Insurance in its purest form was designed to transfer unknown risk to another entity, the insurance carrier.
“But fully insured health insurance can be more accurately described as a payment plan for known or predictable expenses, which includes an element of insurance layered on top,” says Joe Roberts, area vice president of Health and Welfare Key Accounts at Arthur J. Gallagher & Co.
“A large number of frequently used medical services are predictable expenses,” Roberts says. “Consider your annual maintenance medication or a well child visit. Those are things that you can plan for or expect to pay. Funding predictable expenses through an insurance premium is essentially a payment schedule for a known expense and, therefore, like other financing mechanisms, financially inefficient.”
Smart Business spoke with Roberts and Ethan Hendrickx, an area vice president in Gallagher Benefit Services, about why it is important to understand the “financing” behind health insurance and how gaining this knowledge can lead to a more efficient and cost-effective benefits strategy.
What should employers understand about the financing of health insurance?
Paying premiums to an insurance company to fund predictable expenses is financially inefficient. Here is a simplified example. Let’s say you take a medication that costs $100 a month, but because your health insurance includes pharmacy copays, you only have to pay $20 to fill the $100 prescription. For the insurance company to collect enough premium to pay its $80 share of this prescription and cover the cost of doing business, it needs to charge $92-$96 in premium. Thus, you paid $116 for the $96 in premium plus a $20 copay.
Apply that scenario across all of the known or predictable expenses consumed each year by your employees and the numbers get very large.
Why is this important for employers to understand?
When purchasing a fully insured health insurance plan, there is a common misconception that insurance companies are going to pay your claims and lose money in the process without increasing premiums to make up for their losses. The reality is insurance companies formulate their premiums based on past claims experience and future risks.
Employers need to understand how health insurance works at the insurance carrier level in order to determine the best way to manage risk and fund the claims of their employees.
In many cases, employers are able to more efficiently manage their health benefit spend by purchasing an appropriate level of insurance for their business and then funding claims as their employees consume health care on a variable cost basis. This structure is commonly referred to as a partially self-funded plan.
How can employers save money with a partially self-funded arrangement?
There are five main areas from which savings can be derived in a self-funded arrangement:
- Insurance company profit.
- Administrative costs.
- Risk transfer costs.
- Pharmacy programs.
A self-funded arrangement may not be right for all employers; however, they should evaluate the feasibility of an alternative to a fully insured arrangement. In making this determination, there are several issues to consider, like risk tolerance, contract provisions and cash flow implications. It is important to find an adviser who understands the technical aspects of self-funded programs and has experience in structuring and managing those types of programs.
How large does an employer need to be in order to benefit from adopting a partially self-funded approach?
More and more small to midsize employers are converting to self-funding. There are organizations in Northeast Ohio with fewer than 50 employees on their plan that successfully self-fund their medical and pharmacy benefits. And a growing number of stop-loss insurance companies developing new products and contract features make it increasingly prudent for smaller employers to take advantage of self-funding.
Insights Employee Benefits is brought to you by Arthur J. Gallagher & Co.