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.

Total Self-Funding from Current Revenue and Self-Administration

The purest form of a self-funded benefit plan is one in which the employer pays benefits from current revenue (rather than from a trust), administers all aspects of the plan, and bears the risk that benefit payments will exceed those expected. In addition to eliminating state premium taxes, avoiding state-mandated benefits, and improving cash flow, the employer has the potential to reduce its operating expenses to the extent that the plan can be administered at a lower cost than the insurance company's retention (other than premium taxes). A decision to use this kind of self-funding plan is generally considered most desirable when all the following characteristics are present:

• Predictable claims. Budgeting is an integral part of the operation of any organization, and it is necessary to budget for benefit payments that will have to be paid in the future. This can best be done when a specific type of benefit plan has a claim pattern that is either stable or shows a steady trend. Such a pattern is most likely to occur in those types of benefit plans that have a relatively high frequency of low-severity claims. Although a self-funded plan may still be appropriate when the level of future benefit payments is difficult to predict, the plan will generally be designed to include stop-loss coverage.
  

• A noncontributory plan. Several difficulties arise if a self-funded benefit plan is contributory. Some employees may resent paying their money to the employer for benefits that are contingent on the firm's future financial ability to pay claims. If claims are denied, employees under a contributory plan are more likely to be bitter toward the employer than they would be if the benefit plan were noncontributory. Finally, ERISA requires that a trust be established to hold employees' contributions until the plan uses the funds; both the establishment and maintenance of the trust result in increased administrative costs to the employer.

• A nonunion situation. Self-funding of benefits for union employees may not be feasible if a firm is subject to collective bargaining. Self-funding (at least by the employer) clearly cannot be used if benefits are provided through a negotiated trusteeship. Even when collective bargaining results in benefits being provided through an individual employer plan, unions often insist that benefits be insured to guarantee that union members will actually receive them. An employer's decision about whether to use self-funding is most likely motivated by the potential to save money. When unions approve self-funding, they also frequently insist that some of the savings be passed on to union members through additional or increased benefits.

• The ability to effectively and efficiently handle claims. One reason that many employers do not use totally self-funded and self-administered benefit plans is the difficulty in handling claims as efficiently and effectively as an insurance company or other benefit-plan administrator would handle them. Unless an employer is extremely large, only one person or a few persons will be needed to handle claims. Who in the organization can properly train and supervise these people? Can they be replaced if they should leave? Will anyone have the expertise to properly handle the unusual or complex claims that might occur? Many employers want some insulation from their employees in the handling of claims. If employees are unhappy with claim payments under a self-administered plan, dissatisfaction (and possibly legal actions) will be directed toward the employer rather than toward the insurance company. The employer's inability to handle claims, or its lack of interest in wanting to handle them, does not completely rule out the use of self-funding. As will be discussed later, employers can have claims handled by another party through an administrative-services-only (ASO) contract.

• The ability to provide other administrative services. In addition to claims, the employer must determine whether the other administrative services normally included in an insured arrangement can be provided in a cost-effective manner. These services are associated with plan design, actuarial calculations, statistical reports, communication with employees, compliance with government regulations, and the preparation of government reports. Many of these costs are relatively fixed, regardless of the size of the employer, and unless the employer can spread these costs out over a large number of employees, self-administration will not be economically feasible. As with claims administration, an employer can purchase needed services from other sources.

• The ability to obtain discounts from medical care providers if medical expense benefits are self-funded. In order to obtain much of the cost savings associated with managed care plans, the employer must be able to secure discounts from the providers of medical care. Large employers whose employees live in a relatively concentrated geographic region may be able to enter into contracts with local providers. Other employers may use the services of third-party administrators who have either established or entered into contracts with preferred-provider networks.

The extent of total self-funding and self-administration differs significantly among the different types of group benefit plans. Plans that provide life insurance or accidental death and dismemberment benefits do not usually lend themselves to self-funding because of infrequent and large claims that are difficult to predict. Only very large employers can expect stable and predictable claims on an annual basis. In addition, federal income tax laws impede the use of self-funding for death benefits, because any payments to beneficiaries are considered taxable income for beneficiaries. Such a limitation does not exist if the plan is insured.

The most widespread use of self-funding and self-administration occurs in short-term disability income plans, particularly those in which the maximum duration of benefits is limited to six months or less. For employers of most any size, the number and average length of short-term absences from work are relatively predictable. In addition, the payment of claims is relatively simple, because benefits can be (and usually are) made through the usual payroll system of the employer.

Long-term disability income benefits are occasionally self-funded by large employers. Like death claims, long-term disability income claims are difficult to predict for small employers because of their infrequent occurrence and potentially large size. In addition, because small employers receive only a few claims of this type, self-administration of such claims is economically unjustifiable.

The larger the employer, the more likely that its medical expense plan is self-funded. The major problem with a self-funded medical expense plan is not the prediction of claims frequency but rather the prediction of the average severity of claims. Although infrequent, claims of $500,000 to $1,000,000 or more do occasionally occur. Most small and medium-sized employers are unwilling to take a chance that they might have to pay such a large claim. Only employers with several thousand employees are large enough to assume the risk that such claims will regularly occur and have the resources that will be necessary to pay any unexpectedly large claims. This does not mean that smaller employers cannot self-fund medical benefits. To avoid the uncertainty of catastrophic claims, these employers often self-fund basic medical expense benefits and insure major medical expense benefits or self-fund their entire coverage but purchase stop-loss protection.

It is not unusual to use self-funding and self-administration in other types of benefit plans, such as those providing coverage for dental care, vision care, prescription drugs, or legal expenses. Initially, it may be difficult to predict the extent to which these plans will be utilized. However, once the plans have "matured," the number and dollar amount of claims tends to be fairly stable. Furthermore, these plans are commonly subject to maximums so that the employer has little or no risk of catastrophic claims. Although larger employers may be able to economically administer the plans themselves, smaller employers commonly purchase administrative services.

Providers of Dental Coverage | GROUP DENTAL INSURANCE

Since the early 1970s, group dental insurance has been one of the fastest-growing employee benefits. It has been estimated that in the past 25 years, the percentage of employees who have dental coverage has grown from about 5 percent to more than 60 percent. More than 90 percent of firms with 500 or more employees make coverage available. Many employee benefit consultants feel that by the early part of the next century most employees, except for those who work for very small employers, will have dental coverage.

To a great extent, group dental insurance contracts have been patterned after group medical expense contracts, and they contain many similar, if not identical, provisions. Like group medical expense insurance, however, group dental insurance has many variations. Dental plans may be limited to specific types of expenses or they may be broad enough to cover virtually all dental expenses. In addition, coverage can be obtained from various types of providers, and benefits can be in the form of either services or cash payments.

The concept of managed care has had a significant role in the evolution of group dental insurance plans. However, this role has been somewhat different from that in medical expense plans. Group dental plans are more likely than medical expense plans to provide benefits on a traditional fee-for-service basis, but they are also more likely to take a managed care approach to providing those benefits. The most common example of the latter is the emphasis on providing a higher level of benefits for preventive care. As group dental plans have become more prevalent, the percentage of persons receiving preventive care has continued to increase; as a result, the percentage of persons needing care for more serious dental problems has continued to decrease.

One other difference between group medical expense plans and group dental plans is that providers of managed dental care arrangements have been more likely to offer coverage to very small groups.

Providers of Dental Coverage

Group dental benefits may be offered by insurance companies, dental service plans, the Blues, and managed care plans. Like medical expense coverage, a significant portion of dental coverage is also self-funded. An employer may either self-administer the plan or use the services of a third-party administrator. In either case, the plan may use a preferred-provider network to provide dental services.

Insurance Companies

Insurance companies are a major provider of dental coverage, often on an indemnity basis. Coverage is usually offered independently of other group insurance coverages, but it may be incorporated into a major medical contract. If it is part of a major medical contract, the coverage is often referred to as an integrated dental plan, and the benefits are frequently subject to the same provisions and limitations as benefits that are available under a separate dental plan.

Dental Service Plans

Most states have dental service plans, often called Delta Plans or Delta Dental Plans that along with the Blues write approximately one-quarter of dental coverage. However, the extent of their use varies widely by state, and western states generally have larger and more successful plans than states in other parts of the country. The majority of these plans are nonprofit organizations that are sponsored by state dental associations. In addition, they are patterned after Blue Shield plans, and dentists provide service benefits on a contractual basis. Also like Blue Shield, state Delta Plans are coordinated by a national board, Delta Dental Plans, Inc.

Blue Cross and Blue Shield

Many Blue Cross and Blue Shield plans also provide dental coverage. In some cases, the Blues have contractual arrangements that are similar to those that dental service plans have with dentists; in other cases, benefits are paid on an indemnity basis just as if an insurance company were involved. Finally, a few of the Blues market dental coverage through Delta Plans in conjunction with their own medical expense plans.

Managed Care Plans

A significant and growing amount of dental coverage is provided through managed care plans, often sponsored by insurance companies or the Blues. However, the majority of dental benefits are provided through traditional fee-for-service plans. Because dental expenses are more predictable than medical expenses, the emphasis on preventive care by managed care plans provides a real potential to hold down future costs.

Coverage can be obtained from dental health maintenance organizations (DHMOs), which operate like health maintenance organizations but provide dental care only. Like HMOs, DHMOs can take the form of closed-panel plans or individual practice associations. Estimates are that about one-quarter of employers offer a DHMO option to employees but usually as an alternative to a fee-for-service plan.

Coverage can also be obtained from PPOs, which have enjoyed rapid growth in recent years. Point-of-service plans have also become increasingly common for providing dental coverage.

Self-Funded Plans

For several years, it has been common for large employers to self-fund dental benefits, and recently the concept has spread to smaller employers. Under the technique, often called direct reimbursement, the employee visits the dentist, pays the bill, and then submits the bill to the employer or a third-party administrator for reimbursement. This process often generates significant savings for the employer, largely because of a significant savings in administrative costs. The claims process is relatively simple because most reimbursements are small in size, and large claims do not exist because of caps on benefit amounts. The number of claims is also fairly stable from year to year. One problem that often occurs in self-funding of benefits is the lack of control over utilization. However, this has been a minimal problem in dental treatment because employees seem to be reluctant to visit the dentist unless it is absolutely necessary.