Over the year’s, the Canadian employee benefits marketplace has found innovative ways to manage employee benefit programs. None-the-less, benefit costs still appear to be spiraling out of control. At last check, healthcare costs rose by an annual rate of 15% per year and dental costs rose by an average rate of 8%. At these rates, it is easy to see why employers are clamoring for innovative ways to help them manage these costs, which on average range between 4% and 6% of an employer’s gross payroll.
With fully insured plans, employers attempt to control costs using copays, deductibles and plan modifications. The employer’s goal is to reduce the expenditure of claims by employees. Some might argue that this is simply ‘costs downloading’ to employees, however the economic realities of employee benefit expenses, has made this behavior the ‘new reality’. Accordingly, these and other cost containment techniques are being used to limit the employee’s ability to make claims under the group benefits plan. Since lower claims, generally equate to lower costs, employers have little recourse but to explore these sorts of cost containment initiatives.
The shortcomings of a traditionally fully insured benefit plan, is that the employer does not share in any of the experience gains resulting from the cost containment initiatives imposed on employee claims. Employers do however benefit from these claim restrictions (at least initially) by obtaining a premium or rate reduction from the Insurer at the implementation of the plan design change.
Additionally, depending on the credibility of the group’s claims experience, the employer may also benefit from lower claims activity, which should necessitate lower premiums. The premium reductions quoted for plan alternatives are typically not aggressive, as the Insurer has a vested interest in creating an underwriting gain or surplus at renewal time. Giving away those gains upfront and catapulting the plan into an operating loss would of course not be a prudent way to achieve their shareholders desired return on equity.
In the past, unless an employer’s health and dental plan generated over $150,000 in annualized premium, employers would have little recourse but to accept the pricing of the Insurer and to hope that any underwriting surpluses in the plan would ultimately make their way back to the employer in the form of lower renewal premiums. Not surprisingly, the Insurer often absorbed these underwriting gains. Naturally, as the risk manager for claims, they felt entitled to the bulk of these gains.
With the emergence of self-insured products and providers who were willing to dramatically reduce the entry premium for self-insured programs, (in some cases, down to groups below 10 lives) these plans have gained traction in the market.
For those employers with health and dental plans that generate more than $150,000 in annual premium, it is often prudent to look at alternative funding arrangements employing some degree of self-insurance. These programs are referred to as Administrative Services Only (ASO) or Retention/Refund Accounting programs. Depending on the history of the plan, turnover of employees, current business conditions and the risk tolerance of the company, self-insurance may or may not be a prudent financial risk strategy for an organization.
Many employers who presently have fully insured plans, like the convenience of receiving a fairly predictable invoice from the Insurer every month. This of course allows that employer to budget for their employee benefit expenditure from one month to the next. Most self-insured programs however lack this predictability, which can subject the employer to seasonal and other claim fluctuations. Ultimately, these fluctuations will impact the amount of the monthly expenditure made to the third party provider.
This apparent negative is offset quite well by the fact that most self insurance plans do not require annual renewals (which are often quite stressful in themselves as they often involve an increase in premiums, a review of the plan and triannual provider reviews).
Self-insured programs are by their nature dynamic in that seasonal factors will produce monthly fluctuations in claims. To satisfy the need by some employers for monthly premium stability, some providers offer a budgeted self insurance product that allows an employer to pay the projected annual claims costs, plus administration fees for their group in 12 equal monthly installments. This achieves the predictability of finances that small employers need, with the possible benefit of lower costs and the sharing of experience gains that these employers require. Normally a quarterly or semi-annual reconciliation will form part of these agreements, as these providers are reluctant to become bankers for any protracted period.
In its simplest form, a self-insured program is essentially a program whereby an employer chooses to assume the risk of certain components of the health and dental portion of the group benefits plan. The basic premise behind these plans is that insurance is meant to provide protection against risks that are unpredictable, infrequent and of a high dollar value. Consumers have long known that it is always more cost effective to budget for expenses which are frequent and predictable, while it is better to buy insurance for things that are unpredictable. In a benefits plan, life insurance, accidental death and dismemberment and long-term disability are excellent examples of things that should be fully insured, given their relative unpredictability and the potentially high costs of a claim.
The same principle applies to Emergency Out of Country and in some cases hospital and nursing claims (although claims for these benefits can be mitigated by controls placed on the plan design). For all other health, drug and dental expenses (particularly for vision and dental expenses), claims are very predictable, frequent and are of a relatively low dollar value. Of note, these elements are opposite those characteristics, which support fully insuring a specified risk.
From the standpoint of risk, it makes little sense to purchase insurance on items that are predictable and that have relatively low values. For these claims it is more cost effective to budget for their occurrence and to treat them as ‘cashflow expenses’.
The notion of cashflow as relates to health and dental plans implies that an employer will pay 100% of the cost of their employee’s claims, plus the administration fee. Because there is typically no insurance element, there is no need for Insurer reserves that can be as high as 15% of health claims, 5% of drug claims and 10% of dental claims. The insurer risk charge or profit charge of 1% to 3% is also eliminated, as the Insurer is no longer on risk for any experience shortfalls. This means that the employer is only paying the cost of adjudication, taxes and fees.
In a fully insured plan, insurance as relates to health and dental benefits is premised on the notion that for every $1 in premium paid by the employer, the insurer will expect the employee to claim something less than that premium input. Claims have to be less than paid premium because of the fact that an Insurer needs to charge an administration fee to cover adjudication, booklets, taxes, fees, etc. For a small employer, these fees can be as high as 35% of claims and for larger employers, as low as 12% of claims, in part due to the statutory reserve requirements, risk and other administration charges.
If we assume that in a fully insured program, the Insurer will need to retain 25% of every dollar in premium paid by a group with 50 insured employees, it is easy to see why that same employer would gladly pay 15% of every dollar under a self-insured arrangement. The savings in administration costs provides the employer with more money to pay claims, enrich the plan or to deploy that money elsewhere for other corporate purposes.
What stops every small employer from adopting a self-funding approach is that not only can an employer share in the experience gains of the group benefits plan, but also in the experience loses. The reduction in the administration fee paid to the Insurer provides additional monies to pay claims, but with smaller employers and a relatively small premium base, it does not take much for claims to outstrip the premiums that an employer would have paid under a fully insured program. This element of risk (in a self-insured plan) does not sit well with some business owners.
The notion of risk sharing is paramount in self-insured programs. However, insurance protection is not abandoned all together because Insurance is still required to cover drug claims above certain thresholds as well as for emergency out of country etc. The need to purchase insurance protection from the Insurance Company, further erodes some of the savings that might have been realized from the elimination of the reserves and the reduction in the administration fee of the program. So unless an employer has witnessed a protracted period whereby the Insurer has been the only benefactor of experience gains under their plan, an employer might best be advised to enter the self-insurance realm cautiously.
For those employers who want to learn more about self-insurance, Ideal Benefits would be more than happy to provide an opinion on the suitability of this approach for your company.