Small Employers and Self-Insured Health Benefits: Too Small to Succeed?

Small Employers and Self-Insured Health Benefits: Too Small to Succeed?

Issue Brief No. 138
July 2012
Tracy Yee, Jon B. Christianson, Paul B. Ginsburg

During the past ten years, large employers have increasingly moved away from conventional health insurance for their workers, choosing instead to bear the financial risk of enrollees' medical expenses through self-insurance. Because self-insured arrangements can offer benefits -- including reduced costs, exemption from most state-level insurance regulations, and greater latitude in designing benefits -- they hold particular appeal for large firms with enough employees to distribute risk adequately and avoid the financial consequences of potentially catastrophic medical expenses for some workers. More recently, with healthcare costs continuing to climb and market conditions shifting, a growing number of small firms -- those with 100 or fewer employees -- are showing interest in self-insuring their health benefits, according to a new qualitative study from the Center for Studying Health System Change (HSC). Self-insured firms typically engage a third-party administrator (TPA) to handle medical claims and provide access to provider networks. Companies also frequently obtain stop-loss insurance to cover medical expenses that surpass a predetermined threshold. Increasingly competitive markets for TPA services and stop-loss insurance are making self-insurance a more viable option for additional employers. The 2010 national health reform law imposes new mandates and taxes on health insurance that may prompt more small firms to consider self-insurance. In turn, should more small employers choose to self-insure, certain health reform objectives -- such as strengthening consumer protections and improving the viability of the small-group health insurance market -- could be undermined. In particular, adverse selection -- attracting a disproportionately unhealthy population -- represents a potential concern for the insurance exchanges established by reform.

Small Firm Interest in Self-Insured Health Benefits Grows

Confronted with escalating health insurance premiums and the repercussions of the economic downturn, many small employers are finding it difficult to sustain health benefits for their workers. Concurrently, the markets for both third-party administrative services and stop-loss insurance have become increasingly competitive, with some carriers now offering services to firms with as few as 10 employees. As a result, more small firms are exploring self-insurance as a substitute for traditional health insurance products, based on interviews with health plans, stop-loss insurers, and third-party administrators.

Self-insurance, also known as self-funding, is a structure in which an employer -- rather than an insurance company -- assumes the financial risk for covered workers' and dependents' medical expenses. The Employee Retirement Income Security Act (ERISA) of 1974, a federal law governing pensions and health plans, exempts self-insured employer health benefits from most state insurance regulations. In a self-insured plan, employees typically contribute a share of the premium -- referred to as a premium-equivalent in self-insured arrangements -- and pay a portion of their medical costs through deductibles, coinsurance, and copayments, while their employers bear the risk of paying the remaining costs of covered services.

Self-insured employers contract with third-party administrators to set up and manage a provider network, process claims, and carry out other functions typically handled by an insurer. Employers usually obtain stop-loss insurance to limit the risk of large medical costs incurred by individual enrollees in a given year and/or aggregate expenses across enrollees that significantly exceed annual projections. Stop-loss coverage activates based on attachment points -- specific dollar thresholds that an employer must reach in health expenditures before a stop-loss carrier assumes payment of all or a portion of medical claims.

Self-insurance provides several advantages for employers, including lower premiums in exchange for accepting the risk of covering employees' medical costs. Another benefit is greater flexibility in the health benefits they offer. For instance, self-insured plans are not subject to state insurance regulation, including mandated benefits. Consequently, self-insuring enables firms with workers in multiple states to provide a uniform benefit package for all employees. Self-insured employers also gain access to claims data, which is especially valuable for large employers seeking to understand trends in health spending. Additionally, self-insurance helps companies manage cash flow, since funds are not drawn until claims are processed. As one health plan respondent explained, "[Employers] find that the fully insured environment is constraining. They don't have the ability to manage the costs of health care, and they're held hostage to premium increases that fully insured carriers issue, so people are looking to have more control over their own destiny."

Nevertheless, self-insured employers still confront uncertainty regarding the cost of health benefits -- although stop-loss insurance can mitigate these risks -- and this uncertainty grows as firm size decreases. Small firms are considerably more vulnerable to the costs of a catastrophic illness affecting one or two employees and typically require stop-loss coverage with much lower attachment points than large employers that can spread risk across a larger employee base. The heightened financial risk and sometimes elevated cost of stop-loss insurance diminishes the appeal of self-insurance for smaller firms.

Self-Insurance Trends

In 2011, approximately 60 percent of U.S. workers covered by employer-sponsored health insurance were employed at firms that self-insure, according to the Kaiser Family Foundation (KFF). Over the preceding decade, the share of large employers choosing to self-insure had grown substantially. Per KFF data, 62 percent of workers in large firms offering coverage -- those with 5,000 or more employees -- were in self-insured plans in 1999, increasing to 96 percent by 2011. In firms with 1,000 to 4,999 employees, the share of workers in self-insured plans also expanded, from 62 percent in 1999 to 79 percent in 2011.

A comparable trend had not emerged among mid-sized and small firms -- most likely because of the greater financial risk they face under self-insurance. For example, during the same period, the share of workers in firms with 200 to 999 employees in self-insured plans held steady at roughly 50 percent, and a much smaller proportion of workers in small firms -- those with three to 199 employees -- were in self-insured plans, with the proportion varying between 10 percent and 17 percent.

Market Changes Drive Self-Insurance Interest

Multiple respondents reported that the markets for both third-party administrative services and stop-loss insurance had become more competitive, which fueled interest in self-insurance. Large insurers, which frequently offer TPA services and stop-loss products, promoted their competitive advantages as a one-stop solution for employers exploring self-insurance. Respondents noted that a wide array of health insurers and general stop-loss carriers were offering stop-loss products, resulting in more competitive pricing. The affordability of stop-loss coverage is particularly relevant to small employers, since stop-loss insurance prices represent a larger portion of their total self-insurance costs.

According to respondents, small employers also increasingly believed that self-insurance might shield them from health insurers' strategic marketing and pricing decisions unrelated to an individual employer's actual claims experience. Some employers suspected that health plans were raising premiums aggressively during recent renewal periods because insurers anticipated that, under health reform, state regulators would examine premium increases more carefully. Starting in 2010, the Patient Protection and Affordable Care Act (PPACA) required state review of premium rate increases for nongroup, small-group, and fully insured large group plans. Self-insured employer plans were not subject to this review. Consequently, more employers reportedly considered self-insurance as a possible strategy to control costs.

Health Reform and Self-Insurance

Although the health reform law holds self-insured plans accountable for some of the same taxes and fees as fully insured plans, self-insured plans are exempt from the excise tax on insurance, community rating requirements for premiums, and mandates for essential health benefits. Beginning in 2014, PPACA requires modified community rating in the individual and small-group health insurance markets, permitting insurers to vary rates only based on age, geographic location, family size, and smoking status. These rating rules would apply to products offered in the state insurance exchanges and to fully insured products purchased outside the exchanges by employers with up to 100 employees. The maximum ratio of rates for older people compared to younger people would be 3:1, in contrast to the 5:1 or 6:1 ratio that insurance respondents indicated was typical in states without age-rating restrictions. This change in rating methodology may push firms with younger workforces toward self-insurance.

Furthermore, nongroup and fully insured small-group plans would be required to offer an essential health benefits package covering a standardized set of services, as determined by federal and state requirements. Although PPACA specified that the essential health benefits package should be comparable in scope to what a typical employer plan offers, small employers looking to potentially save money by providing less comprehensive coverage may choose to self-insure.

Respondents also suggested that employers may view self-insurance as a way to manage uncertainty about the impact of greater regulation of the health insurance industry under PPACA. For example, by not being subject to medical-loss ratio review requirements that govern how premium dollars are spent, self-insured employers may avoid the potential administrative burden and complexities associated with that process.

Policy Implications

The intersection of state and federal policies, some not yet fully developed, makes the future costs and benefits of self-insurance, as well as its overall prevalence among small firms, highly uncertain. Climbing premiums, combined with new regulations on fully insured products and declining stop-loss insurance costs, could lead to a rise in self-insurance among small employers, potentially creating challenges for state and federal policymakers.

The possibility of adverse selection -- attracting a significantly sicker-than-average population -- in health plans offered to small groups, whether inside or outside state exchanges, has been highlighted as a primary concern by market observers. Small employers' decisions regarding self-insurance may be shaped by the risk profile of their workforce, which could disrupt the small-group market's risk pool. Moreover, if small employers that self-insure fail to secure adequate stop-loss coverage, unexpectedly large medical claims could threaten the firms' financial stability and leave enrollee medical claims unpaid.

Some respondents suggested that growth in self-insurance among small employers could complicate certain federal health reform goals, including making coverage affordable for older individuals. When the new rating requirements take effect, small employers with younger workforces could pay more than they currently do for a fully insured plan, whether purchased inside or outside the exchanges. This could make self-insurance more attractive to such firms but not for those with older workforces. A greater concentration of older workers in fully insured plans could drive premiums higher and create a market dynamic that encourages even more employers to exit the state-regulated health insurance market in favor of self-insurance.

In a separate but related PPACA provision, beginning in 2017, states could decide whether larger firms -- those with more than 100 employees -- may purchase coverage through the exchanges. If states permit this, the potential for adverse selection could increase, since larger firms with older and/or sicker workforces that currently self-insure might find it advantageous to buy coverage in the exchange, while those with younger and/or healthier workforces would continue self-insuring. Although the law does not specify whether insurers must charge the same price for coverage of larger firms inside or outside the exchange, such adverse selection would be problematic in either case.

PPACA acknowledged these issues and mandated a study "to determine the extent to which its insurance market reforms are likely to cause adverse selection in the large group market or to encourage small and midsize employers to self-insure." The study, conducted by RAND Health, predicted a sizable increase in self-insurance only if stop-loss policies with low individual attachment points -- for example, $20,000 -- become widely available after the law takes full effect in 2014. However, the market for stop-loss insurance was already trending toward lower attachment points. HSC study respondents indicated that policies with low attachment points were likely to be widely available, noting that stop-loss policies with attachment points as low as $10,000 were already being marketed.

Another policy issue related to extremely low attachment points for stop-loss coverage raises questions about how much risk self-insured firms are actually bearing and whether self-insurance is simply a mechanism to circumvent state insurance regulation. Such concerns have precedent. In the past, fraud and insolvencies involving Multiple Employer Welfare Arrangements (MEWAs) -- where small firms banded together to self-insure workers -- left enrollees unprotected and responsible for their medical expenses.

Because of these concerns, the National Association of Insurance Commissioners (NAIC) charged a working group with examining updated recommendations to states on regulating stop-loss insurance. The NAIC created a model law in 1995 that prohibits specific individual attachment points lower than $20,000 and aggregate attachment points lower than 120 percent of expected claim costs for groups with 50 or fewer members. NAIC had been discussing revisions to this model law that may include higher attachment points, which could prevent many small firms from self-insuring.

Policy options for revising regulation of stop-loss coverage for small groups have been proposed for states to consider and may be a necessary step toward ensuring stability of the small-group market and state exchanges. The California Department of Insurance pursued legislation to ban stop-loss attachment points below $95,000 per employee, which would make it more difficult for most small employers to obtain adequate stop-loss coverage. Depending on how the California legislation progresses, other states may follow with similar legislation aimed at limiting small employers from choosing self-insured health plans with low attachment points.

Notes

1. The Kaiser Family Foundation and Health Research and Educational Trust, Employer Health Benefits: 2011 Annual Survey, Washington, D.C. (Sept. 27, 2011).

2. Jost, Timothy S., and Mark A. Hall, Self Insurance for Small Employers Under the Affordable Care Act: Federal and State Regulatory Options, NYU Annual Survey of American Law, forthcoming; Washington & Lee Legal Studies Paper No. 2012-24 (June 1, 2012).

3. Eibner, Christine, et al., Employer Self-Insurance Decisions and the Implications of the Patient Protection and Affordable Care Act as Modified by the Health Care and Education Reconciliation Act of 2010 (ACA), Technical Report, RAND Health, Santa Monica, Calif. (2011).

4. Kofman, Mila, "The Proposed MEWA Rules: Cracking Down On Health Insurance Scams," Health Affairs Blog (Jan. 4, 2012).

5. Hall, Mark A., "Regulating Stop-Loss Coverage May Be Needed to Deter Self-Insuring Small Employers from Undermining Market Reforms," Health Affairs, Vol. 31, No. 2 (February 2012).

6. Terhune, Chad, "Proposed Limits on Health Self-Insurance Plans Debated," The Los Angeles Times (April 21, 2012).

Data Source

This Issue Brief draws on interviews with representatives of a variety of organizations involved in self-insurance. Initial information was gathered through HSC's 2010 Community Tracking Study (CTS) site visits, which included 174 interviews with health plans, benefits consulting firms, and other private-sector market experts on a variety of topics. In addition, HSC researchers conducted literature reviews and additional in-depth interviews specifically on self-insurance with more representatives from health plans, reinsurers, and third-party administrators. The additional interviews were conducted between April and June 2011.

Funding Acknowledgement

The 2010 Community Tracking Study site visits and resulting research and publications were funded jointly by the Robert Wood Johnson Foundation and the National Institute for Health Care Reform.

Sources and Further Reading

KFF — Employer Health Benefits Survey Archives — The Kaiser Family Foundation / HRET 2011 Annual Survey, directly cited in this report, provides the data on self-insurance rates by employer size referenced throughout this analysis.

CMS — Health Insurance Market Reforms Under the ACA — This report extensively discusses ACA provisions including community rating, essential health benefits, and medical-loss ratio requirements administered by CMS that affect the self-insurance decision for small employers.

Health Affairs — Regulating Stop-Loss Coverage to Deter Self-Insuring Employers — The Hall study published in Health Affairs, directly cited in this report, examines how stop-loss regulation may be needed to prevent small employer self-insurance from undermining ACA market reforms.

BLS — National Compensation Survey: Employee Benefits — The Bureau of Labor Statistics tracks employer-provided health benefit offerings by firm size, providing additional context for the self-insurance trends among small and large employers discussed in this report.

Robert Wood Johnson Foundation — RWJF co-funded the Community Tracking Study site visits and resulting research that form the basis of this analysis.