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Self-Funded vs. Fully Insured: Weighing the Cost Savings for Your Business

The other day I was talking with a business owner with 50 employees about his health insurance. I asked if he had ever self-funded.

His reply: “Oh, we’re too small to self-fund.”

I hear this often from smaller employers. While it’s true that most self-funded health plans have over 200 employees, that doesn’t mean there aren’t interesting and valuable self-funded options for smaller groups as well. Self-funding gives a group as small as 25 covered employees the opportunity to see and understand where their health dollars are going. The group can also potentially take some control over this significant investment.

What is self-funding?

In a nutshell, self-funding one’s health plan, as the name suggests, involves paying the health claims of the employees as they occur. With a fully insured health plan, the employer pays a certain amount each month (the premium) to the health insurance company. In return, the insurance company covers the costs of the employees’ healthcare. With a fully insured plan, there is no additional risk to the employer. The employer knows exactly what their plan is going to cost each year. The downside is if the employees are healthy and don’t use much health care, the employer has spent a significant sum and doesn’t get any of the money back.

With self-funding, the opposite occurs: the healthier the employees are, the lower the plan costs will be.

This dynamic manifested itself in a somewhat counterintuitive way during the worst of the covid-19 pandemic when many self-funded employers saw their healthcare expenditures drop significantly due to the corresponding reduction in the use of non-covid healthcare services throughout the general marketplace.

Typically, employers with self-funded plans select a Third-Party Administrator (TPA) to administer the health plan (I have yet to meet an employer who wants to receive doctor’s bills on behalf of their employees). The TPA processes claims as they arrive from the doctor, hospital, or pharmacy. They pay the claims by accessing a bank account set up by the employer for this purpose.

In addition to the administration, an employer will want to purchase stop-loss coverage, to protect themselves against large claims. The obvious risk in self-funding is a situation of large claims. Cancer treatments can easily cost over $200,000 in the first year and often continue in the six-figure per year range for years after diagnosis. I regularly see claims for serious illnesses that exceed half a million dollars a year for one individual’s care. For a small employer, such an expense is potentially devastating – which is where stop-loss comes in.

What is Stop Loss?

I always recommend small employers purchase two types of stop loss coverage. Individual or specific stop-loss provides coverage for each individual on the plan.  Aggregate stop-loss covers the total annual cost of the health plan. With individual stop-loss, an amount is set above which the insurance company will cover 100% of the member’s covered claims for the year. The individual stop-loss amount might be $30,000, which means that the employer is responsible for the first $30,000 of health care for each individual covered on the plan. Anything above $30,000 is paid in full by the insurance company.

Aggregate stop-loss provides an upper limit for the overall plan costs. This gives the employer the security of knowing there is an upper limit in terms of annual cost that the plan will not exceed.

Level Funding

A particularly attractive self-funded plan for smaller employers is a level funded plan. Level funding is a type of self-funding where the insurance company bundles all the component pieces – administration, stop loss, and claims – into a convenient monthly premium the employer pays. It looks a lot like a fully insured premium in that the employer knows exactly what their cost will be per person per month. The difference is that in a level funded plan, the claims paid in by the employer are tracked by the insurance carrier, and at the end of the year if there is a claims surplus, the employer can receive some or all of the surplus back. This means when employees are healthy and claims are lower, there may be surplus claims coming back to the plan. I like this solution for smaller groups because it gives the security of the fully insured premium structure, with the ability to participate in a favorable claims experience. And in a bad year, the plan sponsor knows their maximum liability upfront and is not responsible for paying any claims deficit.

Weighing the Pros and Cons

The biggest advantage of self-funding is the potential for cost savings. If employees are relatively healthy and don’t use the health plan very much, the employer’s costs will be lower than if the plan were fully insured. By self-funding, you also avoid paying premium tax and contributing to the insurance company’s profit margin. Self-funding gives you an almost infinite number of creative possibilities for managing the plan’s health care costs, which are not available in a fully insured, bundled arrangement.

So why wouldn’t an employer self-fund? There are some employers for whom a fully insured plan is still the best way to go. Employers without the time or resources to devote to a more hands-on, complex plan should probably stay with a simpler plan like a fully insured plan. Self-funding has a number of compliance requirementsthat are not always present for a fully insured plan, such as non-discrimination requirements and 5500 tax filings. Furthermore, an employer without a stable cash flow may feel the potential cost fluctuations from month to month of self-funding put too much strain on their company’s finances.

There is no one-size-fits-all for group health plans. The important thing is not to rule out any option before discovering if it could be a good fit for your business.

Explore the different funding arrangements and make the best choice for your company based on your finances and resources. I have seen self-funding save employers money many times. However, at times it is not the right choice for an employer. For those employers, a fully insured plan provides the stability and simplicity they need.

Assess the plan that’s best suited for your company by contacting a OneDigital Consultant. For more on alternative funding plans, watch: Cancel the Waste: How To Break the Cycle of Skyrocketing Health Costs.