By Michael J. Moody, MBA, ARM

For the most part, the majority of property and casualty insurance rates have remained flat for the past 10 to 12 years. However, the same cannot be said for health insurance rates. Despite the widely heralded implementation of the Affordable Care Act (ACA), many employers have continued to see increases in annual health insurance rates. This is particularly true for middle market accounts.

However, larger employers (those with 200-plus employees) have found various methods to reduce their overall employee health insurance costs. Over the years, one of the most popular methods has been self-funding the corporation’s employee health coverage. It has been estimated that the number of organizations that do some type of self-funding has grown from about 44% in 1999 to more than 66% that are currently choosing this method to finance employee health benefits, according to the Kaiser Family Foundation. Larger employers had determined the advantages of self-funding years ago; however, many middle market employers were too small to implement this cost-effective approach.

While the primary benefit to self-funding has been and will continue to be reducing the expenses associated with employee health benefits, there are several other key advantages. For example, self-funding typically can provide a flexible environment that offers employers more control over these costs. Additionally, an employer that self-funds its benefit program is not subject to some of the provisions of the ACA, such as community rating. This allows the employer to establish rates based on its own specific loss experience, rather than use community rates. A favorable tax treatment is another important advantage.

Program basics
Unlike property and casualty insurance coverage which obtains financial oversight from state regulators, employee health insurance is subject to federal oversight from the Employee Retirement Income Security Act of 1974 (ERISA). Generally, the provisions for self-funding are much less onerous than those that are administered by the state insurance department, such as self-insuring an employer’s workers compensation coverage. In addition to the ease of entry, self-funding offers an employer a number of unique ways to control program costs not available with traditional health coverages.

One of the most important needs of self-funding is securing excess insurance protection for catastrophic losses. This excess coverage is designed to provide protection for the employer should losses exceed the amount of the deductible selected. The excess coverage, known as medical stop loss is made up of two distinct components: the specific (for individual catastrophic claims above a threshold amount) and the aggregate (for total annual losses that exceed a predetermined amount). In actuality, the specific is protection from severity type losses, while the aggregate is designed to provide the employer protection from frequency type losses.

Most employers think that the stop loss protection is the key ingredient to keeping a self-funded program viable, since it can be established to coordinate with the employer’s tolerance to risk. Limits and deductibles can be selected that are strategically aligned with the employer’s long-term financial goals. Earlier this year, the Self-Insurance Educational Foundation updated a study that Milliman performs annually. Several important trends were noted, including:

• The majority of employers purchased both specific and aggregate coverage. However, the report notes that many employers who had more than 1,000 employees no longer purchased aggregate stop loss coverage. Recently, however, plan fiduciaries have started requesting both specific and aggregate coverage.
• Deductibles under the specific coverage vary greatly but they typically depend on the size and risk capacity of the employer. The study noted a median deductible for the specific stop loss coverage was $85,000.
• Deductibles under the aggregate coverage range from 85% to 200% of expected claims. The most common deductible was 125% of expected claims, which accounted for about 90% of all deductible amounts.

A review of the above numbers, where the specific deductible average amount was $85,000 and 125% on the aggregate side of the house, shows why middle market accounts have such a difficult time self-funding by themselves. As a result, many middle market accounts have begun to band together and purchase medical stop loss coverage as a group. This approach has seen significant interest since the passage of the ACA as middle market businesses struggle to find ways to mitigate the cost of employee health benefits.

One of the alternative risk transfer methods that started showing up several years ago was utilizing a captive insurance company. While it is easy for Fortune 500 corporations who already have existing, single-parent captives to include the stop loss coverage within their captive, it is far more difficult for middle market accounts to do the same. Despite the difficulty of group self-funding, some mid-sized employers have begun to band together to purchase stop loss coverage. At this point, group purchasing has taken the form of either a risk retention group (RRG) or group cell captive.

The group captive concept has had some success; however, there have been some bumps in the road as well—most notable with regard to the RRG approach. Approval to utilize an RRG has, for the most part, been problematic and not widely accepted by some state regulators. Interest in the RRG approach was initially high; however, gaining the necessary cooperation from the state regulators has been difficult. As a result, many of the existing RRGs and those in the planning stages have been forced to utilize a fronting carrier to provide a viable alternative while not running afoul of state insurance regulators.

Further, this meteoric growth of self-funding has caused significant interest at both the state and federal level which are now completing detailed analysis of the financial aspects of the coverage. At this point, regulators appear to be focusing the majority of their analysis on the issue of attachment points of the specific side of the coverage. Regulators believe that the attachment points that some middle market accounts have been able to lower to $20,000 to $30,000 are too low. In an attempt to control this aspect of the coverage, states have started to pass legislation that would require higher levels. For example, California recently passed a law that would require the attachment points to be at least $40,000. Additionally, Connecticut is considering similar legislation but wants to establish the attachment point at $45,000.

Conclusion
Notwithstanding the issues surrounding governmental oversight, being able to obtain stop loss coverage is a key component for all but the largest corporations. Most employers continue to believe that medical stop loss coverage is necessary to maintain a viable employee health insurance program. Continued interest in self-funding appears likely as employers of all sizes search for methods to reduce the overall costs of providing employee health coverage. For many of these employers, new legislation that threatens to restrict the availability of stop loss protection will have a chilling effect.

The real tragedy of this situation is that, at a time when employers are struggling to reduce the overall cost of employee health insurance, regulators are looking for ways to limit the excess coverage. There appears to be significant interest within the insurance industry in providing this coverage and at this point, pricing of the product remains competitive. For some employers, the ability to obtain a stop loss product and implement a self-funded program that is tailored to their needs is the only way they will be able to afford to provide coverage for their employees.