PARTIAL SELF-FUNDING
Partial Self-Funding is a tried and proven employee benefit plan concept that can provide many companies with considerable savings in their search for a better way to fund their employees’ health costs. Its main advantages to an employer are:
Improved cash flow
Sharing of the “profit” of a low claims year
Better access to their group’s claim information
Better control over benefit features
Partial Self-Funding is an alternative method of health plan financing. It simply means that the person (or company) buying coverage is going to purchase less coverage and PARTIALLY SELF-FUND the small, predictable claims with their own money. This might be made clearer if we examine a few basic principles of insurance.
The primary concept of insurance is to form a pool to spread the risk of a particular event amongst the individuals or organizations that are exposed to that risk. In this way, those exposed to the risk can share the risk exposure, and by collecting premiums the pool can reimburse the members of the pool that actually incur a loss. In the real world, this concept can never be 100% efficient. That is to say, even over an extended period of time, it is still quite probable that some members of the pool will have obtained an excess of claims reimbursement over their accumulated contributions, and there will be other members that have never obtained a claim reimbursement, despite their contribution to the pool each period.
Also, the costs of setting up and administrating the pool need to be taken into account. These expenses reduce the pool’s overall ability to pay claims. Many factors (depending upon the type of insurance being purchased) can impact the expense “load” of a pool. In the health insurance world, the most efficient pools operate with a 15-20% expense load.
The second basic concept of insurance is a direct result of the inefficiencies and expense load of all “real world” insurance arrangements – that is – “You should only insure that which you could not afford to budget for yourself”. If you can afford to budget the loss yourself, there is no reason to put up with the expense load and the chance that your contributions will go to pay for someone else’s claims.
With the above concepts understood, it is easy to see the two primary reasons employers may choose to Partially Self-Fund their employee benefit plans.
Reason #1) Employers do not like to pay for the high losses of other employer groups when they believe their own employees represent a better than average risk.
Reason #2) Employers are reluctant to pay for the expense load if they could have paid for the claim directly (without the assistance of the pool).
With that basis framework in mind, we are ready to begin to examine how the concept of Partial Self-Funding (PSF) applies to health benefit programs for employers.
In order to better understand PSF, it is helpful to start with the two conceptual extremes on either side of a PSF. On the right is the traditional, conservative, FULLY FUNDED plan. This is where the employer pays a fixed contribution (premium) to the pool (or the insurance company) and the plan, regardless of the number or size of the claims, is legally bound to pay those claims. With a FULLY FUNDED plan, an employer gets the maximum security from risk, but trades a fixed (maybe higher than necessary) level of contribution for this security. The pool needs the higher contributions to cover its overhead and other employers’ higher than expected claims.
The second extreme on the far left is a completely SELF-FUNDED plan. Here an employer pays no fixed contribution, but rather pays for any claims out of the general assets of the company at the time the claim amount is decided. The handling of claims paperwork can be done by a Third Party Administrator or the employer’s own accounting staff. (If an outside administrator is used, the plan is referred to as an Administrative Services Only “ASO” plan). In a Self-Funded plan there is no security from risk, but the employer is assured of only having to pay for the claims its employees actually incur - it is thus able to achieve maximum efficiency.
In the middle of these two extremes lies the very useful concept of PARTIAL SELF-FUNDING. With PSF an employer attempts to balance the advantages of both extremes, while minimizing the disadvantages.
PSF plans utilize many various design options to help an employer achieve the balance of risk and security they seek. One of the most common is the concept of “Aggregate” and “Specific” Stop-Loss guarantees. A Specific Stop-Loss limits the loss to the employer for any one person to no more than a “Specific” pre-defined amount. If anyone covered under the employer’s plan has a claim grater than the Specific Stop Loss amount, the loss carrier would be responsible for reimbursing the employer for any amount over the Specific amount.
In addition to the employer’s risk of large claims from one individual, there is also the risk that many employees (and dependents) will have a higher than expected level of small and medium claims. If every employee and dependent all got sick at once, the employer could be in financial trouble. An Aggregate Stop-Loss can take much of this type of risk out of the plan. An Aggregate Stop-Loss eliminates the employer’s claims liability at some pre-determined total loss point. This is called the “attachment point”. It is usually some percentage of the total expected losses over a 12 month period of time. For example, a 120% Aggregate Stop-Loss would eliminate the employer’s claims liability when the total of employer funded claims was at 120% of the expected total claims for that contract year.
In other words, Stop-Loss coverages prevent the employer’s claims liability from getting out of hand.
The “Specific” protects the employer against large claim losses for any single person,
and the “Aggregate” protects against the cumulative effect of a “bad claims year” on the plan as a whole.
Another important concept is that of “Run-Off”, as associated with Stop-Loss coverage. Run-Off is the amount of claims that have been incurred, but not yet reported or paid within a plan contact year. The timing of when a claim is paid is very important with regard to Stop-Loss coverage. All Stop-Loss contracts specify a time period in which they will cover a claim. Commonly, the coverage is referred to in an INCURRED/PAID format. A 12/12 Specific or Aggregate Stop-Loss contract would cover claims that are both incurred and paid within the 12 months of the contract plan year. A 12/27 contract would cover any claim incurred within the first 12 months and paid within the same 12 months + another 15 months after the end of the contract year. The advantage of the 12/27 contract is that it allows for claims that occur near the end of the contract plan year to be processed by the claims administrator and still covered under the Stop-Loss contract. The down side is that such a contract costs more. This “extra 15 months” of coverage is in many instances not necessary if a company stays with the same plan, since the Run-Off claims from the first plan year under a 12/12 Stop-Loss coverage may typically be “rolled over” into the subsequent plan year at no charge. In this situation, there is no Run-Off to worry about – the extra coverage afforded by the 12/27 Stop-Loss contract is not needed. The only time the Run-Off coverage of a 12/27 contract is needed when the company does not intend to renew the coverage with the Stop-Loss carrier.
Before we leave this topic of Run-Off Stop-Loss coverage, it is appropriate to inject a note of caution. Most of the problems that employers encounter when using Partially Self-Funded plans can be traced back to not understanding the nuances of Run-Off and Stop-Loss coverage. There is no standard contract wording and (like most insurance contracts) virtually all of them are not easily understood on the first reading. It is of utmost importance for employers to fully understand their Stop-Loss contracts. In this regard it is also imperative to work with a broker or agent who is fully capable to present and explain PSF plans.
The final basic element common to virtually all PSF plans is that of a Third Party Administrator (TPA). Since a PSF plan can save an employer more or cost an employer more (depending on the plan’s experience) than a Fully Funded plan, it is important to stress the importance of a high quality health plan administrator to create and operate the plan. Health plan documentation and claims administration are extremely complicated fields of expertise. The quantity of federal regulation alone is enormous. Professional competence is essential for smooth plan operation. Although using a TPA adds an added expense load to a PSF plan, it is almost always money well spent.
Partial Self-Funded plans are not right for every employer, however,
Any questions please contact us via e-mail by clicking HERE