under a self-funded arrangement. Equally critical is partnering with the right vendors (third party administrators, consultants, brokers, pharmacy benefit managers, etc.) who will work with the employer and provide the required tools to ensure long-term success. Self-funding alone is not enough to change the trend of cost increases. However, if it is undertaken with appropriate planning and budgeting, and is coupled with a smart plan design that engages employees as wise consumers, it can be a powerful tool in an employer’s struggle to control health care costs.
1”Employer Health Benefits: 2013 Annual Survey.” Kaiser Family Foundation/Health Research & Educational Trust, September 2013. http://ehbs.kff.org.
2“A Model Self-Funded Health Plan.” Self-Insurance Institute of America, Inc., 2009.
3www.irs.gov/uac/Affordable-Care-Act-Tax-Provisions.
4Indiana University-Purdue University, Fort Wayne (IPFW) Study, 2006; Dixon, Ian and Courtney Rees. “Preventive Care and Services in Workplace Health Plans.” Benefits & Compensation Digest, December 2004; Clarke, Anne. “The New Frontier of Wellness.” Benefits Quarterly, 2008.
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