Self-Funding - An Overview & Explanation of Misconceptions

by Frederick D. Hunt, Jr. - SPBA President

What is self-funding?

Perhaps its other name "self-insurance" is more descriptive. Instead of paying an insurance company or Blue Cross & Blue Shield money to pay the claims (and keep any profits), a self-funded (self-insured) employer, or plan, puts the money into a trust fund that is overseen by strict Federal government regulation, and that trust fund pays the claims (and keeps any profits on behalf of the workers to offset future expenses). To avoid catastrophic losses, both commercial insurance companies as well as self-funded plans usually buy re-insurance. In self-funding, the re-insurance has the descriptive name "stop-loss". It allows a plan to set in advance the maximum loss levels it is willing to sustain on any specific situation or on the aggregate of claims on the whole group. Thus, even a one-person employer can budget to meet his pre-designated stop-loss trigger points and can self-fund successfully.

Technical note #1:

Within the benefits business, we occasionally use the term "partially self-funded" to differentiate between "bare" and self-funding with stop-loss. However, it is very important to remember that legally & technically, there is no such subset or term as "partially self-funded". A self-funded plan is simply and legally a self-funded ERISA plan whether it has stop-loss or not (just as a barbershop is a barbershop whether it has fire insurance or not.) So, a self-funded plan with stop-loss is subject to the same tough Federal ERISA fiduciary standards and all aspects of the plan (including the stop-loss) are preempted from state intervention. This "partial" term and role of stop-loss has caused confusion for many state Insurance Commissioners. The law is clear, however. It is preempted.

Technical note #2:

Too much of the health reform rhetoric is ignorant of the existence & role of stop-loss, and assumes all self-funding is "bare" (with no stop-loss). Only the largest plans usually find it prudent to go without stop-loss, and that's why there has been misplaced talk about floors and caps of what small employers may use self-funding. Any employer of any size should be allowed to self-fund. The size limits are not only senseless & discriminatory, but also unnecessarily add to the complexity of health reform proposals, which raises suspicion & opposition to reform. It is viewed as forcing small employers into health ghettos.

Medical IRAs/MSAs: There has been significant support in Congress and the public for Medical IRA or Medical Savings Accounts (MSAs). While it is a great idea for people who are responsible savers and knowledgeable medical consumers, it allows others to fall through the cracks. Self-funding for tiny employers achieves the goals of MSAs (and thus attracts those supporters)...while providing a safe structure that remedies the problems of the less responsible or unfortunate. A small self-funded plan is like the workers pooling the equivalent of their MSAs.

Reformers & state officials often make the misstatement that ERISA plans "are not subject to regulation".

That could not be farther from the truth (as the constant flow of new rules, enforcement cases, and specialists attest). ERISA was carefully & specifically designed by Congress to be the ultimate consumer protection law. ERISA fiduciary responsibility has far stronger consumer protections than state insurance regulation or even normal business customs. ERISA demands that the plan as a whole as well as each transaction be viewed to assure that it was the "most prudent" for the safety & efficiency of the plan assets and the plan participants (covered individuals). Thus, for instance, various tie-ins, less-than-arm's-length business arrangements, and administrative costs not fully disclosed in advance can bring civil and/or criminal ERISA penalties...and the penalties go to the person who made the judgment. They can't hide behind a corporate veil. It's powerful incentive!

"Choice" and "efficiency" are big words in the health reform debate...and self-insurance truly accomplishes that. The choice is the flexibility of ERISA self-funded plans to design a plan for the needs of that particular work force...rather than be subject to the 1,100 state-mandated benefits, such as toupees in one state and hair implants in another. It makes the greatest use of limited health dollars. For instance, one plan of food workers includes lead testing for cannery workers and testing for exposure to pesticides for the farm workers (required of the workers by other government agencies) in the plan's benefits. Those, of course, would not be in some government "standard" set of benefits. Yes, state-mandated toupees probably aren't included, but isn't it better for the workers to have these services in the plan rather than having to pay out of pocket?

How big is self-funding, and who uses it most?

In truth, about 85% of employer health plans currently use some form of self-funding, and are subject to ERISA regulation. (The percent is also sometimes reported as 67%, depending on how certain plans are defined.) The point is that self-funding is the major player and the normal mode of health benefits chosen by workers & employers. Fully-insured is the minor player (9% of health plans, according to Foster Higgins). This is the opposite of the assumptions on which most health reformers are basing their proposals. This is especially ironic, since most health reformers vilify the insurance companies...but would end up forcing back to insurance companies the customers who had chosen to leave.

Self-funding has grown many thousand percent in the past 15 years...and most of that growth has been among small and very small employers (and the stop-loss industry has matured and become more and more adept at tailoring services for small plans). Why smalls? The answer is actually quite logical. Big employers can exercise the clout of their size to demand special rates & flexibility from insurers. Small employers tend to get inflexibility at higher prices (or no insurance offered at all). As even tiny employers found that they could safely custom-design a plan for the needs of their particular workers...and save as much as 40% on the overall cost, the choice became clear. Some have their own single-employer plans, and others banded together in their trade association or other group or union to create a large plan composed of small employers. It has been very cost-effective, flexible, and successful. These small self-funded employers & plans are furious at the thought that Congress & states feel financially sound small employer plans should be abolished...but it's OK for large companies who may be on the brink of bankruptcy to do as they please. Angering such a huge portion of the workforce will have serious repercussions.