Employers offering health insurance benefits to employees may do so through insurance plans purchased on behalf of the employees. Certain employers choose to self-fund the the coverage and pay claims directly without involving an insurer. An employer’s choice in selecting the appropriate plans depends on cost and operating strategies influenced by cash flow and risk. Fully insured plans do not present unexpected cash flow risks but also do not provide the potential cash flow advantages of self-funded programs that defer cash outlays.
Fully Insured Plans
A fully insured insurance plan is a straightforward insurance product purchased by the employer for the benefit of its employees. The employer is charged a specific insurance premium that it may in whole, or in part, pass along to the covered employee. Once the premium has been paid, the insurance company has an obligation to pay covered claims on behalf of the covered employee. The premium is set at the outset of the policy, and claims activity or, the lack of claims activity, does not affect the current premium.
An employer may elect to offer a self-funded plan wherein it agrees to pay all claims on behalf of the covered employees without benefit of insurance. The employee may not realize the difference as self-funded plans usually still require the management of claims by a third-party administrator, which is often an affiliate of an insurance company. The employer takes the risk of all claims and administrative expenses but does not pay any premium to an insurance company.
Hybrid Self-Funded Plans
Many employers with self-funded plans buy a certain level of insurance to protect against catastrophic claims expense. An employer with significant historical claim data may effectively predict its expected claims activity and choose to fund those losses for less than the cost of insurance premiums. To hedge against the uncertainty of risk, the employer may purchase a small amount of insurance for a lower premium to cover losses in excess of the expected claims.
Advantages and Disadvantages
The greatest advantage of fully insured plans is the lack of volatility and risk in claims expenses. The disadvantage is the upfront outlay of cash for premiums when claims may not materialize. Self-funded plans provide cash flow advantage to employers by deferring payments to only when claims are made and need to be paid. The sometimes unpredictable nature of claims activity presents a significant risk to employers in evaluating future expenses.