Profiting from health: The self-insurance story

Imagine if you kept all the promises you ever made about your health. You eat healthy. You exercise regularly. You cut down on alcohol. Even though these life changes translate to a reduced risk for your health insurance carrier, your policy wouldn’t cost any less – and there’s nothing you can do about it.

Employers face this same sort of reality when it comes to purchasing fully-funded group insurance – a standard group policy from an insurance carrier that is “community” rated (rate is based only on the age, geography and smoker status of the population). But, unlike the individual, employers have a way to break out of this status quo and realize very real cost savings. Companies can do this through what is known as self-insurance. (“Self-funding,” “partially self-funded” or “level-funded” are other terms used to describe this setup. For simplicity, all the varieties will default to being called “self-funded” for this article.)

At the most basic level, insurance is purchased to shift risk. A policyholder doesn’t want to be liable for a negative outcome, so an insurance company takes on that liability and charges a premium. In a self-funded setup, a company decides to take on this risk itself instead of paying an insurance carrier to assume it. For the employees, everything may look and operate exactly the same. Behind-the-scenes, though, if the administrative costs of running the plan are reduced, and negative health outcomes are limited, the employer directly saves money.

For decades self-funding has been the method of choice for very large companies, but now companies as small as 20 employees are looking to get out of fully-funded plans.

“If we went back five years ago, it made zero sense for an employer to go self-insured unless they had three to five hundred employees minimum. It didn’t make sense financially. They didn’t have the risk pool,” said William Short, the CEO of Ameriflex, a company that helps employers administer health benefits. “Now, because of regulation, because of the cost, it continues to grow at 20% minimum from what we are seeing across our plans; employers are having to get creative.”

That creativity doesn’t necessarily mean transitioning into self-insurance without a backstop. After all, most employers, or people for that matter, aren’t looking to move from assuming no risk to assuming all of it. So, stop-loss (a.k.a. reinsurance) insurance is often purchased, especially among smaller employers (many people call this setup “partially self-funded”).

Let’s say a company has a $6,000 individual out-of-pocket max for its fully-funded plan. Any health expenses an employee accrues above that level are handled by the insurance carrier. If the company switched to a self-funded plan, it might purchase $25,000 specific stop-loss insurance and $500,000 aggregate insurance. With the same out-of-pocket max, the employer would handle all claims for each employee between $6,000 and the stop-loss threshold of $25,000. After that, the stop-loss carrier would pay. Likewise, the reinsurer would assume the costs if claims for the group pierced the aggregate level of $500,000. Because of the risk an employer is assuming, premiums for stop-loss insurance cost a fraction of fully-funded premiums.

“From an actuarial standpoint, if your plan is set up as it should be and is run well, you’re more likely than not going to be able to achieve certain savings over time,” said Mike Ferguson, the CEO of the Self-Insurance Institute of America.

Therein lies the challenge. Just accepting a year-over-year increase from insurance carriers may be frustrating, but it doesn’t require a tremendous amount of decision-making. Self-insurance does. And if knee-jerk, myopic decisions are made, Mr. Ferguson said, “we would recommend that self-insurance is not a good choice for you.”

Moving toward a well-run self-funded plan commences with reviewing as much data as possible. In a fully-funded product, all that’s needed is a health census (location, age and tobacco use of the group) to receive a quote. However, to get quotes from stop-loss carriers, a full health questionnaire from each employee is usually needed so current and future health risks can be properly assessed. This information is not just useful for quoting.

“If you get data visibility, you understand what you are paying, you understand how much you should be paying and you ultimately understand if you should be going self-funded based off the risk profile of your group,” said Aaron Huang, VP of marketing for Lumity, a company that uses data and technology to help administer health plans.

But the best data visibility – claims data – is very hard to obtain according to many consultants. The insurance carrier controls it and is usually reluctant to share. This creates a bit of a paradox: to make the best decisions about self-funding you need claims data, but it’s unlikely you’ll have total control of the claims data until you are self-funded.

With or without visibility, an educated shift to self-funding can and does still occur – 63% of all workers are on a self-funded plan, up 43% since 1999. This shift requires a series of choices that aren’t necessary in the fully-funded world. These decisions usually begin with selecting a third-party administrator (TPA). This entity will handle any number of things like selecting a provider network, which can usually be leased from a major carrier, contracting a pharmacy benefit manager (PBM), and then actually managing all the claims – basically all the things the insurance carrier handled for a fully-funded product.

Major insurance carriers will also bid to play this role through Administrative Services Only (ASO) arrangements. “A lot of times the carriers as an ASO are going to be much more costly than an independent TPA, especially if you want to carve out the prescription,” said Ryan Kastner, a benefits consultant for Innovative Benefit Planning. Carving out the prescription means you contract directly with a PBM to handle prescriptions for the self-funded plan as opposed to having the ASO do it. Mr. Kastner says there are times when a quote for ASO services actually jumps from something like $50 per employee per month (PEPM) to $90 PEPM if you ask the carrier to do less – to not manage the prescriptions.  “The carriers are making a lot of money behind the scenes on rebate and discount percentages on the prescription,” said Mr. Kastner.

To demonstrate how all of these services are purchased, let’s say $100,000 was being paid each year in premiums for the fully-funded product. That $100,000 covers the expected claims costs, the administrative costs, profit and marketing for the insurance carrier. This premium cost is fixed regardless of how much healthcare is accessed during the year.

If an employer devotes the same $100,000 to a self-funded plan, about 40% would be set aside for administrative costs – all those unbundled services like a TPA/ASO, a network, a PBM and stop-loss premiums. The other 60% is allotted for expected claims. If your population is healthy and generates less than $60,000 in claims and/or your administrative costs are contained to less than $40,000, the employer keeps the savings. Also, up to about 5% of the fully-funded premium is state and federal tax that a self-funded employer avoids.  Achieving savings, specifically over the long-term, is common Mr. Ferguson explained. “In many cases, adding up those numbers is going to come out less than a fixed cost you are paying to the insurance company.”

Aside from finding extra dollars by shifting risk to the employer from a carrier, there is another major advantage of self-funding: control.

“Do you want to cover acupuncture? Do you want to have a direct contract with a certain facility? You can recognize your risk. You can recognize your opportunities,” said Adam Russo, the CEO of The Phia Group, a healthcare cost containment company. “You can then design a plan that fits the needs of your actual employees. Not the one-size-fits-all approach that comes in from the fully insured world.”

In theory, this ability to recognize risk and opportunities should only grow over time as claims data accumulates. “Over the course of two or three years you can start gathering the claims data and make more intelligent decisions with real hard data versus kind of the guesstimate you are making when you are coming out of a fully insured plan,” said Julien Emery, an insurance broker and the CEO of Allay.io.

None of this is to say that self-insurance is without downsides. If all the focus in on the potential dollar savings, employers may not appreciate that a very real risk transfer is occurring. Sandra Hartman is a veteran healthcare strategist and consultant who runs Elevate Healthcare ROI and has witnessed this very issue.

“The employer is going to assume some level of risk, and I’ve seen where the CEO doesn’t understand that piece of it, and then it falls apart when they have one large claim or renewal doesn’t go as well as they think,” she said.

Where there are more decisions to be made, there are more chances to err. Poor analysis can lead to purchasing a suboptimal amount of stop-loss insurance. Not fully reviewing contracts with stop-loss carriers can lead to false beliefs that something will be covered. Improper reserve balances can lead to cash flow issues given the volatility of claims.

Then again, all successful businesses must have some skill in analyzing risk and making intelligent decisions. Insurance benefits are often the second largest business expense behind salaries, so it’s a logical place to apply these abilities. Fully-funded insurance isn’t going to disappear anytime soon, but the trend of companies of all sizes exploring self-funding isn’t one that Emery of Allay.io thinks will abate.

“Big companies have always done this. So why wouldn’t small businesses find ways to take advantage of this? If they can get the advantages, why wouldn’t they?”

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