A Case for Self Insuring Small Business

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During the course of 2009, an alarming trend line was broken. For the first time ever, more employers under 50 employees were not offering medical insurance to employees than those who continued to provide employer sponsored healthcare.

Unfortunately, achieving affordability is often a zero sum game and the current system often fails the weakest and most disenfranchised of its stakeholders.  While the burden of spiraling healthcare costs has effected virtually every employer, the weight of cost increases has been borne disproportionately by individuals and smaller employers (1-250 employees).  The opaque science of risk pooling, cost shifting and risk selection has as much to do with unacceptable increases as  poor consumerism, over treatment and inefficiency. As we march toward insurance exchanges and pooled purchasing for employers in 2014, we will continue to witness a game of pass the parcel leaving smaller employers holding the bag.

Healthcare cost shifting begins at the highest levels with federal and state governments routinely cost shifting to the private sector by serially under-reimbursing specialists and hospitals for the cost of their services. Doctors and hospitals, in turn, shift cost to the private sector charging higher fees for services to make up for underfunded Medicare and Medicaid rates. Health systems have consolidated along with multi-specialty medical groups gaining critical bargaining power that results in higher contracted rate increases negotiated with insurers.  Insurers, attempting to keep rising medical trends down, must exact concessions from less well leveraged providers such as community based hospitals and primary care doctors. The result is an Darwinian landscape where only the large survive.

As core medical trends hover between 7%-8%, insurer insured book of business medical trends have climbed into and remain in double digits. Larger employers remain more immune from peanut butter spread book of business trends due to their own unique claim credibility and in many instances, due to the simple act of self insurance.  Lack of size and actuarial credibility leaves smaller employers and individuals to be underwritten within pools of risk — pools that continue to pass on the rising costs of care at an alarming rate.  To add insult to injury, as states and the Federal government become increasingly larger medical payers (already representing over 50% of all medical spend in the US), cost shifting will only accelerate in the private sector resulting in higher medical trends impacting smaller employer pools.

Larger Employers Don’t Bear As Much Burden for Medical Cost Shifting – Larger self-insured employers are less affected by hidden risk charges, expense loads and administrative cost shifting that often occurs in pooled underwriting arrangements. Larger firms enjoy a greater spread of risk across their employees. Self insurance brings greater transparency to employers around administration and claims costs. Given that a self insured are bearing much of their own risk, a self-funded employer generates a much lower gross profit for an insurer than a fully insured customer. Unfortunately, when risk is transferred, the elements of pricing become more opaque. It is not uncommon for insurers to build margin and other conservative factors into the rates tendered to smaller insured clients.  Individuals and smaller clients do not merit the actuarial credibility to be rated on their own claims experience. Cost shifting across each risk within a pool is an accepted practice in pricing risk. It reduces dramatic swings in pricing and is fundamental to profitable risk pooling.

Smaller employers, by definition, do not have enough medical claims predictability to be rated entirely on their own merits. In order to spread risk across a statistically valid sampling of employers, insurers pool employers across a large “block” of risk. Better performing risks subsidize worse performing risks – moderating overall increases for the entire pool. Problems arise when there is little visibility for an employer into how his/her renewal was developed and into the significant variance that can sometimes occur between the insurer’s initial renewal request and the final negotiated rate. Some argue that much of the difference is due to the rigor of the negotiation and the competitive pressure from the marketplace. However, the frustrating reality is the actual rate that is necessary to properly underwrite the risk, the rate the client ends up paying and the individual profitability by account varies dramatically.  Over the last decade, smaller employers have absorbed a disproportionate percentage of rising healthcare cost increases. As medical trends haven risen, fully insured risk pools have been quick to allocate these cost increases across their block of members – similar to the way a utility might pass along the rising cost of oil to its consumers.

The Affordable Care Act May Create Greater Inequities Around Small Employer Risk Sharing – Under health reform, insurers choosing to participate in regulated exchanges will be required to adhere to stringent community rating underwriting practices that will limit their ability to distinguish and price between employers representing better risks and those representing poorer population health risk. An employer who commits to driving healthier lifestyles among employees and generates lower claims experience will be subjected to the same narrow underwriting criteria as an employer with a less healthy workforce. This inability for insurers to properly reward employers for driving consumer engagement and health management among employees will drive many smaller employers to weigh the limited benefit of engaging their employees in wellness versus the disruption of employer sponsored health improvement.

Some argue these regulatory changes will homogenize pricing and create a better spread of risk for groups under 50 lives. With the individual and under 50 market having been historically been the most profitable commercial segment  for many employers, the pundits contend that the ACA will limit profit taking and maximize small employer purchasing power.  Detractors believe that the diametric opposite will actually happen when exchanges initially are populated by the previously uninsured and higher risk, small employer groups.  In either scenario, insurer profits will be squeezed in the under 50 life market segments. Insurers will have to look ” up market” to maximize profitability within their 50+ block of insured, manually rated clients.

For groups over 50 lives, insurers will be afforded more flexibility to manage pooled risks but they will be confined to a maximum of 15% of profit and administration charges. The level of precision and attention insurers must pay to underwriting their 50+ life block of insured business will determine much of their success or failure.  Price this business too conservatively and you risk losing members or having to refund rebates to customers.  Price to aggressively and you risk creating a political hot potato when asking a regulator to approve a politically undesirable double-digit increase. The optics of pricing will become very important to insurers and will become less flexible for employers to negotiate.

Pooled small group underwriting already creates inequities. As underwriters price their overall block of insured business to achieve a targeted yield (increases necessary to cover rising healthcare costs), there is typically more latitude afforded to larger insured employers whose claims experience is statistically credible. Most underwriters would argue that only cases with at least 1000 participants merits 100% claims credibility. The reality is there are no hard and fast formulas for any sized case.  Underwriters have discretion to lend more or less credibility to certain cases if it allows them to renew a desired piece of business.

While ACA Caps Insurer Margins, It Reduces the Incentives to Control Costs – The minimum loss ratios mandated by Congress will cap potential profit taking on individual and small group coverage but it will also reward those whose clients have richer plan designs and higher per employee per month (pepm) costs. The maximum administration and risk percentage an insurer may realize for its larger case book of business is 15%. Thus, the greater the insured’s premium cost for a given level of benefits, the larger the actual profit dollars of operating income for the insurer. Insurers have already begun to fight over the benefit plans of certain white-collar and collectively bargained industries who have proven more willing to pay for rich plan designs – – investment banks, hedge funds, high-tech, professional services and bloated municipality and bargained plans.

Ironically, lower insured pepm plans may actually experience less underwriting flexibility as insurers seek to balance their book of 85% loss ratio employers to the highest premium plans. The only incentive to insurers confined to limited profits under ACA’s 85% MLR legislation is the specter of a public option being introduced to compete with private plans that cannot rein in costs. While most pundits seem to agree that a public option would not solve our affordability crisis, it could use taxpayer dollars and rationed provider reimbursement to offer lower cost alternatives – further eroding the private marketplace and leading to a tipping point towards single payer coverage.

With the added constraints of new community rating in exchange based insurance for 2014, the 50+ smaller employer that is already seeing large increases will have limited ability to impact their own risks. As of 2011, small group increases are averaging 11 – 13% medical trends and average overall increases in excess of 20%. Insured employers under 250 employees are essentially trapped in these risk pools and it may only get worse in 2014 as community rating and the uninsured are mixed into the stew of risk.

It’s Time To Self Insure Small Business –  It is rare that an employer under 100 employees can access its paid claims experience. Insurers provide little to no actionable data for smaller employers and defend  the lack of disclosure arguing that small group claims can be easily deconstructed to identify actual employees which can be a violation of privacy rights. When claims data is released to smaller employers, it is often released as “incurred” claims which include conservative assumptions on reserves – – the future costs of claims incurred but not yet reported.

In other cases when pressured for claims data, insurers counter requests with concerns that if they release data and a competitor does not, the competing insurer can cherry-pick better risks. With the exception of Texas, where House Bill 2015 requires the release of claims experience to employers down to 100 employees, small employers have little line of sight into claims and therefore little motivation to view insurance as anything other than a commodity to be shopped every year.

Insured group pricing is often calculated months in advance. It is an imprecise alchemy where uncertainty around a myriad of factors — future medical costs due to utilization trends, hospital and provider contract renewals, H1N1, Medicare reimbursement changes and pending or recently passed regulations – – can all prompt an underwriter to build margin into rates. Insured premium pools tend to be loaded with risk charges and margin to reduce the potential that the insurer will price premiums below their cost.

In situations where insurers need to expand margins or increase profits, the path of least resistance is to build margin into insured pricing. In risking tendering increases in rates above what the competitive market might bear, carriers rely on small and agent loyalty, customer apathy, the hassle of changing carriers and/or their own superior cost position above competitors to allow for margin expansion. If an insurer loses some members to more competitive pricing, the remaining clients may more than cover the lost margin with their higher premiums. While it is a risky endeavor, an insurer has to weigh the risk/reward of asking for more premium than the risk may actually require. If the insurer is too conservative in pricing, competitors will seek to steal market share.

Larger employers understand that medical claims drive costs. Employers with over 100 employees are increasingly entertaining alternative financing arrangements such as minimum premium and self insurance to cut the risk premiums they pay to insurers. Generally, a self-funded program generates one-third the profit dollars of an insured health program. In doing so, an employer assumes more risk. However, that risk can be capped based on the client’s risk tolerance. As a self insured employer begins to make a connection between their own population’s health, wellness and healthcare claims, they begin to focus on higher value activities — holding vendors more accountable for managing costs.

Administration costs are generally higher in fully insured health plans – as much as 20+%. These administration costs include risk and pooling charges, administration, broker commissions, clinical programs, taxes and other administration. Insured claims costs include the cost of state mandated benefits which can add 8%-10% to premiums. As premiums rise, insured health plan administration charges often rise proportionately. Self insurance avoids state premium taxes, allows you to exclude state mandated benefits and reduces risk and profit charges. Self funding has been generally ignored by brokers and agents who do not understand alternative funding and who do not like the increased transparency of per employee per month administrative fees versus embedded commissions.

With the exception of CIGNA that uses the Great West chassis as a platform for small employer self funding, most insurers have not been eager to offer self funded products that essentially cannibalize their more profitable insured pools. If this is ever going to change, smaller employers must come to understand that they are paying a very high price for transfer of risk and given the fact that costs continue to increase, there is justifiable concern about whether employers are getting value for their insured arrangements.

This frustrating cycle of pooled increases and a limited sense of control over one’s destiny is driving smaller employers – – some as low as 50 employees to give serious consideration to self insurance. With average composite costs per employee now eclipsing $11,00o, a 110 employee company is paying over $1mm a year for healthcare.  For firms operating on slender margins, a 10% compounded annual increase in pooled insurance costs will consume operating profits in just a few years.  Liberating oneself from the rigidly predictable cycle of double-digit pooled increases is only the first step toward regaining control over healthcare costs.

What Next?  – With the barriers to entry being so high in healthcare, the only player large enough to compete with insurers is the Federal government. Most recognize that a Federal government that presides over Medicare with its serial under reimbursement of doctors, excessive fraud, abuse and deficits is today hardly qualified to supplant commercial plans. The key is changing the nature of commercial insurer cost plus risk based pool pricing. When it comes to small group insurance, one could argue that the managed care industry is failing to manage care.

It is time to consider new risk bearing models that moderate profit taking and reduce cost shifting between customer segments and deliver total transparency around all administrative costs and claims experience. In addition to encouraging market based small employer self insurance solutions, we should:

1) Allow for creation of multiple employer welfare association risk pools that offer smaller employers insured and self insured purchasing leverage coupled with a defined, highly focused plan designs that drive health improvement, wellness, chronic illness screening and coaching. Instead of granting rebates, create reserve mechanisms to invest any dividends resulting from a better than target 85% loss ratio into a premium stabilization fund to offset future increases for pool participants. Require a two-year participation in the pool to prevent adverse selection.

2) Require transparency for all claim and non-claim related expenses. This includes claims administration, clinical programs, brokers commissions, taxes, fees and any other non-medical claim related costs. Insurers should be allowed to include in the claim expense calculation those programs proven to drive savings. Insurers should also disclose any costs charged to the claims loss ratio that originate from an entity owned by that insurer. As insurers migrate into health services, employers must understand if insurer costs are being included as an administrative cost and as a claim cost. Regulators must approve any administrative program included as a claims expense to make sure it is a competitively priced, proven cost mitigation program.

3) Mandate the release of claims experience for all employers down to 100 employees. Do not hide behind HIPAA as a means of preventing the release of claim data. This is a red herring.

4) Create a small group self-insured solution with a maximum liability limit of 105% of expected claims. Retention expenses might run higher than traditional self insurance but it would offer greater flexibility and a line of sight on claims cost. Consider state-run self insurance stop-loss pools offering smaller employers dividend eligible non-profit pooling.

We should not wait for Congress.  States and the private sector have the means to improve imperfect reform to achieve smaller employer affordability goals. If we cannot successfully rein in these expenses, smaller employers will accelerate dumping coverage and in doing so, shift the burden of healthcare subsidization to the Federal government, exchanges, the states that manage them, and ultimately taxpayers.

The private sector has the skill to drive many of the changes necessary to fix gaps in care, improve consumer engagement, realign incentives and drive affordable options.  The question remains whether employers have the will to take the lead in driving reform.  Should smaller employers choose to self insure, they will quickly shift from commodity buyers to value buyers and in doing so, join the ranks of those who fundamentally believe that the only real means of preserving quality and achieving affordability is market based reform.

Michael Turpin is frequent speaker, writer and practicing benefits consultant across a 27 year career that spanned assignments in the US and in Europe. He served as the northeast regional CEO for United Healthcare and Oxford Health from 2005-2008 and is currently Executive Vice President for Benefits for the New York based broker, USI insurance Services. He writes at Usturpin’s Blog.

12 replies »

  1. I did an analysis on a block of small group business we moved from traditional fully insured to small self funded plan under a high deductible.

    of 139 groups 90 had a loss ratio under 50%. It wasn’t community rating but was under small group reform with underwriting limited to .6 to 1.4.

    Only 19 groups had a loss ratio over 100%.10 where between 80% and 99%

    All 139 groups received a double digit rate increase. Even 16 groups with a loss ratio under 1%.

    Community rating is a failed concept that should be retired. Eliminates all motivation to fix the problem driving cost. If your going to pay the same premium either way why invest any money, time, or effort to lower your claims.

  2. According to my latest book of regualtion NY does not have any stop loss limitations meaning a sub 50 life group could self fund.


    Community rating is a great reason why employers should self fund, if your even slightly healthier then average you could save considerable money self funding.

    That being said there is a lot of TPAs that wont touch business in NY becuase of the onerous state regualtions.

  3. Can you legally write self insurance for a 50 or under life employerin New york . I thought that when community rating ame into effect it was no longer legal.

  4. “and it is certainly not paying below actual costs,”

    I have actually seen some cases lately where it does. We have been trying to do more cost plus auditing, the firm we uses shows Medicare when they work up the cost plus allowable and there has been cases where cost +25% exceeded Medicare allowable, by more then 25%. I think those are the exception not the norm but it does happen.

    There is so much waste in hospitals I think you could argue it is all profit. CEO and doctor salaries for example, if they don’t get a raise is it because the hospital wasn’t profitable or is their excessives salaries why they are not more profitable. I think you could only fairly call it shifting of hospitals desired income. As far as reimbursment goes. Now Medciare secondary payor laws for example are clearly cost shifting. The 26 dependent law is nothing but cost shifting.

    “smaller pools are causing higher volatility and uncertainty, ”

    Its not the pools its the size of the groups in the pool. Once you get to even 50,000 to 100,000 lives you have a stable pool. If groups were locked in pools for multiple year periods they would be more stable but groups are free to change pools year to year in search of better deals. Its always attractive for the healthiest in the pool to go to a cheaper pool.

    The problem with large pools in inertia. For example due to our small size and the fact our clients are rated on their own experience to a degree if we can move someone from CVS to Wal Mart and save $10 we will do it. If you have a pool of 10,000,000 people not only do they not even look at $10 claims they don’t look at $10,000 claims. Any increased efficience of a 10 million person pool, if there are any, does not make up for ignoring all the small dollar waste taking place. At a low number you realize negative returns on increased pool size.

    Is place of employement any more arbitrary then state of residence, age, or what ever other factor would be used?

    The Bureaucracy takes offense to you questioning it’s sanity. Do you really want to upset The Bureaucracy?

  5. Although I think I understand the problem, I guess I don’t quite understand the proposed solution, so I have a couple of questions.
    First, everybody keeps talking about cost-shifting from Medicare to the private sector. Is it indeed cost-shifting, or is it really profit-shifting? Medicare does not pay peanuts (unlike Medicaid), and it is certainly not paying below actual costs, so what exactly is it that gets “shifted”?
    Second, if smaller pools are causing higher volatility and uncertainty, why is the answer not considering creation of as big a pool as possible, say a State or Federal pool? Wouldn’t such pool obviate the need for the insane bureaucracy and obvious inequity of defining pools by something as arbitrary as current place of employment of a particular household member?

  6. Nate —

    Thanks very much. That’s the clearest and most thorough review and explanation of health reinsurance that I’ve seen. Very helpful.

  7. “reimburse either spending for a given member beyond $250K during the policy year,”

    Most employers couldn’t afford such a high attachment point but it would cost a couple percent of total plan cost. I just had a 100K cross my desk and it was low $20s. Assuming it wasn’t a nursing home you would be close to $10 PMPM. This is referred to as Specific Insurance.

    “or spending for all members combined beyond what a full risk policy would have cost.”

    This is referred to as Aggregate Insurance and is based upon the groups experience if actuarially significant or manual(which is never good) if they are not. Aggregate is made up of two parts. The first part is the factors, this is a dollar amount of claims the group is liable for per person per month. The second part is the premium that caps the employers liability at the factor times the number of lives. It’s the aggregate that prevents the floodgates from opening on small groups going self funded. Without experience the aggregate factors for small group are usually higher than their fully insured premium. When you add specific and other fixed cost the worst case liability can easily be twice their fully insured premium.

    On experience rated groups only 3-5% of groups will have an aggregate claim in any given year. They are rare but that is a factor of the underwriting that goes into calculating them. If a carrier ever finds a solution to manual aggs BUCA would be in for a blood bath.

    “to what extent is reinsurance available”

    Available in every state with some exceptions, HI is tricky because of their state plan but it is still used there for some groups. Some states have laws that limit self funding on small groups. It is very easy to find reinsurance, it is also possible to reinsure things fully insured carriers would never look at. For some groups reinsurance is the only option.

    “how vibrant and competitive is the market?”

    Under 25 lives there are a couple of national carriers and a dozen or so proprietary products.
    25-50 you have a few dozen options

    50+ I would guess you could get close to 100 quotes if not more.

    For existing self funded groups with experience it is very cut throat, soft market for a long time. All those carriers competing for the same small number of groups. For groups that are fully insured and lack information it is competitive but not nearly like those that are already self funded. Very slim margins in the market as a whole compared to fully insured. In Self funded the insurance aspect stands on its own. In Fully insured you might pay extra to have a bigger network or work with a payor that has a cool new program. In Self Funded those decisions are all separate, you can have any network you want or whatever bells and whistles you want regardless of carrier. It’s hard to justify paying one carrier $1 more then another when they deliver the exact same service. Now that being said you do need to be recognizant of how they pay their claims and financial strength etc but it is much more competitive.

    “Is it considered an attractive business or not?

    As many people as are in it I would guess so, it’s not sexy and it doesn’t have huge margins but you can make money at it. There is lots of volume and any time you have billions of dollars looking for a home someone is going to be interested. You would think reformers would take notice of how well it works it build on it but they do the exact opposite. Interestingly BUCA is not very competitive in the market. United owns a huge TPA and a large portion of their reinsurance is written with other carriers. A number of your regional carriers tried to market stop-loss and couldn’t be competitive.

  8. Mike and Nate –

    I was wondering if you could provide some information regarding how much reinsurance would cost self-insured plans to reimburse either spending for a given member beyond $250K during the policy year, or spending for all members combined beyond what a full risk policy would have cost. Also, to what extent is reinsurance available and how vibrant and competitive is the market? Is it considered an attractive business or not?

  9. “by serially under-reimbursing specialists and hospitals for the cost of their services.”

    This statement totally misses the real problem in health care costs. Mr. Turpin, exactly how much should a specialist be paid (RUC)? How much is not enough for hospitals and their bonused CEOs to earn? Do you believe hospitals are efficiently run organizations that have their costs under control? Are you claiming that small group health plans will pay specialists and hospitals their “fair” share?

    Nate, please outline in detail how your small group plans work and what they provide, cover, cost employees(premiums, deductibles, co-pays, including caps), manage and pay for care. We all know you work on less overhead and reimbursement than an insurance company, but I think it’s about time we all knew the transparent details from the man behind the curtain who constantly claims he has the solution, yet also has stated (if I remember correctly) only 10% of his presentations result in gaining an an employer client.

  10. ” some as low as 50 employees to give serious consideration to self insurance.”

    We have clients under 15 lives doing it. Soon we will be down to 5.

    ” With the barriers to entry being so high in healthcare, the only player large enough to compete with insurers is the Federal government.”

    I can open shop in any state but 2-3 and compete with any fully insured carrier with little to no cost. The biggest hurdle to competition is all the government regualtion and expense they keep piling on.

  11. Very interesting post. Thanks you. Brings to my mind echoes of the 1994 Einer Elhauge paper “Allocating Heathcare Morally.”


    “Health Law policy suffers from an identifiable pathology. The pathology is not that it employs four different paradigms for how decisions to allocate resources should be made: the market paradigm, the professional paradigm, the moral paradigm, and the political paradigm. The pathology is that, rather than coordinate these decision-making paradigms, health law policy and employs them inconsistently, such that the combination operates at cross purposes.

    This inconsistency results in part because, intellectually, healthcare law borrows haphazardly from other fields of law, each of which has its own internally coherent conceptual logic, but which in combination results in an incoherent legal framework and perverse incentive structures. In other words, health care law has not – at least not yet – established its self to be a field a law with its own coherent conceptual logic, as opposed to a collection of issues and cases from other legal fields connected only by the happenstance that they all involve patients and healthcare providers.” [pg 1452]

    I’d love to hear JD Kleinke and Joe Flower weigh in on your post.