What is a self-funded health plan?

A self-funded health plan is a type of plan where the employer assumes the financial risk for providing health care benefits to its employees. Employees pay their employer for their health care premiums, and the employer uses that money to pay out-of-pocket as employees file medical claims.

Self-funded health plans differ from traditional fully-funded plans in that with fully-funded plans, the employer and the employees share in the annual payment of the insurance carrier premiums and the carrier covers the cost of the benefits.

Benefits of self-funded health plans

Pro #1: Cost reduction

Companies can save money with self-funded health plans because they are only paying for claims as they happen versus paying annual or monthly premiums for claims that may or may not be filed. With a self-funded health plan, the less money your employees spend on healthcare, the more cost savings for your company. Unlike a fully-funded plan, you don’t pay for what you don’t use.

Most employers who opt for a self-funded health plan earmark money to pay for claims as they come in, setting aside the premiums paid by employees and any contributions the employer decides to make. This ensures there is a proper budget to pay for claims.

Related: How Sana saves your small business money

Because your costs are directly linked to the costs of your employee claims, you can find ways to reduce those costs by introducing less expensive health care options, such as telemedicine, nurse hotlines, and wellness programs. You can also save money with effective case management programs, claims negotiations, and bill audit reviews.

With fully-funded plans, up to 20 percent of your premium payments go to the carrier to administer the plan. In a self-funded health plan, you can pay a Third-Party Administrator (TPA) to administer your plan for much less. You will also pay less in-state insurance premium taxes as only the excess-loss coverage premium is taxable.

Pro #2: Customizable plans

Self-funded health plans are more flexible than fully-funded plans. Fully-funded plans are one-size-fits-all and have few options for customization. Self-funded health plans afford companies an opportunity to design a plan and contract with the providers and provider networks that fits the needs of your employees.

You can also make changes to your health plan whenever necessary. This ensures you have a plan that best suits your employees’ needs and the needs of the business, even as things change. For instance, you can add or remove benefits, increase or decrease the number of participants, or move people to or from specific providers.

Pro #3: Greater control

In self-funded health plans, the employer accumulates the premiums each year instead of the insurance carrier. The company has control over what they do with that money. Many companies choose to invest that money in low-risk investments that yield interest income. That interest can build up reserves in case claims cost exceed premium payments, or it can fund health and wellness programs for employees.

One of the downsides of fully-funded plans is that annual premiums can change annually without notice. Whether driven by increasing market costs or higher-than-expected claims costs, carriers are free to increase their rates. Not so with self-funded health plans. Because you don’t pay an annual or monthly premium fee to a carrier, you can control your costs a bit more, choosing how much to collect from your employees instead.

You also have greater control over plan design, selecting the plans that meet the current needs of your workforce. You determine which benefits you want to provide (as long as they meet any requirements and regulations) and how much you want your employees to pay in premiums.

There is greater transparency into how many claims are made, the cost of those claims, and the nature of the claims. With fully-funded plans, the carrier retains that data, making it challenging for you to understand where your money is going so you can better support a healthier workforce.

Related: When should my startup begin offering health insurance?

Disadvantages of self-funded health plans

Con #1: Cost variability

Unlike traditional, fully-funded health plans that have a set annual or monthly premium, self-funded health plans do not have a pre-established premium cost. As an employer, your costs will vary depending on the dollar amount of your claims, and those claims can vary year to year. This uncertainty can make it difficult to plan and budget for health care, as well as ensure you have adequate cash flow to cover claims as they come in.

The challenge is determining how much to budget for during the planning phase. This will depend on the demographics of your employee base. An older base will be more likely to incur a greater cost because they tend to file more claims than a younger demographic. You will also need to consider how many of your employees will desire a family plan and the general health of their family.

The key is to understand as best as you can how many and the types of claims you should anticipate, then design your plan around that.

Con #2: Risk for overage

Because a self-funded plan has so much variability, there is always a risk that you come up short. If your claims over the year total more than the premiums you have collected from your employees during that same period, your earmarked money will run out. You will need to allocate budget from elsewhere to cover those costs.

For this reason, many companies choose to look at their self-funded health plan over the long-term. Over-budget costs from a year of more-than-expected or higher dollar claims may be balanced by a subsequent year of under-budget costs due to fewer and/or less costly claims. When taken as an average, your company may still be able to keep costs under control.

You can also purchase stop-loss insurance to protect from overages. If claims exceed premium reserves, your stop-loss insurance kicks in to pay the overage. The downside for smaller companies with self-funded health plans is that this insurance isn’t activated until claims reach a certain threshold (and that threshold is typically higher for smaller companies than larger companies). You will be responsible for any overages that fall below that threshold.

Con #3: Administrative hassles

Of course, since a health insurance carrier is not processing your employees’ claims, that means someone else has to and it’s a big job. Beyond enrolling participants and administering the plan, every time an employee files a benefits claim, you have to negotiate that claim with the provider and pay the bill. Many small businesses do not have a dedicated HR staff member to manage the plan and all of their employees’ claims, and the larger your business, the more there is to manage.

To help with the management of claims, the majority of small businesses hire a TPA. You pay for them to help with enrollment, the collection of employee premiums, healthcare provider access, reviewing and processing claims, providing customer service to plan participants, and recording plan data. They may also assist with stop-loss insurance coverage.

How to choose a self-funded health plan for your business

There are several benefits of self-funded health plans over traditional, fully-funded plans. There are also a few downsides that you must factor into your decision. If you are considering self-funded health plans, be sure you look at all of your options. A level-funded health plan, for instance, is a type of self-funded health plan that brings more pros and fewer cons to small businesses, while providing your employees with excellent coverage.