What Is Self-insurance? A Guide for Small Businesses
Self-insurance, sometimes called self-funding, is when your business forgoes traditional insurance coverage and takes on all the financial risk by setting aside money to pay employees’ healthcare claims. Small businesses may consider this option for several reasons, including a lack of negotiating power, resistance by insurance companies to take on the risk of a small pool, and cost-prohibitive premiums that come with offering health insurance.
Although you may avoid regularly increasing premiums with this option, we do not recommend that small businesses self-insure. The financial risk is simply too great, and for most businesses, the cons vastly outweigh the pros. We cover the risks in more detail later in this article.
How Self-insurance Works
For small businesses finding it challenging to get affordable health insurance for their employees (which can especially be the case if they’re not using an HR or payroll service), let’s take a look at how self-insurance works.
Setting Up a Self-insured Plan
Setting up a plan isn’t as simple as just collecting money from your employees each month and holding it in a special account earmarked for their healthcare costs. You still need to find a benefits broker to set up your plan. For a fee (around 3%–6% of the total premium), it will help you determine the types of healthcare plans to offer your employees and give you a rough idea of costs.
Are you going to have your employees pay the full premium, or is your company going to contribute a portion? Regardless of what you choose, you need to ensure that any contributions are directed to a special bank account dedicated to holding the premiums. It’s advisable to open a separate bank account where you keep this money that’s specifically used to cover potential healthcare bills for your employees.
The benefits broker will also help you find a third-party administrator (TPA), which manages your healthcare plan, ensures compliance, and deals with all claims.
You are generally not involved in the administration of your self-insured healthcare plan. But using a TPA does come at a cost. A TPA will charge you between 4%–7% of your total self-insurance plan costs. The more participating employees you have, the more expensive this piecemeal approach becomes.
You’re not required to use a TPA, but if you don’t, you open your company to additional liability. Without a TPA, your internal HR team or a dedicated staff member will process healthcare claims for their colleagues. While the individual may be trustworthy and keep all medical information confidential, other employees may feel uncomfortable and not participate in the plan. If the individual processing claims isn’t trustworthy, that could lead to employee lawsuits if the individual breaches confidentiality or shares medical information.
To calculate your self-insured premiums, you’ll need to work with your benefits broker and TPA. They’ll take your company census and look at any existing health problems your employees may have. Essentially, they’re assessing the risk you’re taking on by insuring your employees.
If you have lots of workers with prior or ongoing health problems, they may suggest higher premiums to better balance your risk. On the flip side, if your workers are generally healthy, you may be able to charge lower premiums. This calculation is entirely unique to each company.
Self-insurance vs Traditional Insurance
You calculate plan premiums, collect them, and set them aside for specific healthcare use
Insurance company determines and collects premiums
Use TPA to assist in plan administration and payout of claims or assign someone internally to handle it
Insurance company administers plan and pays claims without involvement from your company
When you choose to self-insure (essentially acting as both employer and healthcare insurance company for your workers), you need to calculate the risk of your employees getting sick or injured (an older workforce tends to have higher healthcare expenses than younger). You must also estimate the costs for their medical care and set aside an equal sum of money to tap into should any employee need to cover healthcare costs. On top of that, you will have to navigate the complexities of health, age, and disability discrimination, as mistakes in handling these will lead to costly legal battles. If this sounds complicated and time-consuming, you’re right.
Compare that to traditional insurance coverage, where you find a reputable insurance provider that offers health coverage to your employees. You don’t have to do any manual calculations or set aside large sums of money for needs that may never arise. You simply pay a pre-negotiated premium each month—split between you and your employees—and, if an employee needs to cover healthcare costs, they submit a claim to the insurance company. There’s nothing for you to worry about.
Businesses Likely to Try Self-insurance
The smaller your business, the more likely it is that you’re at least considering self-insurance. Very small businesses find it difficult to get affordable health insurance for their employees and look to self-insurance as an option.
If your company operates in an industry where employees may suffer frequent injuries, like construction or demolition, you may also consider self-insurance as a way to help reduce high premiums.
Risks of Self-insurance
Your business assumes all the risk by going self-insured. And the unknown magnifies your risk.
Budgeting, costs, administration, and legal compliance are all issues you’ll need to deal with, on top of running your business.
The risks can be extremely costly. Health insurance is strictly regulated at the federal and state levels. Without a TPA, you’ll need to ensure your plans and company are compliant with these regulations, which often vary across state lines. Even innocent mistakes can lead to costly fines and penalties.
Mistakes such as plan misadministration and breached confidentiality can also lead to employee lawsuits. Without a TPA, your company is open to lawsuit risk from several angles.
All of this combines to create an extreme financial risk that could bankrupt your company. If you have an employee who suffers a catastrophic injury that requires extensive medical treatment, your business could be on the hook for hundreds of thousands of dollars in medical bills. If you don’t have the cash set aside in your healthcare bank account to cover these bills, the employee and their healthcare provider may be able to take legal action against you for the balance.
Self-insurance can reduce your overhead costs while maintaining some of your benefits; however, it is rarely the answer. It brings too many risks and too much additional work. Most small businesses are better off going a traditional insurance plan route, which is a much less risky option.