Financing Approaches to Healthcare Programs

Organizations have two options when financing their employees’ healthcare programs:

• Insurance-based financing
• Self-insured (self-funding)
  Insurance-Based Financing
  The main method for financing healthcare programs is through insurance, which typically has four major characteristics:

1. Pooling, or sharing, of losses. These losses are spread over a group of individuals so that each employee pays an average, as opposed to the total, loss that is incurred. Pooling permits the sharing of these costs and allows for more accurate predictions of these losses because a large sample is used for loss calculations.
2. Insurance is based on the premise that payments are only made for random losses.
3. The risk of payment is transferred from the insured to the insurer; by collecting premiums, the insurer has effectively absorbed all risk of payment from the insured.
4. Indemnification, which occurs when an insurer pays the insured—either in whole or in part—for expenses that have arisen from illness or injury.
   Generally, insurance companies are concerned with another fundamental issue called adverse selection; this occurs when the most “at-risk” individuals submit claims for benefits, which refers to anyone who needs a medical procedure in the first place. This principle is detrimental to the company because it inevitably increases overall costs for the program. Charging higher premiums for high-risk employees usually mitigates this exposure to high losses. This process is called an underwriting provision.
   Another concern for insurance companies is the concept known as moral hazard, which happens when employees sustain unnecessary expenses specifically because they know that someone else is paying them. A protective measure against this is partial payment, requiring the employee to pay a portion of the costs involved. Primarily, copays are used, alongside co-insurance and deductibles. Traditionally, in a full health plan, the company pays a premium, the rates for which are fixed for one year. Payments are made monthly, based on the number of enrolled employees. The premium changes during the course of the year only if the number of enrollees increases.
   The insurer collects these premiums, and claims are paid based on predetermined policy benefits. Employees are then responsible for any deductible amounts, or copayments required, for services given under the policy.
   With an indemnity plan, which is also called a fee-for-service plan, an employee is permitted to use any medical provider. The bill for any medical expenses is sent, by the employee or by the provider in question, to the insurance company, which then pays a percentage of it. Typically, the employee incurs a deductible—that is, a specified amount (for example, $200), which must be paid each year before the insurer begins issuing payment of its own. Once this is met, the majority of indemnity plans then pay a percentage of the “usual” or “customary” charge for the medical services in question. Generally, the insurer pays 80%, and the employee covers the remaining 20%; this is known as co-insurance. If, by chance, the provider happens to charge more than the customary amount, the employee must pay the difference, alongside the co-insurance. For example, if the customary fee for a procedure is $100, the insurer usually pays $80, leaving the remaining $20 to the employee. However, if the doctor charges $105, the insurer will still pay $80, and the employee must pay $25. Keep in mind, though, that many fee-for-service plans pay hospital expenses in full, whereas some reimburse at the 80/20 level just described.
   It is standard for a policy to have an out-of-pocket maximum. This means that once expenses have reached a certain amount within a given calendar year, costs for covered benefits will be paid in full by the insurer, and the employee pays neither excess charges nor the standard co-insurance. However, if the bill for a procedure equals more than the typical charge, the employee may still be required to pay that portion.
   Lifetime limits may apply on benefits paid under the policy. Most experts recommend a policy that is limited to a lifetime total of $1 million. Anything less than this may prove to be inadequate.
   Self-Insurance or Self-Funding
   As was discussed briefly in Chapter 2, “Healthcare Benefits,” a major financial issue with regard to healthcare benefits is the option of self-funding these plans. In such a plan, instead of buying a product from an insurance company, an employer funds a given worker’s healthcare plan from the company’s general funding. Considering the rise of healthcare costs previously mentioned in this book, employers are seeking out ways to manage them and improve corporate profitability. Self-funding health plans provide just such an opportunity.
   Claims submitted under these plans can be paid utilizing a pay-as-you-go process. That is, an employer pays each claim submitted by employees as they are received. Alternatively, the employer may set aside resources in advance specifically for the purpose of self-funded plans and, when claims are received and reviewed to determine eligibility, the claims are paid using these specific resources.
   Aside from the fact that such an arrangement may be construed as a company insuring itself, there is no element involved in such a healthcare plan that involves actual insurance. By contrast, an insured plan involves an insurer paying the claims submitted by employees, while the company pays the insurance company. The insurance company, based on the company’s claims against the plan for the prior year, adjusts the rate of pay.
   Note here that medical premiums have seen the highest increase in costs among all market items in the consumer price index. Another point to make here is that usually, on the basis of annual fees, a company will hire a third-party administrator to handle claims received under the company’s self-insured plans because the processing of these claims is a time-consuming effort.
   ERISA and Self-Funding
   Self-funded healthcare plans received a boost to their growth by the Employee Retirement Income Security Act, also known as ERISA. This act covers all benefit plans that are sponsored by an employer for its employees, including pension and welfare plans; welfare plans include any nonpension benefit, including health, life insurance, and disability plans. The emphasis, however, is on pensions.
   The provisions in ERISA that relate specifically to healthcare can be found in Section 514, known as the preemption clause, which states that: “the provisions of this title and Title 4 shall supersede any and all state laws insofar as they now and hereafter relate to any employee benefit plan.” Under Section 514, all private-sector employee-provided health plans are considered ERISA plans and are therefore exempt from state regulations due to the above-quoted clause. This means that self-insured plans are exempt from state-mandated benefits and from paying premium taxes, because of the fact that employers providing such plans are not, under law, considered insurance companies. However, ERISA does not prevent the state regulation of actual insurance; therefore, states can, and do, regulate health plans covered by insurance contracts, which is an added form of encouragement for the self-funding option.
   By setting up their healthcare plans as self-funded, companies avoid these state regulations, but also assume the risks normally shouldered by an insurance company. Large companies with broad resources may prefer this option to retain the use of their capital, rather than dealing with an insurance company.1 Further, because of a large employment base, claims are stable from year to year, allowing this financial risk to be taken in relative safety.2
   1 Scammon, D. L. “Self-Funded Health Benefit Plans: Marketing Implications for PPOs and Employers.” Journal of Healthcare Marketing 9, no. 1: 5–14.
   2 Park, C. H. “Prevalence of Employer Self-Insured Health Benefits: National and State Variation.” Medical Care Research and Review 57, no. 3. Sage Publications, 2000.
   Funding of Self-insured Plans
   Two options have been indicated for such plans: Money is set aside for paying claims, or else the company pays them as they are received in a pay-as-you-go arrangement. However, hybrid options can be utilized, with self-funding as their primary feature.3
   3 EBRI Databook on Employee Benefits. Chapter 28, “Employee Benefits Research Institute.” 2008.
   In some cases, employers may choose to carve out only certain elements of the full healthcare plan and buy an insurance contract to cover only these elements, permitting the remainder of the plan to be self-funded. Typically, these insured elements would be related to mental health or prescriptions. The state government can regulate these, specifically the states where the benefits are being paid.
   Another funding mechanism is through the purchase of stop-loss coverage. This is usually done to provide for catastrophic losses. There are, in general, two types of stop-loss coverage:
5. Individual (coverage that insures against the risk that a single claim will exceed a certain amount)
6. Aggregate (coverage that insures against the entire plan’s losses exceeding a certain amount)
   Prevalence of Self-insured Plans
   The Kaiser Family Foundation and the Health Research and Educational Trust, in their 2012 annual report on Employer Health Benefits, provided the data shown in Table 3.1 on the prevalence of self-insured healthcare plans.

Source: Kaiser/HRET Survey of Employer-Sponsored Health Benefits, 1999–2012
*Estimate is statistically different from estimate for the previous year shown (p<.05)
Note: Due to a change in the survey questionnaire, funding status was not asked of firms with conventional plans in 2006. Therefore, conventional plan funding status is not included in the averages in this exhibit for 2006. For definitions of Self-funded and Fully Insured plans, see the introduction to Section 10.
Table 3.1 Percentage of Covered Workers in Partially or Completely Self-Funded Plans, by Firm Size, 1999–2012
Example of a Self-Insured Plan
Overview of the Healthcare Plan Accounting Process
Bagan Inc. is a self-funded health care plan administered by Anthem Health Plans, Inc., with a pharmacy plan administered by Delta Dental. This health plan includes deluxe, standard, and economy levels. Alternatively, with proof of another avenue for insurance, employees are permitted to opt out of coverage.
Health and accounting are maintained on a fiscal-year basis. The plan incurs costs from medical, dental, and pharmaceutical claims, along with vision plan insurance premiums. Administrative fees are paid to a third-party administrator to process these claims. Funding is received from the company and its employees.