Captive insurance is key to managing risks of middle-market self-insurance

Health insurance is one of the key benefits that employees and potential new hires expect from an employer. For middle-market companies relying on traditional fully insured health plans purchased from insurance carriers, it can feel like a critical cost of doing business over which they have very little control. The fully funded model requires that the employer pay a fixed premium to the insurance carrier in exchange for the carrier assuming all risk for paying employee claims. To help gain control, reduce costs, and enhance benefits, businesses have increasingly turned to self-funded insurance models, also known as self-insured plans.

To help gain control, reduce costs, and enhance benefits, businesses have increasingly turned to self-funded insurance models, also known as self-insured plans.

For many years, it was thought that businesses needed to have hundreds of employees in order to take advantage of the benefits of self-funding. A 2021 survey by the Kaiser Family Foundation found that 64% of covered workers are now enrolled in plans that are self-funded, but that only 21% of covered workers at small firms (3–199 employees) are in these plans as opposed to 82% of the covered workers at large firms (200 or more employees). It’s likely that the small firm number will rise, though, as smaller and middle-market employers are increasingly turning to group captives to take advantage of the benefits of self-funding while mitigating some of the risks traditionally associated with self-funding.

Self-funding offers more than just cost containment

Self-funded health insurance certainly offers potential cost savings and cash-flow improvements for employers. By holding claim reserve that would otherwise be paid to a fully insured carrier and paying claims as they are incurred, the plan sponsor benefits from interest earned on the reserves and from favorable claim experience. Accounting rules generally require that the reserves include estimated costs for things like “run-out” claims, which are claims that would be paid after plan termination if the employer decided to return to a traditional full insurance plan. These amounts are only paid out if an employer terminates its self-funded plan but must be kept on hand under the rules. The opportunity to earn interest on them gives the employer some benefit out of the restricted funds.

With the fully funded model, an employer is basically “prepaying” all of the claims that the insurance carrier projects it will ultimately use to pay claims and the related reserves. If actual paid claims are less than the insurance carrier projected (and collected from the employer), then the insurance carrier keeps the difference as a recognized profit. If actual paid claims are higher than what the insurance carrier projected, the insurance carrier would recognize a loss. Since any excess remains with the insurer as profit, the carrier in the fully funded model has an additional incentive to be conservative when estimating claims and setting premiums that are likely to exceed the costs of the claims against the policy. Self-funding also reduces amounts paid for state premium taxes.

Cost containment is just the tip of the iceberg when it comes to the advantages of self-funded insurance.

But cost containment is just the tip of the iceberg when it comes to the advantages of self-funded insurance. As the plan sponsor takes on greater responsibility for and oversight of the claims process, it can realize additional benefits from the new arrangement, such as:

• Access to actionable data. Fully insured plans typically provide only limited high-level claims utilization data (if any), making it difficult or even impossible for a plan sponsor to discern the underlying causes driving their healthcare spend. Self-funded plans typically have access to virtually unlimited specific claims utilization data. This information provides a plan sponsor the opportunity to identify cost drivers, allowing them to be more strategic in deploying specific cost containment solutions.
• Insights on advisor compensation. In most cases, advisors are compensated via commissions that are included in the cost of the fully insured premiums, making it difficult for an employer to know what an advisor is making off of the plan. In addition to the lack of transparency, advisor compensation in a fully insured environment typically increases at the same rate as the fully insured premiums. If the underlying claim experience in a fully insured environment is high, the employer will effectively suffer two increases — the first hit is a higher cost to the renewal rate, and the second is a corresponding increase in advisor compensation. If the fully insured premium rates increase 15%, advisor compensation also increases by 15%.
• Enhanced control. Self-funded plans aren’t subject to varying regulations at the state level. They are regulated at the federal level by the Employee Retirement Income Security Act, where virtually unlimited plan design flexibility exists.
• More efficient risk transfer to insurance carrier. From a practical perspective, fully insured plans shift very little risk from the plan to the insurance carrier. In the past, insurance carriers set premiums based on community ratings, and employers benefitted from the sharing of risks across a wide pool of insured individuals. In recent years, carriers have relied much more heavily on experience underwriting to establish premiums on a prospective basis using the specific claims of each client from the previous year.

  This approach reduces the risk shifted from the employer to the insurance carrier, and results in a prepaid health expense driven by the employer’s actual claim experience from the previous year. If the actual claims and the insurance carrier’s expenses are less than the total collected premium, the insurance carrier retains the difference as profit, at best offering the business a favorable renewal. If the actual claims and the insurance carrier’s expenses are more than the total collected premium, the insurance carrier recognizes a loss and will almost certainly pass along costs in the form of a much larger renewal.

  Self-funded plans will typically purchase stop-loss insurance to provide much more targeted protection from abnormal claim severity and frequency. The employer chooses an appropriate amount of risk retention for the business as a whole with an aggregate stop loss policy (typically set at 125% of “expected” claims), as well as a specific stop-loss deductible for each covered individual.

  For example, if a plan sponsor chooses a specific stop-loss deductible of $100,000, that means that the employer will be responsible for paying the first $100,000 of claims on behalf of any one member. Claims that exceed $100,000 would be the responsibility of the stop-loss insurance carrier.

Challenges to self-funding insurance in the middle market

While self-funding offers many advantages over fully insured plans, this option does present some challenges that can make it more difficult for smaller and middle-market employers to self-insure. First, the advisors that these employers have relied on for insurance advice may not have much experience with self-funding and therefore may be reluctant to introduce the employer to this type of opportunity. Given the compensation advantages for advisors selling fully insured policies, even those with knowledge of self-funding may have little incentive to promote it.

Second, smaller and middle-market employers are more susceptible to greater claims volatility and multiyear risks by virtue of their smaller employee counts relative to much larger employers. If a covered employee is diagnosed with a chronic condition that has a high cost of treatment, such as cancer, multiple sclerosis, Crohn’s disease, or rheumatoid arthritis, the treatment can span multiple stop-loss policy contract years. In situations like these, it’s not uncommon for the stop-loss carrier to impose a significantly higher individual deductible on the covered employee, a practice known as “laser underwriting.” For example: if a plan has a specific stop-loss deductible of $100,000 per individual, and the stop-loss carrier recognizes that the plan includes a member who’s taking a high-cost specialty medication used to treat Crohn’s disease at an annual cost of $300,000, the stop-loss carrier might issue the specific stop-loss renewal with a deductible of $300,000 for that individual and $100,000 for all other members.

Captive insurance balances claim volatility and multiyear risks

To protect against laser underwriting, smaller and middle-market businesses have increasingly turned to captive insurance groups to provide more reliable stop-loss alternatives. One of these groups is formed when a group of like-minded, self-funding employers band together to manage costs and pool some of the risks associated with high-cost medical treatments. They effectively buy or create their own stop-loss insurance company to spread the costs among a larger pool of employers and reduce or eliminate the impact of laser underwriting on the group members. The rise of these insurance companies has made self-funded insurance much more accessible to smaller and middle-market employers with as few as 50 employees.

To protect against laser underwriting, smaller and middle-market businesses have increasingly turned to captive insurance groups to provide more reliable stop-loss alternatives.

Finding the best healthcare solution

The best healthcare solution for any business will always be the one that takes into account the unique facts and circumstances of the plan sponsor and its employees. To learn more about the effectiveness of your current plan and other fully funded or self-funded options that could deliver better healthcare and more manageable costs for you and your employees, please contact a Plante Moran advisor.