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Are Self-funded Benefits Nirvana? Rethinking Delivery Of Employee Benefits

By: Robert J. Crowder

The rise of third-party benefit administrators is making Administrative Services Only plans an option to control health benefit costs for employers large and small. Robert J. Crowder, of Nelson B. Crowder & Associates Inc., explains how they work and some of the advantages of taking this approach.

With healthcare costs escalating out of control, smart employers are thinking differently these days and using a new funding method – self-insurance – to finance employee benefit plans. Once confined to large companies such as banks and railways, self-insurance – using an Administrative Services Only (ASO) contract – is now a viable option for smaller enterprises, thanks to a blend of better technology, developments in financial and insurance products, and the rise of third-party benefit administrators.

A benefit plan can be divided into two parts.

There is an insurance component to cover a catastrophic event such as longterm disability, the death of an employee, or an unforeseen need for special medicines or treatments.

Then there is a cash contribution component used to pay for everyday benefits such as drug costs or dental care.

A self-insured arrangement for benefits coverage provides employers with more flexibility, cuts down on administration costs, and gives firms greater control over the amount they actually spend on benefits. That’s because employers only pay for what they use.

Traditionally, most firms have simply purchased a benefit plan through an insurance company. That was fine when benefit plans were first introduced and multiple insurers were competing to provide employers with options.

Events Conspiring

However, a number of events are conspiring to force employers to think about benefits differently.

First, consolidation and demutualization of the insurance industry means fewer competitors and options when it comes to plan selection. The offerings are more generic and apply a one-size-fits-all approach to benefit planning.

Second, rates are skyrocketing. While the cost of inflation has been running between two to three per cent, insurers have been hiking the cost of their benefit plans significantly higher. Healthcare inflation trend factors used by insurance companies are averaging increases of 18 to 22 per cent annually.

In the group insurance industry, insurers spread the risk associated with loss of life, long-term disability, and other catastrophic claims over their entire client base, so employers pay similar rates within their industry regardless of their claims record. There’s no way for insurers to accurately predict what these low-frequency, highexpense claims will be at each employer, so the risk is spread across many employers based on actuarial assumptions. This is the purpose of pure insurance – to cover highcost, unpredictable losses.

On the other hand, medical and dental claims occur frequently but are relatively low cost. Claims experience in a group tends to remain relatively stable when monitored over time. As such, you can predict and budget for these types of expenses.

Rainy Day Fund

However, insurance companies often look to recover more in expenses than what they pay out, so when they get it wrong, they simply hike their rates or increase their claim reserves.

Reserves are an ill-understood concept that insurance companies use to protect themselves should an employer with high claim costs decide to terminate the relationship and move elsewhere. It’s an amount over and above what they actually think it will cost them to insure an event, a rainy day fund if you will. Frequently, reserves are explained as funds held to protect the employer in the event of unexpectedly high claim costs, or ‘run-off claims,’ paid out after a contract ends.

I look at it differently. I say it’s there to protect the house and we know, in the long run, the house always wins.

Because of the consolidating market, employers have fewer options. If they don’t like the annual renewal increases, then the insurer shrugs its shoulders. In the past, employers had nowhere else to go.

Well, now employers have another option. ASO plans are finding their way to the market through third-party benefit administrators, which manage the program on behalf of the employer.

Here’s how they work.

First, the third-party benefits administrator protects against risk by assessing the correct type of insurance coverage needed to cover the catastrophic event component. This depends on a number of factors, ranging from the type of business to the number of employees. The administrator works with group insurance brokers and insurance firms to obtain quotes and find the appropriate stop-loss insurance plan that fits the employer’s needs. By separating the pure insurance component from the budgeting portion of the plan, the administrator can take advantage of group buying power and shop for lower rates, which are passed onto the employer. Typically, group benefits consulting and administration businesses purchase stop-loss insurance with a $5,000 deductible to protect the employer from catastrophic medical claims such as prescription drug ‘cocktail’ treatments (some of which can run $30,000 to $40,000 annually), hospital claims, or private duty nursing expenses. Out-of-country emergency medical expenses are also fully insured, usually with no deductible.

Monies Placed In Trust

When it comes to the self-insured health and dental care component, the administrator and the employer work together to establish a budget for those items, and the monies are placed in trust with the administrator, which runs the plan and adjudicates claims. Employees, or their healthcare providers, simply submit their claims directly to the administrator which processes them and issues claim cheques. Some administrators can issue health cards for purchases like drugs and medical devices.

The administrator’s job is to monitor the claims experience and help clients develop a better understanding of their true costs. If, at the end of the year, there are surplus funds left in the trust account, they are either returned to the employer or become part of the budget for the next year’s claims and the employer need only top up the fund.

Alternatively, if the account is ‘overdrawn,’ the employer must make up any deficit with additional contributions. The plan can be monitored monthly and spikes in claims can be quickly identified and dealt with.

As well, the flexibility of a self-insured health and dental plan allows employers to reward loyalty. They can set up a phased-in benefits schedule so that more benefits are provided the longer the employee remains with the company. You can also budget for benefits across an organization according to profit centres and category of employee or management level. This will assist the employer to further understand the source of their true benefit costs.

These plans work best with organizations that employ 15 or more people. The employer usually pays the administrator a percentage of self-insured contributions as a plan operation fee. The strategy applies to any industry – from retail to manufacturing – and for most business structures – from family- owned companies to professional firms.

While benefit costs have been rising, experience with the self-insurance model over the past five years shows a number of employers have had minimal increases in the costs of their benefits coverage.

So are self-funded benefits nirvana? Not necessarily. But for the average employer, they open the door to a whole new way of thinking about benefits and how best to structure a plan that meets the needs of both employers and employees, while providing the flexibility needed to grow a successful company.

Robert J. Crowder is the president of Nelson B. Crowder & Associates Inc.

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