The advantages of alternative funding for small and mid-size employers

John Crable

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By now, you’ve realized that the rules have changed in group employee health insurance. The landscape brought about by the Affordable Care Act (ACA) and shifting market conditions means that many of the assumptions we’ve been operating under for years are now no longer true. That includes the assumption that alternative funding solutions for health benefits are only for mega-employers.

Smaller and medium-sized employers—even those under 100 lives—can benefit from alternative funding approaches.

There are 3 main categories of alternative funding approaches employers should consider: captives, private exchanges and full and partial self-insuring. Let’s dig into each. We include private exchanges in this conversation because of the significant publicity they receive. Private exchange options are more about employer contribution funding and less about premium or claims funding.

Captives
Captives have existed and been popular for Workers’ Compensation insurance for years, but have never been heavily utilized on the employee benefits side. Now, they’re getting more traction in the wake of healthcare reform.

With a captive, an administrator will pool multiple employers who enter into a risk-sharing agreement. They move into a self-insuring situation, with the captive being controlled by an administrator. This mitigates the employer’s risk.

Captives typically have 4 “layers:” Here’s an example of a typical captive funding arrangement:

  1. An employer is responsible for first $25,000 for any claims made by individual plan participants.
  2. All employers in the pool share in the risk, from $25,000 to $250,000.
  3. For claims higher than $250,000, the captive has individual stop-loss coverage for any claimants that exceed the $250,000 mark.
  4. There is usually additional coverage, called aggregate stop-loss coverage, that protects each employer for the total claims by the company, typically ranging from 115% to 125% of expected claim costs in any given year.

Captives are usually multi-year agreements, so that employers cannot jump in and out of them.

When captives work. Captives tend to be most attractive to small to mid-employers (up to 200 employee lives), although some include larger employers.

When captives don’t work. If an employer’s plan is running well and participants are coached on wellness and engaged in their health, the employer could end up subsidizing other employers who don’t manage their plans as carefully. Of course, the opposite is also true. In short, captives are best for employers who need to mitigate their insurance risk. Importantly, employers should pay attention to the individual and aggregate stop-loss coverage on the top end of the risk spectrum; unlike with Workers’ Compensation, there can be significantly higher upside risk due largely to the pure cost of catastrophic health claims.

Private Exchanges
Private exchanges are gathering momentum in the wake of the ACA’s implementation. These follow a defined contribution model that offers employees the opportunity to choose from multiple plans at multiple price points. The exchange is accompanied by a decision-making technology platform.

Why they work. Employees need to be educated in order to make a private exchange work for them. If the exchange does not provide a smart and intuitive decision support tool, or appropriate personal support, the exchange can lead to employee dissatisfaction.

Self-insuring
The ACA has led many employers to consider full or partial self-insuring for the first time. There are many different flavors of self-insurance, from minimum-premium or risk-sharing arrangements to a fully self-funded plan, in which the employer is responsible for all claims. Employers who want to consider self-insuring must understand there are many different levels to explore. Here’s a quick overview:

  • Retrospective premium arrangement, in which an insurance carrier will credit back a portion of the unused premium to the employer (typically as a credit for the following year). This is often used in a fully insured arrangement. Under a retrospective premium arrangement, an employer usually doesn’t pay more than the agreed-to amount.
  • Minimum premium arrangement. This is typically also fully insured. Under this plan the employer pays fixed costs (administration charges, stop-loss insurance and network access fees) and claim costs up to a maximum liability each month (a monthly cap). If the plan runs well, the employer will save money; they pay as they go with a monthly max. Sometimes there are carry-forward arrangements so if an employer exceeds its monthly maximum it may be applied to the next month. If you’re thinking of using a minimum premium arrangement, make sure you understand the variables. The total liability is often capped at or near the fully insured equivalent plan.
  • Partial self-funding. This is similar to a minimum premium, but it’s not an insured product. The employer pays fixed costs (administration, network access, stop-loss premiums and some fees and taxes) but has more liability. Administrative charges will be much lower than in minimum premium arrangement because the employer takes on more liability. The employer has individual stop loss insurance, which typically means the employer is responsible for all claims up to a certain threshold. After that, stop-loss kicks in. There can also be a second tier of stop-loss, in which the employer has an annual maximum of, for instance, 125%, often purchased from same carrier.
  • True self-funding is where the employer has an administrator and no stop loss. The employer pays the administrator and assumes total cost of claims. This is usually reserved for large employers. However, some medium-sized businesses are considering this option in this new world in which we’re operating.

A way for employers to dip their toe into the self-funding world is to self-fund a portion of coverage, such as dental. This provides an opportunity to take the concept for a test drive. One idea employers may want to consider is the self-funding of prescription plans, with a stop-loss provision to cap expenses.

These alternative funding approaches are just the tip of the iceberg. There are clearly many moving parts in group employee health insurance these days, and every employer’s situation is different. However, these alternatives may be worth exploring.


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