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Can Smaller Firms Self Fund? Surprise–Many Already Are

By Brian Schilling

Nine years ago, when David Kohmescher stepped in as chief executive officer of the Newburgh, Indiana-based Women's Health Care, the 20-physician obstetrics–gynecology practice was in its first year of being self-insured. His immediate predecessor had led the organization through the transition from fully insured to self insured for what Kohmescher said were the usual reasons: cost, lack of control, general frustration.

"Costs were going up every year and the organization never had the freedom to build the plan it really wanted," said Kohmescher. "I think the general sense among our owners was 'Hey, we're well established, we have good cash flow, and we are doctors and know health care. We're good candidates for this.' That has certainly turned out to be the case."

Kohmescher's conclusion that self-insuring was a good decision comes despite the fact that in many ways, the practice might not seem like an ideal candidate, especially retrospectively. It had one very bad claims year in terms of costs. Three employees have died in the past decade. And the firm is small in comparison to the usual self-insured entity: only about 80 of the firm's 120 employees participate in the health plan.

None of that has made self-insuring tenuous or, as one might expect, cost-prohibitive. "We've saved money every year versus buying a fully insured product on the open market, including the one year where we had to cover costs of one catastrophic case that ran into the $100,000 range," said Kohmescher. "Every year our costs have been 10 percent to 20 percent lower than they might have been because we self-insure."

A Trend in the Market

The ranks of small employers that self-fund their health benefits are certainly growing. In 2010, 16 percent of employees who work for firms with 3 to 199 employees were covered by self-funded health plans. That's up 60 percent from 2004, when only 10 percent of employees in small firms were covered by self-funded plans.1 Larger employers are increasingly turning to self-funding as well, but the practice has been commonplace in that end of the market for some time. Today, 93 percent of employees working for firms with more than 5,000 employees are in self-funded plans.2

Most self-insured companies purchase reinsurance to protect against unexpectedly high claims. Reinsurance comes in two different forms. A company can buy a per-employee stop–loss policy, which limits the amount the company might have to pay for any given employee at, say, $30,000 per year. Firms can also purchase an overall stop–loss policy, which caps their overall financial risk at a certain level.

Self-Funding Highlights

Risk: The employer acts as its own insurer and ultimately bears the risk for all claims incurred.

Reinsurance: Employers that self-fund can purchase a reinsurance policy that caps their liability per year or per individual. Claims over a set amount are paid by the reinsurer.

Plan Administration: Self-funded employers contract with area health plans or a third-party administrator to manage health benefits for their employees and their families.

Flexibility: Self-funded plans are not subject to many state or federal regulations guiding plan design; hence, there is substantial flexibility in designing benefits to meet employee or employer needs. 

Curtis Donely, a benefits consultant based in Indianapolis who specializes in the small employer end of the market, says he's seen an uptick in interest among smaller firms looking to self-insure. Not all of them are a good fit. "I tend to discourage firms that have fewer than 35 employees," he says. "Below that point it gets hard to find reinsurers interested in their business."

For firms with between 35 and 100 employees, Donely proposes a straightforward means test. "I look at whether they are committed to self-insuring or if they are just looking for a quick way to lower costs. Do they have strong cash flow? What does their claims history look like? Are they willing to stay engaged enough to make self-insuring work?"

Staying engaged is a big deal. According to Donely, a self-insured employer must be able to take an active role in designing the company's benefits and managing vendors. "The biggest advantage of self-funding isn't costs, it's that you get control of your benefit plan. You can tweak it and make it work for you," he says. "But the flip side is that your vendors don't have any skin in the game. So you can't just defer to them to manage costs or ensure that your employees get quality care. That becomes your job or your broker's job."

Kohmescher takes that part of his job seriously. In the past six years, the practice has tweaked its benefit plan five times in various ways. It has also dumped vendors that didn't perform and required those they work with to provide regular reports on various measures of use, cost, and performance.

When a firm opts to self-fund, it is essentially deciding to act as its own insurer. It still contracts with area health plans or a third-party administrator to do things like manage physician networks, contract with providers, handle negotiations, and process claims, but the money to pay those claims comes out of a dedicated fund or the company till.

Even with reinsurance, in a bad year, paying claims out of the company's operating cash can be painful. "We plan ahead and allocate a set amount each month to pay for expected claims, but expected claims and actual claims don't always match," says Kohmescher. "In a bad month or a bad year, the overage comes out of your pocket. You make up the difference and then wait for the reinsurance check to arrive. You have to be prepared to float a significant amount of money to self-insure."

Smaller firms that self-insure also face the threat that after a bad year, or perhaps several bad years, their reinsurer might decide not to renew their policy. No law prevents a reinsurer from dropping a customer, and all but the largest of firms need stop–loss insurance to guard against financial ruin. Kohmescher acknowledges the concern, but gives high marks to the two reinsurers he's worked with. "Even after a very bad year," he says, "we sat down and had a reasonable, fair conversation about current versus future costs and our premiums. We still felt like they wanted our business."

The increase in self-funding among small employers is primarily a reaction to cost pressures. The Kaiser Family Foundation found that in 1999, small firms paid about 10 percent more than large firms for skimpier benefits. By 2009, the difference had grown to 18 percent.3 Industry-wide, between 1999 and 2009 health care premiums have increased 120 percent.

Though cost may be driving the trend toward self-funding health benefits, experts say that the flexibility it affords an employer to design a benefit plan that suits its employees may be the most valuable benefit.

 Good Candidates for Self-Funding Will Have:

  • a good track record of low-to-normal annual medical claims;
  • strong cash flow;
  • more than 35 workers; and
  • a strong interest in actively managing their own health benefits or a consultant who can help do so.
Attorney George Pantos, a leading champion of the self-funding movement, says that flexibility and cost savings can be related. "You can design a plan that is exactly the same across state lines; you can tweak your benefits to help recruit or retain workers; and you're free from various state mandates that apply to insurance companies. All these things can save money," he says. He also notes that because self-funded plans aren't subject to state and federal premium taxes, there's often an "off-the-top" savings, which varies by state, of about 2 percent.

Even though they aren't subject to the same state and federal regulations, self-funded plans tend to offer similar benefits compared to their fully insured counterparts. According to a recent RAND analysis, the actuarial value of benefits offered by small and mid-sized self-insured employers was marginally higher (by about 1%) than the value of the benefits offered by comparable fully insured firms.4 Among self-insured large employers, researchers found the opposite: they were 1.7 percent less generous than benefits offered by fully insured firms.

The Affordable Care Act may also be driving interest in self-insured plans. The Act includes a number of exemptions for self-funding that may make it financially attractive to small firms. These include allowing self-insured plans to opt out of a risk-adjustment system that will help set premiums, and excusing self-insured plans from meeting strict medical loss ratio requirements designed to limit insurer earnings.

An issue brief by the National Health Policy Forum concluded that, "in 2014 and beyond, smaller employers with relatively healthy workers…may find it financially advantageous to pay for their own firm's risk [rather] than to purchase a plan through the exchanges." 5

That remains to be seen, but in the interim, expect more and more firms to give self-funding a serious look.


1 The Kaiser Family Foundation and Health Research and Educational Trust, Employer Health Benefits, 2010 Annual Survey, (Menlo Park, Calif.: KFF and HRET, 2010).
2 Ibid.
3 S. R. Collins, K. Davis, J. L. Nicholson, and K. Stremikis, Realizing Health Reform's Potential: Small Businesses and the Affordable Care Act of 2010, (New York: The Commonwealth Fund, Sept. 2010).
4 C. Eibner, F. Girosi, A. Miller et al., Employer Self-Insurance Decisions and the Implications of the Patient Protection and Affordable Care Act as Modified by the Health Care and Education Reconciliation Act of 2010, (Santa Monica, Calif.: RAND Corp., 2011).
5 K. Linehan, Self-Insurance and the Potential Effects of Health Reform on the Small-Group Market, (Washington, D.C.: National Health Policy Forum, Dec. 2010).

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