May 10, 2009

Self-Funding with Stop-Loss Coverage and/or ASO Arrangements

Two of the problems associated with self-funding and self-administration are the risk of catastrophic claims and the employer's inability to provide administrative services in a cost-effective manner. For each of these problems, however, solutions have evolved—namely, stop-loss coverage and ASO contracts—that still allow an employer to use elements of self-funding. Although an ASO contract and stop-loss coverage can be provided separately, they are commonly written together. In fact, most insurance companies require an employer with stop-loss coverage to have a self-funded plan administered under an ASO arrangement, either by the insurance company or by a third-party administrator.

Until recently, stop-loss coverage and ASO contracts were generally provided by insurance companies and were available only to employers with at least several hundred employees. However, these arrangements are increasingly becoming available to small employers, and in many cases the administrative services are now being purchased from third-party administrators who operate independently from insurance companies.

Stop-Loss Coverage

Aggregate stop-loss coverage is one form of protection for employers against an unexpectedly high level of claims. If total claims exceed some specified dollar limit, the insurance company assumes the financial responsibility for those claims that are over the limit, subject to the maximum reimbursement specified in the contract. The limit is usually applied on an annual basis and is expressed as some percentage of expected claims (typically between 115 percent and 135 percent). This arrangement can be thought of as a form of reinsurance and is treated as such by some regulatory officials. It is interesting to note that the employer is responsible for payment of all claims to employees, including any payments that are received from the insurance company under the stop-loss coverage. In fact, because the insurance company has no responsibility to the employees, no reserve for claims must be established.

Aggregate stop-loss coverage results in (1) an improved cash flow for the employer and (2) a minimization of premium taxes, because they must be paid only on the stop-loss coverage. However, these advantages are partially (and perhaps totally) offset by the cost of the coverage. In addition, many insurance companies insist that the employer purchase other insurance coverages or administrative services to obtain aggregate stop-loss coverage.

Stop-loss plans may also be written on a specific basis, similar to the way an insured plan with a deductible is written. In fact, this arrangement (most commonly used with medical expense plans) is often referred to as a big-deductible plan or as shared funding. The deductible amount may vary from $1,000 to $250,000 but is most commonly in the range of $10,000 to $20,000. It is usually applied on an annual basis and pertains to each person insured under the contract. Although stop-loss coverage was once written primarily for large employers, more recently it also has been written for employers with as few as 25 employees. These plans have particular appeal for small employers who have had better-than-average claims experience but who are too small to qualify for experience rating and the accompanying premium savings.

The deductible specified in the stop-loss coverage is the amount the employer must assume before the stop-loss carrier is responsible for claims and is different from the deductible that an employee must satisfy under the medical expense plan. For example, employees may be given a medical expense plan that has a $200 annual deductible and an 80 percent coinsurance provision. If stop-loss coverage with a $5,000 limit has been purchased, an employee will have to assume the first $200 in annual medical expenses, and the plan will then pay 80 percent of any additional expenses until it has paid a total of $5,000. At that time, the stop-loss carrier will reimburse the plan for any additional amounts that the plan must pay to the employee. The stop-loss carrier has no responsibility to pay the employer's share of claims under any circumstances, and most insurance companies require that employees be made aware of this fact.

Misunderstandings often arise over two variations in specific stop-loss contracts. Most contracts settle claims on a paid basis, which means that only those claims paid during the stop-loss period under a benefit plan are taken into consideration in determining the liability of the stop-loss carrier. Some stop-loss contracts, however, settle claims on an incurred basis. In these cases, the stop-loss carrier's liability is determined on the basis of the date a loss took place rather than when the benefit plan actually made payment. For example, assume an employee was hospitalized last December, but the claim was not paid until this year. This is an incurred claim for last year but a paid claim for this year.

A second variation has an impact on an employer's cash flow. Assume an employer has a medical expense plan with a $20,000 stop-loss limit and that an employee has a claim of $38,000. If the stop-loss contract is written on a reimbursement basis, the employer's plan must pay the $38,000 claim before the plan's administrator can submit an $18,000 claim to the stop-loss carrier. If the stop-loss contract is written on an advance-funding basis, the employer's plan does not actually have to pay the employee before seeking reimbursement.

Most insurance companies that provide stop-loss coverage for medical expense plans also agree to provide a conversion contract to employees whose coverage terminates. However, the employer must pay an additional monthly charge to have this benefit for employees.

ASO Contracts

Under an ASO contract, the employer purchases specific administrative services from an insurance company or from an independent third-party administrator. These services usually include the administration of claims, but they may also include a broad array of other services. In effect, the employer has the option to purchase services for those administrative functions that can be handled more cost-effectively by another party. Under ASO contracts, the administration of claims is performed in much the same way as it is under a minimum-premium plan; that is, the administrator has the authority to pay claims from a bank account that belongs to the employer or from segregated funds in the administrator's hands. However, the administrator is not responsible for paying claims from its own assets if the employer's account is insufficient.

In addition to listing the services that will be provided, an ASO contract also stipulates the administrator's authority and responsibility, the length of the contract, the provisions for terminating and amending the contract, and the manner in which disputes between the employer and the administrator will be settled. The charges for the services provided under the contract may be stated in one or some combination of the following ways:

  • A percentage of the amount of claims paid

  • A flat amount per processed claim

  • A flat charge per employee

  • A flat charge for the employer

Payments for ASO contracts are regarded as fees for services performed, and they are therefore not subject to state premium taxes. However, one similarity to a traditional insurance arrangement may be present: The administrator may agree to continue paying any unsettled claims after the contract's termination but only with funds provided by the employer.


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