This year, employers have gotten their first taste of the Affordable Care Act’s (ACA’s) community rating rules. As a result of the rules, many organizations with fully insured health benefit plans and relatively healthy workforces have seen their premiums go up. This development has, in turn, spurred interest in self-insurance and captive insurance programs.
The ACA’s community rating rules constrain insurers’ ability to vary premiums significantly by the health risk profile of companies within a particular geographic area. The community rating rules have not only raised premiums for some employers with good claims track records, but also removed some of the incentive for them to sponsor initiatives to improve employee health.
Of course, the converse is also true. Many employers experiencing above-average claim costs have come out ahead on premiums under the community rating rules. Still, self-insuring allows employers to regain some control over the situation and perhaps lower their overall health care costs.
Freedom to tailor
As the name suggests, self-insurance simply means employers pay claims as they become payable — generally administered by a third party. To protect themselves from a catastrophic claim, or a year when they experience a spike in employee health problems, self-insured employers typically buy stop-loss coverage. This coverage is, in effect, an insurance policy with a huge deductible. Stop-loss can kick in when claims for one covered individual reach a given cutoff, when aggregate claims exceed a specified amount, or both.
The potential benefits of self-insurance aren’t limited to employers with healthier-than-average workforces. One possible advantage stems from the fact that self-insured plans are regulated by the Employee Retirement Income Security Act (ERISA), while fully insured plans are covered by state law. Some states mandate coverage of certain health services, such as in vitro fertilization, not required by ERISA or the ACA.
With self-insuring, employers have the freedom, within the constraints of the ACA, to tailor benefits to their needs and priorities. For example, they can customize their own provider networks, making them more or less restrictive than the network offered by locally available insured plans.
The ACA sets different coverage standards for insured small group health insurance than for self-insured plans. Specifically, insured plans are required to cover 10 “essential health benefits,” the details of which are set by each state based on so-called “benchmark plans” sold via public exchanges.
Self-insured plans, in contrast, need to satisfy only the ACA’s affordability and minimum value tests. This opens more leeway in deciding the value level of basic plan components such as hospitalization and pharmacy benefits.
Potential cost savings
In theory, self-insurance is less expensive because employers aren’t paying the cost of ensuring an insurance carrier’s profitability. Also, lean-and-mean independent third-party administrators often can handle claims more economically than a large insurer with substantial overhead can.
In addition, self-insured employers generally have access to more-detailed claims data that’s still compliant with the Health Insurance Portability and Accountability Act — thereby enabling them to identify the employee health risks best addressed by targeted wellness programs and plan design modifications.
Many such potential benefits have been a draw for self-insurance since long before the ACA was enacted. But self-insurance isn’t a guaranteed winning strategy, nor is it suitable for every employer.
Balance sheet sufficiency
A basic determinant of suitability for self-insurance is the employer’s balance sheet. The greater the savings goal on the basic insurance function, the greater the financial exposure — even with stop-loss coverage. Over time, claims average out. But the company must have a balance sheet sufficient to withstand years when claims are above average.
It used to be that most self-insured employers simply paid claims as incurred. That often meant coasting along some months with limited outlays and putting the spare cash to use until needed.
Today, however, third-party administrators that handle self-funded plans typically project the entire year’s worth of claims. The employer then pays a level monthly amount to reach that total by year end. Doing so stabilizes cash flow. Any surplus at year end is usually applied to the next year’s reserve.
The captive option
For midsize to large companies, the principle of self-insurance can be extended to the stop-loss portion of the equation — that is, employers can establish their own “captive” insurance companies to cover that excess risk.
Most Fortune 500 companies have done so, though more typically to cover property/casualty risks. Two of the biggest potential benefits of creating captives are that:
- The premiums likely will be less than what an employer would pay to a traditional insurer, and
- As owner of the captive, the employer benefits from any underwriting profit — that is, the difference between the premiums and the cost of paying the claims and servicing the policy.
An employer can even set up a captive to pay all claims, rather than just as stop-loss coverage. An advantage here over self-insurance is that the employer can get a tax deduction when paying the premiums. With a self-insurance arrangement, the employer gets a tax deduction only when it pays claims.
Companies too small to start their own “pure” or “single parent” captive can participate in association-sponsored captives similar to policyholder-owned mutual insurance companies. A third option in some areas is the “sponsored” captive, with the sponsor in question being an actual insurance carrier. Essentially the employer “rents” a piece of the captive to defray the administrative overhead but still assumes the basic risk.
No small undertaking
Starting a captive is no small undertaking. When captives are used for employee benefit purposes, an employer must secure Department of Labor (DOL) approval. The DOL requires captives used for benefits to be licensed to sell insurance or conduct reinsurance activities in at least one U.S. state or territory.
In addition, a captive must contract with a “fronting insurer” that holds, at minimum, an “A” rating by global credit rating agency A.M. Best. The fronting insurer’s role is to write the basic insurance policy and then resell most or all of the risk.
Because DOL approval requires a captive to be licensed in at least one state, the captive in question is subject to that state’s general requirements for insurance and capital reserves. Furthermore, the captive must comply with the state’s specific health care coverage rules. Thus, an employer that creates a captive insurance program won’t escape state regulation, as a self-insured employer could.
The ACA has motivated employers to reconsider their respective approaches to health care coverage in many ways. The act’s community rating rules and the resulting interest in self-insurance and captive programs are yet another example of this. If you think self-insuring and perhaps even forming a captive insurance company might help your organization, consult your tax, legal and benefits advisors before proceeding.