Many small business owners continue to struggle in their search for health insurance solutions in order to remain competitive in the wake of the Affordable Care Act—which requires that larger employers provide comprehensive employee health insurance coverage, but also changes the way premium costs are determined for small business owners. 

Although many of these business owners are not strictly required to provide health coverage, failing to offer this important employee benefit can hinder a firm’s ability to retain crucial employee talent. The rising cost of health insurance premiums, however, can present a barrier to providing traditional group health coverage.

Fortunately, a method for self-funding health coverage has recently surged in popularity among small business owners—and for the right firm, the self-funding option can help employers mitigate the risk of rising health insurance premiums while continuing to assist employees with health coverage.

The Self-Funding Option

Self-funding health insurance is an option that has typically been reserved for the largest employers—those that are able to spread the risk of loss among a large pool of employees. However, the rising costs of traditional health insurance has motivated more small and mid-sized businesses to look to self-funding in order to manage risk and contain costs.

Under the Affordable Care Act, traditional health insurance providers no longer consider the individual medical risk profile of the employer’s group of employees when setting insurance rates. Instead, they use a type of community rating that considers factors such as age, location and tobacco use in order to set rates—resulting in increased premiums for many small business owners with healthy employees. 

The community rating system does not apply to self-funded health insurance plans, however, so that the rates can be determined based on the actual group of employees—potentially generating savings for small businesses with relatively healthy employees. Further, self-funded insurance generally allows an employer to gain more knowledge of its individual employees’ health care use, so that it does not simply see premiums rise from year to year with no explanation from the insurance company.

With self-funded insurance, the employer sets up a trust with a third party administrator (TPA), which administers the trust and coordinates with the insurance carrier to pay claims (in this way, employees receive a health insurance card from an insurance carrier so that they remain able to use the insurance with health care providers as they would with traditional health insurance). The employer collects employee contributions to the health plan and transfers the funds to the TPA.

Several variations on the self-funded health insurance plan exist.

For example, some employers may choose to switch to a high deductible health plan combined with a health reimbursement arrangement (HRA) that reimburses the employee for the difference between the lower and higher deductibles. In this case, the employer uses the HRA to self-fund a portion of its employees’ health coverage. Potential Risks

Because of the potential risks and costs associated with self-funded health insurance, the option is typically only a smart move for businesses with at least 25 employees—though the option has only recently begun to gain traction among small and mid-sized employers. A self-funded health plan carries fixed costs, such as fees paid to the TPA for administering the plan and any stop-loss insurance premiums.

Costs can also vary substantially from year to year with a self-funded plan, depending upon the health of the firm’s employees (while the cost of a traditional health insurance plan is fixed for the year, regardless of employee usage). Because of this, a small business considering self-funding should carefully examine both its stability and history in order to determine whether the option is appropriate.

Despite the risks, with self-funded plans, the employer typically purchases a stop-loss insurance policy that limits its risk exposure with respect to catastrophic health claims by one individual employee, as well as in the aggregate.  In this way, the employer’s liability is capped with respect to claims incurred by any one person, but it is also capped at a maximum amount that can be hit if many employees hit the individual cap.

Conclusion

While self-funded health insurance can help small business clients save considerably on employee health coverage costs, it is also risky. As a result, the client should be advised to carefully consider the potential risks associated with self-funding before making the choice.

See these additional blog postings by Professors Bloink and Byrnes:

Small Business Group Health Insurance: The Sequel

DOL Fiduciary: Outsourcing Offers Small Firms a Lifeboat

Originally published on Tax Facts Onlinethe premier resource providing practical, actionable and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.    

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