by Jim Edholm
November 2, 2011

Larger employers are often thought to have a health insurance cost advantage over their smaller brethren because they can "self-fund" their insurance.

Smaller companies, on the other hand, must "fully insure."

Why should self-funding be superior to fully insuring?

Well, it's not superior for everyone. But the reason it's superior for many employers is the 80/20 rule. Approximately 80 percent of health-carrier losses (excess of claims over premiums) are caused by 20 percent of the employers---the sick groups. The healthy groups, however, pay a proportionate 80 percent of premiums.  So, any healthy group can potentially profit from self-funding, which is good for construction firms because their employees are generally younger and healthier than the average company.

The assumption is, however, that only healthy groups that are "large enough" can self-fund---smaller groups are doomed to live in fully insured purgatory.

Like most "conventional wisdom," this assumption is frequently wrong. All but the smallest construction companies have much the same access to "partial self-funding" that larger employers do. Self-funding is a bit more complex than fully insuring, but if your broker is experienced in this field, he or she can easily walk you through the mechanisms.

Sadly for their bottom lines, only a tiny percentage of firms with fewer than 100 employees self-fund, despite potentially profiting from it.

Let's review two primary self-funding methods---traditional self-funding and "do-it-yourself" self-funding. Traditional self-funding typically applies to firms larger than about thirty-five insured employees.  "Do-it-yourself" self-funding is appropriate for firms with two employees up to about seventy-five employees, so there's overlap in the middle.

We use the term "partial self-funding" because very few companies truly self-fund their health insurance. True self-funding would require the employer to assume all the risks inherent in providing health coverage to its employees, and few employers can afford such risk when individual claim costs as large as $2 million are increasingly common.  Even large

employers share the risks with an insurance company.

How "Traditional" Self-Funding Works

Starting at thirty-five to fifty covered employees, this approach has the self-funded employer pays three costs:

  1. Administrative costs
  2. Claims
  3. Reinsurance

The employer uses an administrator to review and pay employees' claims. Also, since most plans today are Preferred Provider Organization (PPO) plans, the administrator also arranges for the employer to "join" a network of providers who offer pre-arranged-discounts---that cost is included in the administrative plan costs.

The administrator provides an actuarial projection of what the group's claims are expected to be over the coming plan year, and that cost is the claims factor.  It's the largest portion of the employer's self-funded health cost.

Because medical costs can be outrageous, the employer chooses a point beyond which it's not willing to risk its money. The employer, working with his administrator, finds an insurance carrier---who may also be the stop-loss provider---to absorb the claims above that level.

That reinsurance policy is called a stop-loss policy, and it comes in two flavors---specific and aggregate. The specific stop-loss policy covers the costs of any individual claim that exceed the threshold the employer has selected. Smaller companies also typically buy an "aggregate stop-loss" policy, which puts a cap on the total of all the claims that fall below the specific stop-loss threshold.

The specific stop-loss policy is the more expensive of the two policies---large "shock claims" are fairly common. The aggregate is a much lower cost since only about 3 percent of employers ever hit the aggregate stop-loss point.

You can lower the premium (and increase the risk) by increasing the specific stop-loss point. However, you don't want your whole group held hostage to a couple of claimants. One rule of thumb is to set the specific stop-loss point at 10 percent of the total projected loss. So a $20,000 stop loss here would be used with a $200,000 claims projection.

Now the employer has a worst-case scenario number: 

     Total annual administrative costs

     + Premiums for the specific and aggregate stop-loss policies

     + The maximum claims projection

     = Worst case costs

While in practice it's more subtle than this, the employer can compare the worst-case costs to the renewal cost of his fully insured health plan. If this projected cost is less than his renewal cost, he has little to risk by self-funding.

However, think about these factors:

  • Your claims cost will probably be less than the projection, which is typically the actuarially expected claims plus 20 to 25 percent. Only about 3 percent of employers typically hit the maximum.
  • If you decide at renewal to return to fully insured coverage, remember:
    • You're responsible for all claims incurred during the contract year, even if they're presented for payment later; therefore, you'll continue to pay claims for a period after returning to fully insured.
    • Depending on your size and experience, carriers might refuse to write your case, so you'll be forced to remain self-funded.
    • If your firm is over 100 insured employees, your bad self-funding experience will be considered in your fully insured premium.

Self-funding for the Smaller Employer

In at least some states, there is a carrier that provides a similar structure all the way down to as few as five covered employees. Here's how it differs:

  1. The administrator and the insurer are the same company---the program is self-contained.
  2. The plan is medically underwritten, so if your company has employees with serious medical conditions, you won't get coverage.
  3. You make equal contributions to claims every month, irrespective of the actual claims. Any money left at the end of the contract year rolls forward to the next year. If claims exceed the amount collected, you walk away.

Second, you can create your own "do-it-yourself" self-funding. Presuming you have an experienced and imaginative broker, you can structure something like the case shown, a real-life example. The firm's home is Massachusetts, so the plans are specific to that state; however, almost all states have similar plans. To simplify the explanation, we assume the employer pays the entire cost, although this is seldom the case.


Plan Design & Cost