REASONS FOR ALTERNATIVE FUNDING

The increasing interest in alternatives to the traditional, fully insured group arrangement has focused on two factors: cost savings and improved cash flow. To a large extent, this interest has grown in response to the rising cost of medical care, which has resulted in an increase in the cost of providing medical expense benefits. Even though alternative funding methods are most commonly used for providing medical expense benefits, many of the methods described here are also appropriate for other types of benefits.

Cost Savings

Savings can result to the extent that either claims or the insurance company's retention can be reduced. Retention—the portion of the insurance company's premium over and above the incurred claims and dividends—includes such items as commissions, premium taxes, risk charges, and profit. Traditionally, alternative funding methods have not focused on reducing claims, because the same benefits have been normally provided (and therefore the same claims have been paid) regardless of the funding method used. However, this focus has changed as state laws and regulations increasingly mandate the types and levels of benefits that must be contained in medical expense contracts. To the extent that these laws and regulations apply only to benefits that are included in insurance contracts, employers can avoid providing these mandated benefits by using alternative funding methods that do not involve insurance contracts. It should be noted that federal mandates apply to benefit plans, not just insurance contracts, and cannot be avoided by self-funding.

Modifications of fully insured contracts are usually designed either to lower or eliminate premium taxes or to reduce the insurance company's risk and, consequently, the risk charge. Alternative funding methods that involve a degree of self-funding may be designed to also reduce other aspects of retention and to reduce claims by excluding mandated benefits.

Improved Cash Flow

Under a fully insured contract, an employer has the ability to improve cash flow because premiums are collected before the funds are actually needed to pay claims. The employer generally is credited with interest while these funds are held in reserves. Alternative funding arrangements that are intended to improve cash flow are designed either to postpone the payment of premiums to the insurance company or to keep the funds that would otherwise be held in reserves in the employer's hands until the insurance company needs them. Such an arrangement is particularly advantageous to the employer when these funds can be invested at a higher rate of interest than that credited by the insurance company to reserves. It must be remembered, however, that earnings on funds invested by the employer generally are subject to income taxation, while interest credited to reserves by the insurance company is tax free.