Introduction
When you receive your health insurance benefits through a large employer, you usually see the logo of a major insurance carrier on your ID card. This leads to a natural assumption. Most of us assume that our employer is simply buying a large group health insurance policy from that well-known carrier. For many small and mid-sized companies, this is true. However, for a very large number of the biggest employers, there is something different happening behind the scenes.
Many of these large companies are not actually transferring your health risks to an insurance company. Instead, they are managing that risk themselves through a powerful, alternative model of risk management. This strategy is known as self-insurance or self-funding. This guide will clearly define what self-insurance is. We will also explain how it works. In addition, we will discuss the key differences between a self-insured plan and a traditional, fully-insured plan. Finally, we will explore why a company might choose this sophisticated approach.
Defining Self-Insurance: Becoming Your Own Insurer
First, let’s establish a clear definition. Self-insurance is a risk management strategy. A company or an organization that uses this strategy chooses to pay for its employees’ health claims directly from its own funds. This is in contrast to a traditional model, where the company would pay a fixed, regular premium to an external insurance company to cover those claims.
The core concept is a shift in risk. Instead of transferring the financial risk of all potential employee health claims to an insurer, the company retains that risk. In effect, the company acts as its own insurance provider for its employee population. The company sets aside its own money to pay for its employees’ medical bills, prescription drug costs, and other healthcare expenses as they arise throughout the year.
It is important to know that these companies do not typically manage the complex, day-to-day tasks of processing claims and managing a provider network themselves. Instead, they usually hire a Third-Party Administrator (TPA) to handle all of these administrative services. The TPA is often one of the major insurance companies. This is why your insurance card might still have a familiar logo on it, even if your health plan is actually self-funded by your employer.
The Mechanics: How a Self-Funded Plan Works
A self-insured plan has several key components that make it work.
The employer first establishes a special trust fund or a dedicated bank account. The employer then contributes money into this fund to cover the anticipated claims. Any contributions that the employees make toward their health coverage, which are taken from their paychecks, are also added to this fund. All of the health claims for the entire group of employees are then paid directly out of this fund.
However, no company, no matter how large, can handle an unlimited amount of risk. A single catastrophic claim, such as for a premature baby’s care or a major organ transplant, could cost millions of dollars. To protect themselves from these massive, high-cost claims, self-insured companies purchase a special type of insurance for themselves. This is called stop-loss insurance.
Stop-loss insurance is a critical safety net. It is essentially insurance for the self-insurer. This policy reimburses the company for claims that exceed a certain, predetermined dollar amount. It protects the company’s assets from devastatingly large claims. This protection typically comes in two forms:
- Specific Stop-Loss: This protects the company against a single individual employee having extremely high claims in a year.
- Aggregate Stop-Loss: This protects the company against the total claims for the entire group of employees exceeding a certain amount in a year.
Self-Insurance vs. Fully-Insured Plans: A Comparison
The choice between a self-insured plan and a traditional, fully-insured plan represents a major strategic decision for a company.
- Assumption of Risk
- In a self-insured plan, the employer assumes the financial risk of paying for all employee health claims.
- In a fully-insured plan, the insurance company assumes all of the financial risk.
- Cost Structure
- For a self-insured plan, the costs are variable. They depend directly on the actual health claims that the employees make during the year. The total cost is the sum of the actual claims paid, the TPA fees, and the stop-loss insurance premiums.
- For a fully-insured plan, the costs are fixed. The company pays a predictable, monthly premium to the insurance carrier for each employee. That price is the same whether the employees have a very healthy year or a very sick one.
- Flexibility and Control
- A self-insured plan offers the employer much more flexibility. The company can design a custom health plan from the ground up. It can choose its own provider networks, set its own benefit levels, and create wellness programs that are tailored to the specific needs of its workforce.
- A fully-insured plan offers less flexibility. The employer must choose from the standard, off-the-shelf health plans that are offered by the insurance carrier.
Why Do Companies Choose to Self-Insure?
Large companies are motivated to take on the extra risk and complexity of self-insurance for several powerful reasons.
The primary driver is potential cost savings. In a traditional, fully-insured plan, the premium that the insurer charges includes not only the expected cost of claims, but also administrative costs, risk charges, and a profit margin for the insurance company. In a year where a company’s employees are relatively healthy and have low claims, a self-insured company can save a significant amount of money. They avoid paying that built-in profit margin to an external insurer.
Another major benefit is increased control. Self-funding allows a company to have complete control over the design of its health plan. This allows them to create unique benefit packages that can help them to attract and retain top talent.
Finally, self-funding provides a company with access to valuable data. With a self-funded plan, the employer can analyze detailed, but anonymous, data about their employees’ health claims. This data can be used to identify common health trends within their workforce. They can then use this information to implement targeted wellness initiatives, such as diabetes management programs or smoking cessation support, which can improve employee health and lower the company’s future healthcare costs.
Conclusion
In conclusion, self-insurance represents a sophisticated and powerful approach to managing employee benefits. It is a strategic decision where a company chooses to take on the financial risk of its own employee health claims, rather than paying a traditional insurance company to assume that risk for them.
The company makes a clear trade-off. It gains the potential for significant cost savings and far greater control over the design of its health plan. In exchange, it takes on a much higher level of financial risk and administrative complexity. The next time you look at your employee benefits handbook from a large company, you will have a deeper understanding of what might be happening behind the scenes. Whether your plan is fully-insured or self-funded, the goal is the same. However, understanding the difference gives you a clearer picture of the world of corporate risk management and how your own health benefits are structured.