Self insurance (also known as self funding) allows small business owners to create and manage their own insurance plans, without being subjected to the restrictions and costs of working with a larger traditional insurance carriers. However, self insurance does come with a high level of risk and liability.
We want to preface this article by stating that self insurance is generally NOT the best choice for small business owners. It can be a huge administrative burden, and there are both legal and financial risks to self funding your insurance. However, please read on to learn more about why it may or may not be a potential match for you.
What is Self Insurance?
In a self insurance arrangement, the employer takes on the risk of providing health insurance coverage for their employees. Ultimately, it means that the business is responsible for paying members’ eligible claims from a designated fund created and maintained by the business.
This is in contrast to a traditional arrangement where the employer/employee pays premiums (the monthly bill) to an insurance company, who then is responsible for paying all the eligible claims.
In addition to medical plans, you can also self fund other benefit types, like dental, vision, disability, and insurance of the like. The process is the same regardless of which type of insurance you choose to self fund. However, the most common approach is to start off by self-funding your medical coverage.
Self Insurance vs Traditional Insurance
With traditional health insurance, insurance providers work with a set network of doctors and hospitals and provide employers with several plan options to offer their employees. Once an employer has selected a plan, they pay premiums (the monthly bills) to the insurance company to cover all of their employees enrolled in the plan. The employer can also elect to have their employees cover a portion of these costs through payroll deductions. The money is then kept by the insurance provider, earning returns (as invested by them) until it is needed to pay out a claim.
With self-funded insurance, you need to work with a benefits consultant or broker to set up your plan. They will be able to help you draft the specific details of a plan, help you find a provider network of healthcare professionals, and help find you a third party administrator (TPA) to manage the ongoing busywork, like claims filings. The consultant or broker will advise you on how to structure your plan, but the TPA will actually manage and administer the plan.
Just like with traditional insurance, the employer can pay for coverage, or have their employees pay a portion each month via payroll deductions. Rather than send payments to an insurance company, however, this money is placed in a designated bank account that’s used to cover potential bills.
To your employees, self insurance will look just the same as traditional insurance: They’ll present an insurance card at the doctor’s office, pay copayments, and request reimbursements when necessary. The key difference is these costs are payed out of your designated bank account, and managed by your TPA. If you are worried about costs getting out of control, you can purchase stop-loss insurance that will cap off the amount of money you may potentially pay out-of-pocket for any claims made on the plans.
So in summary, with traditional insurance, the insurance provider assumes the risk. With self insurance, YOU take on the risk and the administrative pieces.
How to Find a Third Party Administrator
To find a third party administrator that can manage a self-funded insurance plan, you’ll generally work through a local healthcare consultant or broker. They should be able to locate a TPA that can setup your type of a plan, and has experience with companies of your size.
Even if you’re going through a broker, don’t forget to check the TPA’s references and confirm that they can offer you assistance with everything you need.
Small Businesses & Self Insurance: Not Usually a Match
As stated previously, self insurance is often not the best choice for a small business. Here are a few of the reasons why:
- Liability and Risk – The employer takes on a much greater risk if there are any major claims or issues with the plan. In addition, the employer is provided with medical information and data on their employees (HIPAA information) that needs to be securely stored, accessed, and managed. You also need to be trained in HIPAA, which will cost additional money (the medical privacy law).
- Cost “Savings” – An employer with less than 100 employees may not see much (if any) sort of savings from going with a self funded plan. The costs associated with the time and effort spent on setting up, implementing, and managing the plan usually outweigh the potential savings. Not to mention the stress.
- Steep Learning Curve – As a small business owner, you have a lot on your plate as it is. Health plans follow many legal guidelines which can vary from state to state and are not the easiest to understand, let alone manage. Unless you have previous experience in benefits administration, there is a lot of information to understand and process. Your best bet may be to leave it to the pros!
There is another option that might be worth considering for your organization and it combines some of the aspects of self funding and traditional insurance. This is known as a partially self funded plan.
Partially Self Funded Plan
I previously worked for a small technology company and we were in the process of working with our benefits broker for our annual renewal. That year, our renewal quotes were over 40% higher than the year before! This was not financially feasible for the business or for our employees.
One of the main reasons for this increase was our size – given that we had under 50 employees, our rates were determined using a composite rate. This meant that we were being lumped into the demographic of our zip code using that insurance to determine our rates. Essentially, our prices were going up because other companies were running up utilization of their plans!
Since we had a relatively young and healthy workforce that didn’t go to the doctor much, the price increase didn’t seem fair. At that point, we decided to explore a partially self funded plan:
In a partially self funded plan, the plans are provided and administered by a large traditional insurance company. However, like a self-funded plan, the risk pool is limited to just your employees. The underwriters for your plan will do a detailed census and health survey of all of your employees to determine your options and costs.
You will continue to pay a monthly premium to the provider, but the amount is based upon a “worst case cost scenario” determined by underwriters of the plan. The money is put into a claims fund that will be used to pay out claims. By the off chance this fund runs out, additional expenses are covered by the insurance company, but your rates will most likely increase the following year. On the flipside, if your plan runs below what the underwriters anticipate at the end of the year, you can potentially get some money back.
If you have a relatively healthy workforce, but don’t want to take on the risks and liability of a self funded plan, this might be the right option for you to explore.
Self Insurance Costs to Consider
When determining if a self insurance plan is right for your small business, there are some potential costs to consider. The costs you will pay with a traditional insurance provider are very straightforward and consistent— there’s typically just the monthly premium per employee that will change from year to year.
The costs associated with self insurance are a bit more complicated:
- The potential amount of money you may need to pay to cover employee claims against the plan, minus the money your employees put aside, plus interest.
- Administrator and vendor costs to run the plan.
- Cost of stop loss insurance, which will limit your total financial liability on a plan (the price on this can average anywhere from $12-$100 per employee per month and there are many factors involved – so consult a broker on your options).
- Keep in mind that claims will not be consistent and may affect cash flow of the business.
However, given all these potential costs, there are still some valid reasons to consider self insurance.
Why Would a Small Business Try Self Insurance?
Again, most small businesses would not have the capacity to properly implement and manage a self funded plan. In order to even consider this option, you’ll typically need to be large enough (over 100 employees) to properly manage the risk pool and to experience any cost savings.
That said, if you do own a larger business, here are the top reasons why you may consider self funded insurance:
- Employers with self insurance have the freedom to tailor the plan based upon the health of the workforce and are not bound by the plans offered by insurance carriers.
- Reduced plan cost over traditional offerings, due to the elimination of insurance company overhead and fees in addition to lower state taxes (self funded plans are not subject to state health insurance premium taxes).
- Other employers do not impact the coverage carried by your organization, since the risk pool is limited to your employees only. For a business with a mostly younger & healthier workforce, this can mean potentially lower costs. This benefit also applies to partially self-funded plans.
Drawbacks of Self Insurance
Although there are many benefits to switching to a self funded health insurance plan, there are also several potential disadvantages that you should be aware of:
1. The cost potential can be intimidating.
If one employee is unexpectedly diagnosed with a severe medical condition, medical claims could fluctuate much higher than initially anticipated. Your employee will still be responsible to pay their portion but you will cover the rest.
2. Budgeting can be challenging.
Relating to the first drawback, how do you budget for the unexpected? If you have inconsistent cash flow, this can be especially challenging.
3. You could expose yourself to legal action.
The employer and its assets can be exposed to liability if there is any legal action taken against the self funded plan.
4. It can be an administrative pain.
Even with the assistance of a third party administrator, you will still have more of an administrative burden placed on you to run the plan than you would with a traditional insurance company. You will receive monthly reports as to how your plan is running and the plan will require strong oversight on your part.
The Rules Around Self Insurance: Dos and Don’ts
- DO research and speak with several third party administrators before selecting one to manage your claims. Make sure that they have worked with companies similar to yours in size and ask about what services they will offer your employees (enrollment assistance, claims management tools, etc.)
- DO review the fine print of any stop loss coverage if you decide to get it. Ask what happens in the event of a large catastrophic event with one of your employees – will your plan have the possibility of getting renewed?
- DO remember that you or your administrator may have to do annual ACA (Affordable Care Act) reporting depending on your company size and plan choices.
- DON’T assume that coverage laws are the same in all states. Review your local guidelines and make sure that you are following all applicable laws.
- DON’T make the assumption that moving to self funding is the best option for you to save money – do the math and use your best guesses before making the switch! Self funded plans are typically cost effective long term, but not a quick financial win.
The Bottom Line
If you are looking for a way to reduce medical insurance expenses, have a relatively healthy workforce and are willing to take on the liability of this type of plan – self insurance may be the right decision for you. However, be aware of the high amount of risk, administrative burden, and steep upfront costs. For these reasons, most small businesses opt for traditional health insurance, or the less risky partially-self funded option.