Self-Insurance: A Fool's Bargain?
Self-insurance is a riskier option for small and medium-sized companies.
When your company's budget feels tight, you might start wondering whether your insurance expenses need to be as high as they are. If you could shave down your insurance spending, you could free up some much needed resources.
That's when you'll probably start considering self-insurance.
But is it really a smart idea, or just a fool's bargain? Let's answer that question by going over the basics of self-insurance and covering what you could gain from self-insuring – and what you could lose.
Your company can try to save money by deciding to offer its employees health insurance benefits without buying a group health insurance plan from an insurance company (see An Overview of Commercial Group Life and Health Plans to learn more about these policies).
Here's how it works. Instead of getting coverage through an insurer, your company sets aside the amount it would normally deduct from an employee's paycheck to pay for their health benefits. That money is deposited into a pooled account that is used to cover losses suffered by the employees.
This is a practice known as self-insurance.
The idea behind it is that insurance companies are a little bit like casinos: the house always wins. Insurers make a profit by charging a bit more in premiums than what it actually costs them to provide their services and pay out claims.
A company that self-insures will have to pay for all their employee's covered medical expenses, but it does so in the hope of holding on to that profit instead of handing it over to the insurance company (see Employee Benefits: What's in it for the Employer? for related reading).
What You Can Gain from Self-Insuring
The most obvious benefit to self-insurance is that it eliminates some of the costs associated with insurance. Employees may not realize it, but traditional insurance comes with some additional costs that are often invisible because they're lumped into the premium, such as various administrative fees. By being self-insured not only does the employee save, but the company itself also saves.
Administrative costs are just a start. Here are some of the other benefits that self-insurance brings.
Freedom to Tailor Plans
There is a wider array of options open to the self-insured than a limited health insurance plan.
An added benefit is that all steps are handled in-house, from enrollment to benefit payout, through a company-designated plan administrator.
Other Businesses Have No Impact on Your Coverage
Medical underwriters have developed a methodology that rated multiple groups of similar people and charged a level rate across the groups.
Because of the Employee Retirement Income and Security Act of 1974 (ERISA), self-insured plans are exempt from those group rates.
Avoiding Affordable Care Act Mandates
Under the Affordable Care Act, there are ten essential benefit categories that health insurance plans must cover. Self-insured plans, however, are exempt from this requirement. (The ACA requirement that the coverage must be affordable still applies, however.)
Avoiding Higher Premiums Due to Adverse Selection
Under the Affordable Care Act, insurance companies are required to accept all applicants, regardless of their health status and history. This drives up the premiums.
Under a self-insured plan, however, this adverse selection rate hike is no longer a factor, making the premium more affordable for the employees.
The Drawbacks of Self-Insurance
The savings and freedom are attractive, but being self-insured does have its downsides.
Some of them are in what health insurance providers like to call co-insurance and out-of-pocket maximums (see All the Ways You Pay: Premiums, Deductibles, Co-Pays, and Coinsurance to learn more). This leaves the insured paying beyond the limits they normally would have with regular health insurance.
Some of the other risks the employer faces with self-insurance include:
- Not having enough employees contributing to the plan during a weak economy, which can lead to not being able to pay out benefits for an employee's claim
- Dealing with multiple major medical events, which can deplete funds and leave the next claim unpaid
- Having a catastrophic event happen to even one employee can cause a lack of benefits for the next employee who needs to file a claim
- Breach of fiduciary duty through an improperly handled plan by an unqualified or lazy administrator (learn more in Fiduciary Liability: Do You Need Special Protection?)
There are ways to protect a self-insurance plan. Having stop-loss coverage can prevent a major crisis in funding when you have to pay out too many large claims.
Stop-loss coverage is an insurance policy that protects against claim expenses above a specific dollar amount or when funds are depleted in the pooled account.
These policies, however, are issued annually and are not guaranteed renewable, which means they run the risk of being canceled. In the end, even with stop-loss insurance, it's all a gamble.
Is Self-Insurance Worth the Risk?
Whether or not it's foolish to self-insure your employees will depend on your company.
The size of the company can be the deciding factor. If you have fewer than 100 employees, it might not be the best option (if that's the case, see A Guide to Group Health Insurance for Small Business Owners). A larger company with 100 or more employees contributing to the self-insurance scheme will create a larger pool of funds, which makes it less likely that they will be depleted.
Matching employee contributions to the fund can also help keep the plan secure even in the event of large claims.
In the end, there is no way to completely eliminate the risks. But if the gains are attractive enough, it's worth seriously considering self-insuring your company's health insurance plan.