Self-Funded vs. Fully-Insured Health Plans

Group medical benefit plans typically fall into one of two categories: self-funded or fully-insured. The choice of one over the other should not be made arbitrarily. Each type carries its own set of administrative rules and legal constraints.

What is Self-Funding?

Under an insured health benefit plan, an employer pays an insurance premium to an insurance company, which assumes the financial and legal risk of paying medical claims.  Under a self-funded (or self-insured) plan, the employer retains the risk of paying for the medical claims of its employees from its general assets.

Most employers with more than 200 employees self-fund some or all their employee health benefits. Many employers with fewer than 200 employees also self-fund, but these employers require greater stop-loss insurance protection than larger employers (stop-loss insurance is discussed in greater detail later).

The risk with any healthcare plan is that employees will become ill and require costly medical treatment. In a fully-insured plan, the insurance company bears the risk.  In a self-funded plan, the employer bears the risk.  When employees have few claims and few expensive illnesses, the self-funded employer realizes an immediate positive impact on overall healthcare costs. Conversely, if the employee group has unfavorable claims experience, a self-funded employer would incur an immediate expense beyond what may have been expected. Insured plans have a more predictable cost for the year; however, large employee claims costs from one year can affect future premium amounts.

ERISA vs. State Regulation

Self-funded health plans are subject to the Employee Retirement Income Security Act of 1974 (ERISA). ERISA preempts state insurance regulations, meaning that employers with self-funded plans are not required to comply with state insurance laws that apply to fully-insured plans.  On the other hand, while fully-insured plans are primarily governed by the laws of the state where covered employees reside, they also are subject to some of ERISA’s requirements.

The distinction between state and ERISA regulations is important when determining if self-funding is right for your organization. Multi-state companies with fully-insured health plans must comply with the regulations of each state in which they have covered employees. Multi-state self-funded plans need only comply with ERISA.

Premium vs. Unbundled Fees

The risk an insurance company takes with fully-insured plans can be translated into a dollar amount for the employer. That dollar amount is the premium an employer pays each month for the insured group’s medical benefits. The premium amount includes the following:

  • Current and predicted claims cost
  • Administrative fee
  • Premium tax paid to the state
  • Insurance company profit

Employers who self-fund their medical benefits do not pay the premium tax or insurance company profit. They do, however, assume the costs of paying for claims and administrative functions. Typically, employers with self-funded health plans will outsource plan administration to a third-party administrator (TPA) or insurance company who charges the employer a fee for performing administrative services.

Stop-Loss Insurance

Employers with self-funded health plans typically carry stop-loss insurance to reduce the risk associated with large individual claims or high aggregate claims from the entire plan. The employer self-insures up to the stop-loss attachment point, which is the dollar amount above which the stop-loss carrier will reimburse claims. Stop-loss insurance comes in two forms: individual/specific stop-loss and aggregate stop-loss.

Individual/Specific Stop-Loss Insurance

This protects a self-funded employer against large individual healthcare claims. Essentially, it limits the amount that the employer must pay for each individual. For example, an employer with a specific stop-loss attachment point of $25,000 would be responsible for the first $25,000 in claims for each individual plan participant each year. The stop-loss carrier would pay any claims exceeding $25,000 in a calendar year for a particular participant.

Aggregate Stop-Loss Insurance

This protects the employer against high total claims for the healthcare plan. For example, aggregate stop-loss insurance with an attachment point of $500,000 would begin paying for claims after the plan’s overall claims exceeded $500,000. Any amounts paid by a specific stop-loss policy for the same plan would not count toward the aggregate attachment point.

Nondiscrimination Rules

Nondiscrimination rules require employers to offer employee benefits that do not favor certain employees. Employers with fully-insured plans do not have nondiscrimination rules for group medical benefits, provided they follow the policy requirements of the sponsoring insurance carrier. However, employers with self-funded plans are required to comply with nondiscrimination rules. Generally, these requirements are not difficult to meet, but failure to comply can result in some employees having their benefits treated as taxable income.

Employers with either type of group medical plan are required to comply with certain reporting and disclosure requirements, usually by providing tax and other pertinent documents to the United States Department of Labor or to their state.

Typically, self-funded plans are required to provide copies of plan communications such as summary plan descriptions (SPDs) and summary of material modifications if the plan language changes.

Employers with insured plans that require employee contributions must file certain financial documents with the IRS. IRS filings are also required of self-funded plans, including Form 5500 and any accompanying documents.

For other related articles on self-funded health plans, click here.

This article is not intended to be exhaustive, nor should any discussion or opinions be construed as professional advice. © 2015, 2018 Zywave, Inc. All rights reserved.