Level Funding

Executive Summary: A small employer that provides medical benefits through a self-insured, level funded plan may save money in the direct costs of providing those benefits.  However, there are significant added costs and burdens associated with the maintenance of such an arrangement that may more than offset these savings.

What Is Level Funding?

“Level Funding” is an attractive alternative for employers, particularly small employers, who wish to self-insure their employee health benefits.  While the idea of level funding itself is not new, current interest is being driven by the desire to avoid some of the requirements of the ACA and mitigate the cost of providing insurance. The term “level funding” does not have an official definition; however, such arrangements do have common features.

This page examines legal and regulatory issues that may impact such arrangements.

• Self-Insuring
• The Role of Community Rating
• State Oversight
• ERISA Compliance
• HIPAA Requirements
• Refunds
• Exiting a Level Funded Plan

Self-Insuring

Level funded plans purport to be self-insured.  Their status as self-insured plans is not as obvious as it may seem at first blush. For now, we will assume for purposes of discussion that level funded plans are self-insured.

As self-insured health plans, they are not subject to the insurance reforms of the ACA.  This means that they do not have to provide the ten “essential health benefits” that insurers in the small group market must provide.  Freed from that requirement, employers can offer a less expensive package of benefits to its employees.

• For example, an insurer offering coverage to small employers must provide benefits for treatment of mental illness and substance abuse.  A self-insured employer could offer a plan that pays no benefits for those conditions.

The Role of Community Rating

Insurers in the small group market are obliged to use community rating in their underwriting.  This means that a small employer is grouped with all other small employers in a given region to determine premium rates; an employer with a healthy workforce essentially subsidizes insurance coverage for employers with less healthy employees.  Self-insured plans are not subject to community rating; an employer with a healthy workforce only has to pay for coverage based on its own experience.

In a conventional self-insured plan, the employer pays claims out of its own funds as they arise.  Claims are processed and paid by a third party administrator.  In some months, claims may be higher than others and there is a risk that in a few months, claims will be much higher than average.  This may create cash flow problems, particularly for a small employer.

In an extreme case, claims for an entire year will be much higher than they have been previously.  Most employers (even larger ones) protect against this through the purchase of stop loss insurance (i.e., excess loss insurance).  The stop loss carrier will determine an employer’s annual expected claims and then provide coverage for claims that exceed a stated percentage of the expected claims, commonly 120%.  The 20% difference between expected and actual claims is called the risk corridor; the employer assumes the risk that actual claims will exceed the expected claims by up to 20%.  The stop loss carrier may also insure against annual claims for a specific individual that are greater than a stated amount.

A level funded arrangement differs in several key respects.

• The risk corridor for the stop loss insurance is 0%. In other words, the stop loss carrier is responsible for all claims over the expected amount.  This means the employer is never at risk for paying more for claims than the amount projected at the beginning of the year.
• The employer does not pay claims each month as they occur. Rather, it pays a fixed monthly amount to the TPA.  This amount consists of three parts:

1. a “benefit amount” equal to one-twelfth of the expected claims for the year;
2. a fee for administrative services; and
3. the monthly  premium for stop loss coverage.

• If claims exceed the benefit amount, the stop loss carrier will pay them.   If claims are less than the benefit amount, the surplus is carried over to pay the following month’s claims but the employer still pays the predetermined fixed monthly amount. Accordingly, there is no month-to-month volatility, and therefore no cash flow issues caused by the plan.
• At the end of the year, if the total claims paid are less than the total benefit amount paid by the employer, the employer can get a refund of the difference.[1]

A level funded plan:

• Gives an employer flexibility in plan design, including the ability to provide fewer benefits than insurance companies are required to provide.
• Is not subject to community rating.
• Does not expose the employer to any risk from larger than expected claims.
• Does not expose the employer to any monthly claims volatility.
• Offers the prospect of a refund if actual claims are less than expected claims.

What’s not to like?

It’s A Good Deal…If You Can Get It: State Oversight

Many states look with disfavor on stop loss policies that provide for no risk corridor.  The reason is simple. Stop-loss coverage is not considered health insurance; and states cannot regulate self-insured health plans.

A self-insured plan with no risk corridor looks a lot like a fully insured plan with insurance that is not subject to the laws governing health insurance companies.  Consequently, nearly half the states have laws or regulations that prohibit stop loss carriers from issuing policies that do not include a minimum risk corridor[2].  They may also regulate minimum individual claim amounts; and limit the arrangements to employers with more than a certain number of employees.

In short, level funding as it is frequently described may not be an option.

ERISA Compliance

Although ERISA applies to most employer group health plans, the bottom line for small employers with fully insured plans:

ERISA compliance is not that difficult. 

We can illustrate the compliance burden of a small, fully-insured employer through what we believe to be a fairly typical scenario:

• a small employer[3] sponsors a fully insured plan;
• it collects employee contributions through a cafeteria plan and pays the premium (which consists of the employee contributions and amounts paid from the employers general assets) to the insurance company every month.
• In these circumstances, the employer is viewed as having an “unfunded” plan and is not required to hold any money in trust;
• Nor is it required to file an annual Form 5500 or purchase a fidelity bond.

The same rule would apply to a small employer that self-insures its health plan, paying benefits out of its general assets.

Consider the same scenario except that the employer sponsors a self-insured level funded plan and is the policy holder on the associated stop loss policy.  This employer may not have such an easy of time of it.

• The critical question is whether the employer, by transferring money to a third party (the TPA) to hold for the express purpose of paying claims, has created a “funded” plan[4].
• If it has, then ERISA’s trust, reporting, and bonding requirements will apply.  We state this conditionally because the Department of Labor has not expressly ruled on the issue.  However, the conclusion follows logically from the rules and guidance the Department has given.
• ERISA’s trust filing and bonding requirements will apply.

Because there are significant penalties associated with the failure to comply with the rules for funded plans, a cautious employer will want to confer with experienced counsel before entering into a level funded arrangement.

HIPAA Privacy and Security Requirements

The distinction between fully insured and self-insured plans is important for purposes of HIPAA’s privacy and security rules.  This distinction can be stark.

The Privacy Rule

An employer with a fully insured health plan has no costly or burdensome obligations, particularly if the employer has no or limited access to protected health information (PHI).

In contrast, an employer with a self-insured plan is responsible for a significant measure of administrative overhead including:

• creating and implementing a privacy policy that governs the uses and disclosures of PHI;
• amending the health plan to meet HIPAA requirements;
• providing individuals with rights, including rights to review, amend, and receive an accounting of their PHI;
• preparing and providing a privacy notice;
• appointing a privacy officer;
• complying with various administrative safeguards; and
• entering into business associate contracts.

The Security Rule

Security Rule requirements are relatively easy to manage for an employer with a fully insured plan that receives some electronic PHI.

More precisely, the security rule is largely about process.  The same process applies to fully insured and self-insured plans; it’s simply that stepping through the requirements of that process tend to be much easier for a fully insured plan.

It’s harder for a self-insured plan to avoid access to electronic PHI; as access increases, so do the burdens of compliance. Those burdens include specific and detailed requirements related to risk analysis; risk management; creation of policies and procedures; ongoing review and evaluation of security needs and practices; and documentation, documentation, documentation!

Additional burdens are not unique to level funded plans as opposed to other types of self-insured arrangements. A small employer may well underestimate how much work it takes to properly comply with HIPAA requirements.

The point: a small employer considering adoption of a level funded plan is likely to be coming from a fully insured plan and hasn’t thought about HIPAA compliance issues.

Refunds

One of the more attractive features of level funding is the prospect that an employer may receive a refund at the end of the year if claims are lower than expected.

Employers: this refund may not be “free money”.

If the plan is considered funded, then the entire amount of the refund will be deemed to be a plan asset and, therefore, must be used to provide ERISA-type benefits.  Whether the plan is funded or unfunded, if part of the benefits were paid using employee contributions, the portion of the refund attributable to those contributions must be allocated in some way to, or for the benefit of, plan participants.

Failure to handle a refund in accordance with ERISA can expose the employer to substantial penalties.

Exiting a Level Funded Plan

At some point, an employer that adopts a level funded plan may want to return to a fully insured plan.  This could happen if an employer’s claims experience deteriorates to the point that it is cheaper to go with a fully insured, community-rated plan.  The employer will want to fully understand what it costs to exit. Obligations on termination may include forfeiture of any claims surplus or funding some time period of run-out claims.

The Bottom Line

A small employer that switches from a fully insured plan to a self-insured level funded arrangement can mitigate the risks of self-insurance and potentially reduce benefit costs.  But there is no free lunch; the trade-off is a substantial increase in regulatory complexity and administrative overhead.

[1] Employers with fully insured plans may also get a refund under the ACA’s medical loss ratio rules.  However, these rules are based on the experience of the insurer’s community rated block of business, rather than the experience of a particular employer.

[2] An employer may also level fund the risk corridor, but at a higher monthly cost.

[3] For ERISA purposes, a small employer is one with fewer than 100 participants.

[4] To learn differences between funded and unfunded plans and how they are created, please review this reference material.