Self-Funding Options for Small Group Employers under Regulatory Review

Both the National Association of Insurance Commissioners (NAIC) and the federal government have initiated reviews of the practice of small group employers self-funding their employees’ health insurance benefits.  The catalyst for much of this activity is fueled by concerns that some employers will prefer to self-fund rather than participate in the new insurance reforms being implemented through the Patient Protection and Affordable Care Act (PPACA).  Simply put, it may be more economical for some employers to self-fund and avoid some of new regulatory requirements that are being implemented.  This legislative alert provides an overview of how the federal and state regulations may be tightened to restrict future self-funding options for small business employers.  In large part, the impetus for doing so is tied to public policy concerns that smaller groups cannot really afford to self-insure and should participate in PPACA’s exchange system. 

What is an employer self-funded health insurance benefit plan?

A self-funded employee health benefit plan is one in which an employer assumes the financial risk of the claims and administrative expenses.  In many instances, an employer will purchase individual and aggregate stop-loss coverage to protect itself from exceptionally large individual claims or from the cost of the benefit exceeding a specific sum.   Actuaries are used to estimate the expected claims for each policy plan year based on the population demographics and designated risk factors.  From this information, employers and the stop-loss carriers will identify the premium levels that the employer will have to pay and the actual thresholds where the reinsurance coverage kicks in.   

Why are state and federal regulators concerned with small employer groups self-funding their health benefit plans?

Statistically speaking, the larger the group, the more likely the covered lives will replicate both the use of health care services and the cost of the resultant health care claims, plus an inflation factor, from year-to-year.  The predictability of the claims expense from year-to-year is the critical factor in the long-term success of a self-funded health benefit plan.  Small groups have less predictability because the actuarial “law of large numbers” does not apply as strongly as it does to larger groups.  Below a certain threshold, an employer group may be too small for the actuarial assumptions to be valid.

Why is this issue gaining the attention of regulators?

A recent report by the Center for Studying Health System Change entitled, “Small Employers and Self-Insured Health Benefits: Too Small to Succeed?”, predicts more small employers will look at self-funding their employee health benefits to avoid some of the more expensive elements of PPACA.  Many sections of PPACA do not apply to self-funded employer health benefits, including provisions requiring compliance with community rating, guaranteed issue, minimum loss ratios, justification of significant premium increases/benefits cuts, and offering essential health benefits.  In addition, self-funded health benefit plans are not subject to a state tax on an insured health benefit plan.

The report states, “Rising premiums, coupled with new regulations on fully insured products and declining costs of stop-loss insurance, could lead to an increase in self-insurance among small employers, which could pose challenges for state and federal policy makers.”   The report notes that small group employers with favorable demographics (younger and healthier employees) covered under their health benefit plan might be tempted to convert to self-funding.  If enough small group employers take their younger, healthier employees out of the insured market, the cost to the remaining small groups will go up.   The cost of stop-loss coverage has become more favorable and the market for third-party administration services has become more competitive.   The study anticipates that more small employers may consider self-funding due to the fact that they will pay less until faced with a catastrophic expense.  When faced with a budget busting catastrophic claim, a small employer will be able to apply to a state health benefits exchange for guaranteed coverage in 2014 and shift the costs to the exchange. 

What actions are the state regulators taking?

The Centers for Medicare & Medicaid Services of the U.S. Department of Health and Human Services (HHS), the Employee Benefits Security Administration of the U.S. Department of Labor (DOL), and the Internal Revenue Service (IRS) recently issued a joint request in the Federal Register for information regarding the use of stop-loss insurance by group health plans. The purpose of the request for information is to understand how prevalent low attachment points are and what the consequences of stop-loss insurance are at these low points.  The RFI states,

“It has been suggested that some small employers with healthier employees may self-insure and purchase stop loss insurance policies with relatively low attachment points to avoid being subject to these requirements while exposing themselves to little risk.  This practice, if widespread, could worsen the risk pool and increase premiums in the fully insured small group market, including in the Small Business Health Options Program (SHOP) Exchanges that begin in 2014.”

The RFI is asking for a long list of particulars including information on attachment points, specific versus aggregate coverage, and the prevalence of the use of stop-loss coverage in specific industries.

Given these recent actions on the part of state and federal regulators, and the perception that they have shown to date, it is relatively safe to assume that the states and the federal government will move to significantly circumscribe the ability of small group employers to self-fund their health benefits by increasing the financial exposure of a self-funded health benefit plan option for small employers. 

We will continue to keep you up-to-date on these and other developments in our ever-evolving marketplace. Please visit www.HealthcareExchange.com for blog posts, polls, surveys and numerous resources, or you may visit www.benefitmall.com to view past Legislative Alerts.

The views expressed in this post do not necessarily reflect the official policy, position, or opinions of BenefitMall. This update is provided for informational purposes. Please consult with a licensed accountant or attorney regarding any legal and tax matters discussed herein.