Level-Funding: A Viable Alternative for Small Group Insurance?

There has been a recent uptick in interest in so-called “level funding” as 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, the current interest is being driven by the desire to avoid some of the requirements of the ACA and mitigate the cost of providing insurance.

As a starting point, it is worth noting that the term “level funding” does not have an official definition; however, such arrangements do seem to have some common features. A level funded arrangement differs from a self-insured plan 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.
• The employer does not pay claims each month as they occur. Rather, it pays a fixed monthly amount to the TPA.  Accordingly, there is no month-to-month volatility and therefore no cash flow issues that are 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]

Potential positives a level funded plan provides:

• 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; and
• Offers the prospect of a refund if actual claims are less than expected claims.

However, employers may want to weigh the risks when considering a level funded plan:

First, 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.

Second, 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 need to understand that 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.

And last, 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 get out.  Obligations on termination may include forfeiture of any claims surplus or funding some period of run-out claims.

Bottom Line

A small employer that switches from a fully insured plan to a self-insured level funded arrangement can mitigate then 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, the latter is based on the experience of the insurer’s community rated block of business rather than the experience of a particular employer.

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