While stability is the goal, however, isk-taking is his means of shouldering health costs. Years ago, Cohen dropped the safety net of health coverage offered by Insurance companies. Instead, he started paying most of his employees' health-care claims out of company coffers—an approach called self-insuring, or self-funding.
Cohen, whose Arni's restaurants employ 220 workers, understood that he was gambling. If his employees' claims were low in a given year, his payouts would be less than the premiums he would have paid. But if several of his workers suffered major illnesses at the same time, he might face a cash-flow crunch.
Nevertheless, he knew he could never lose his shirt. He protected himself by buying special coverage called "stop-loss" insurance, which takes over the payment of claims that exceed a predetermined level.
For Cohen, self-insuring has paid off. While he doesn't have an exact figure, he says, in the 18 years since he began self-insuring, his company has saved tens of thousands of dollars compared with the costs of buying a standard health plan.
At the same time, self-insuring has enabled Cohen to tailor his plan to the needs of the 65 full-time employees who participate. He has added dental and vision benefits, and he has also established a wellness program aimed at helping workers who smoke to kick the habit.
"We feel like basically we're in charge," Cohen says, referring to types of health coverage offered to his employees. "It's like being our own boss. Decisions are ours to make, not an insurance company's."
Self-insuring is not always a positive experience for companies, however. Some small firms that have made the switch have seen their costs increase. Even at Arni's, two "disastrous years” of high claims in the mid-1980s left managers wondering if it had been wise for the company to go it alone, says Nancy Conners, the firm's office manager: "But we've learned that if you want to try it, it has to be a long-term commitment," she says. "You're kind of playing the averages."
Among small companies, Arni's was something of a pioneer when it made the switch in 1978. At that time, it was generally believed that the approach could work only in large companies, where the risk of high claims could be spread among hundreds or even thousands of employees.
Over the years since then, many other business owners have decided to self-insure. In fact, companies flocked to such plans during the past decade as health-care costs soared. Between 1985 and 1994, for example, employers' average cost of health and dental insurance per employee increased 85 percent, to $2,757, according to statistics compiled by the U.S. Chamber of Commerce. During the nearly identical period 1985 to 1995 employers who were selffunding their companies' health plans grew to 57 percent from 39 percent, according to broad-based surveys by Hay/Huggins, a Philadelphia-based benefits consulting firm.
While research focusing exclusively on small companies has been limited, it too shows a migration toward self-insurance. According to the U.S. Bureau of Labor Statistics, 28 percent of employees in 1990 who had medical benefits and worked at establishments with fewer than 100 workers were in self-funded plans. That share rose to 32 percent in 1992, the most recent year for which such figures are available.
“Employers, under the present scheme of health care in America, are the payers of most medical bills," says Carlton Harker, executive director of the Self-Funding Academy, a professional association based in Winston-Salem, N.C. "They realize that if they are going to pay the bills, they will want to have as much control over those bills as possible."
Although control is a powerful incen tive, self-insurance could not have flourished without the protective shield of the Employee Retirement Income Security Act of 1974. ERISA regulates private pension plans and also provides a federal regulatory framework for self-funded health plans.
ERISA's health-insurance provisions were intended to enable large companies operating in more than one state to create plans that would be uniform in all locations and not subject to a crazy quilt of state regulations. In effect, the law blocks states from regulating all self-insured plans, whether the company employs 10 workers at one site or 10,000 workers in several states.
By insulating selffunded plans against state regulation, ERISA has made those plans potentially less costly than insurance companies' plans for two reasons:
First, self-insured companies do not have to pay state insurance-premium taxes, typically 2 percent, or other state taxes to help cover the costs of the uninsured. These taxes are routinely applied to health plans sold by insurers. Second, self-insured plans are not subject to state laws requiring insurance carriers to include certain benefits in their plans. Many states have adopted such mandates, ranging from child immunizations and treatment for mental illness to hair transplants and coverage for herbal medicine.
Self-insured firms can also save in other ways. Insurers build a percentage into their premiums for paper handling. Firms that fund their own plans typically pay someone else to handle the paperwork at a lower cost.
Over time, the exemption from state taxes and benefit mandates and the savings on administrative costs can enable selfinsured firms to achieve average annual savings of about 5 percent-sometimes much more-over the cost of insurancecompany premiums, says Mike Carter, senior vice president of Hay/Huggins.
But just as important as cost savings is the ability to limit risks under a self-funded plan. Beginning in the mid-1970s, insurance companies began to offer stop-loss coverage. It comes in two forms. One is "aggregate" coverage, which places an overall cap on the amount of claims a company might pay in a given year and pays all of the costs above that cap. The second form is “specific" coverage, which pays claims exceeding a cap for each worker.
Self-insuring is not the best approach
for every employer, however. Many benefits consultants warn that once the number of employees covered by a plan drops below 50, it becomes hard to forecast annual claims costs. With fewer workers among whom to spread risks, some say, one or two illnesses can suddenly make a big difference.
All small firms should consider funding their own health-care plans only if they have strong assets and cash flow, says Steve Stucky, president of S.P. Stucky Co. Inc., a West Lafayette, Ind., firm that offers stop-loss underwriting and benefits consulting. "You need a lot of revenue and a lot of assets to back up the promises you're making to your employees and their dependents," he says.
The biggest mistake some employers make when they consider self-insuring, Carter says, is to focus entirely on the potential savings from a year of low claims, since they retain the unspent reserved funds. Instead, they need to see selffunding as a long-term strategy in which good and bad years should average out in the employer's favor. Also, they need to examine whether they can handle "maxing out”-handling the worst-case scenario.
In such a scenario, a company fails to set aside enough money to pay health claims up to the point at which stop-loss insurance kicks in. The stop-loss trigger for total claims is typically set at about 15 to 25 percent above the level of expected annual claims, benefits consultants say. The gap between the expected claims and the stoploss coverage is where a company is taking its financial risk.
"In any particular year, you could make out like a bandit, but you have to be able to tolerate the bad years," says Carter. It's quite possible that in a bad year the total costs incurred by a company will exceed what it would have paid if it had been fully insured, he says.
That's what happened to Herzog-Meier, a Beaverton, Ore., car dealership. It switched from an insured plan to a selffunded plan in 1989. In 1993 and 1994, major illnesses among several of the 115 covered employees drove costs higher than expected. In both years, the firm had not set aside enough money to pay all the claims, and it faced cash-flow problems when it had to dig into other funds to pay bills.
In 1994 alone, three unanticipated illnesses, plus many other small claims, required the company to spend $192,000, the point at which aggregate stop-loss coverage took over. Premiums for stop-loss coverage and payments to an outside administrator drove the cost of the firm's self-funded plan to $280,000 that year.
A risk broker helped the company's managers decide on a fully insured Blue Cross/Blue Shield plan last year that lowered the dealership's annual health-care costs to $190,000. Co-owner James Meier says the company is more comfortable being fully insured again, although, to help control costs, it has been forced to require employees to use only the services of a small network of medical providers.
Even when an employer switches to self-funding and saves money, there is no guarantee that the courts or lawmakers won't later weaken the potential advantages of the arrangement.
For example, last year the U.S. Supreme Court handed down a decision that appears to open the door for states to tax selfinsured health plans. In April 1995, the court ruled unanimously in New York Conference of Blue Cross and Blue Shield Plans et al vs. Travelers Insurance Co. that New York can place a surcharge on hospital bills paid by self-insured companies. The
court said the tax's economic impact on self-insured plans was indirect and therefore was not in conflict with the federal regulatory preemption under ERISA.
Many employment-law attorneys expect other states will try to tax self-funded plans. "I think everybody anticipates more legislative activity on the part of states and more litigation to clarify things," says Russell Greenblatt, a partner with the Chicago firm of Katten,
Muchin and Zavis. Meanwhile, health insurance reforms could move to the front burner on Capitol Hill this year. Among other things, some bills would make fully insured plans more attractive to small firms.
It's at the state level, however, that debate over whether to tighten regulation of self-funded plans is expected to play out in 1996.
In some states, regulators want to mandate the levels of stop-loss coverage that small companies must purchase to qualify as self-insured.
Small firms in some states buy stop-loss coverage that kicks in when claims from any one individual in a calendar year top $250 or $500, says David Randall, deputy superintendent of the Ohio Department of Insurance. As a result, he says, employers assume little financial risk while they avoid state regulation
Currently, 21 states have minimum levels at which stop-loss coverage can take over, and many more could set their own levels. Last year, the National Association of Insurance Commissioners (NAIC) drafted a model regulation stipulating that an employer would have to pay at least $20,000 per individual in claims before stop-loss coverage could pick up the rest.
Such a requirement could force C&W Underwriters Inc., an Alexandria, La., property and casualty insurance agency, to drop its self-funded plan and return to regular, insurer-provided coverage for its 14 employees.
In July 1994 the company switched to self-insurance largely because it could limit risk for any individual's illness at $5,000, says Frank James Campo, who co-owns the firm with his wife, Patti. Campo has multiple sclerosis, and several other employees have had costly conditions. Campo says he would not want to expose the company to $20,000 per individual in claims, as advocated by the NAIC.
If states raise their stop-loss requirements, Campo says, "a lot of small businesses will be out in the cold. It would be devastating to us."
Meanwhile, the market for commercial health-care insurance appears to be improving a bit, giving small employers more incentive to buy plans from insurance companies. Stiff competition among carriers and the increased use of managed-care networks of providers have helped hold down costs.
None of these developments, how ever, should necessarily deter a small company from considering self-insurance, says George Pantos, chief lobbyist for the Self-Insurance Institute of America, a Santa Ana, Calif., trade association that promotes self-funding. In particular, state efforts to regulate selffunded health plans are likely to face legal challenges, he says.
Before a small firm switches to selfinsurance, say health-coverage experts, it should take these steps:
Start With Objective Advice The first thing an employer must do is gather data that could help an outside analyst determine whether self-funding or fully insuring is the better approach, says Jim
Kinder, executive vice president of the Self-Insurance Institute of America. Key information, he says, includes a company's total annual health-care costs for the past two or three years, a list of benefits it hopes to offer, and the amount of money it could set aside each month for claims.
Next, go to a benefits consultant or an independent risk broker, who should be able to examine all the options objectively and make recommendations.
Be mindful that some risk brokers are paid commissions from insurance carriers and thus might be inclined to recommend full coverage, says Bret Connors, president of Connors and Associates, an independent risk brokerage in South Haven, Mich. The employer should at least know where a broker's affinities lie before taking any advice, he says. "You really need to find someone who will unequivocally look out for your interests."
Find An Outside Administrator Most companies contract with a third-party administrator (also called a TPA) or with an insurance company to handle routine claims paperwork. The relation ship with that outside administrator is crucial to the plan's success. Slow processing of claims can create headaches for an employer and for employees as well.
On the flip side, a TPA who is quick to act and is well-versed in the workings of a self-funded plan can greatly reduce an employer's involvement. Take the case of R.L. Dresser Inc., a self-funded Raleigh, N.C., company that installs acoustical ceiling and floor tiles. Shirley Irwin, the company's internal insurance administrator, simply collects employee claims and forwards them to her TPA firm.
The firm's staff processes them and resolves any disputes Irwin may have over charges from a provider. The outside firm has access to a special trust fund the company established as a reserve to pay provider bills, and the TPA writes checks from that fund to pay each claim.
The TPA also provides reports detailing where Dresser's health-care dollars are being spent and advises Irwin on changes to rein in costs. Among other things, the TPA steered her toward a managed-care network to help reduce expenses. "It's so important to us that we work well together with the TPA)," Irwin says. "They are very efficient." Examine Risk-Pooling In some instances, small companies can pool their risks, forming one much larger selffunded plan.
For example, about 600 employersmost of them small firms—are participating in a self-funded group plan in California through an Irvine-based agricultural association, the United Agribusiness League. Each employer pays a set fee each month into a trust fund established by the league, which offers participants a range of negotiated health-care services from providers.
Such plans, called multiple-employer wel fare arrangements, or MEWAs, were once more common, but their popularity has diminished. In the early 1980s, many small companies fell prey to poorly administered MEWAs that collapsed when premiums failed to keep up with claims.
In 1983, Congress amended ERISA to clarify that states can regulate MEWAs. Since then, some states—including Texas and California—have imposed restrictions. The new rules include requirements that rates for small firms fall within an established range. Under the pressure of heavy oversight, many MEWAs have gone out of business.
Bill Goodrich, president of the United Agribusiness League, says small employers who want to join self-funded MEWAs can take some precautions to ensure the plans are well-run. In particular, he says, a MEWA that is connected with a well-known trade association is most likely to be on the up and up.
In addition, MEWAs must file annual financial reports with the U.S. Department of Labor; the filings are on the public record and can provide a wealth of information about a plan's viability, he says.
Consider Stop-Loss Coverage When a company buys stop-loss coverage, an actuary first estimates the employer's likely claims expenses in the coming year. Aggregate stop-loss coverage the cap on total claims—is typically set by carriers at about 125 percent of anticipated claims.
For specific coverage, which caps expenditures on any individual, no consensus has emerged on how much an employer should spend before stop-loss kicks in. However, Carter of Hay/Huggins recommends that the individual stop-loss figure should not exceed 20 percent of the company's estimated total claims.
For instance, when estimated total claims come to $100,000, the individual stop-loss cap should be no more than $20,000. A company that must exceed that level to afford stop-loss insurance may not want to self-insure, says Carter.
Companies can negotiate two important provisions—in the form of riders-as additions to their stop-loss insurance policies, says William M. Bennett, executive vice president of VASA Brougher Inc., an Indianapolis-based provider of stop-loss insurance.
One provision, known as a "monthly accommodation rider" or a "monthly aggregate," protects an employer if there are a lot of high claims early in a year before enough money has been set aside to cover them. The stop-loss insurer will advance funds to cover the claims.
The other provision is a "terminal-liability rider.” It protects a company that switches back to being fully insured. It requires the stop-loss carrier to continue paying claims incurred before the switch but not filed by employees before the year ended. Decide How To Fund The Plan Under ERISA, an employer must keep all employee premiums paid to a self-insured plan in a fund, known as a 501(c)(9) trust because of the section of the federal tax code where the trust's rules are spelled out. While companies are not required to put their share of payments into the trust, many self-insurance experts advise that businesses do so.
Using this approach has several advantages. First, all contributions are taxdeductible, and there is no tax on interest that accrues, says Ron Woods, chief executive officer of Health Care Solutions Inc., a third-party administrator in Muskogee, Okla. Second, company managers are prevented from using the funds for other purposes, which protects the plan if the company falls upon hard financial times.
To fund the plan, many small companies simply divide their expected annual claims costs by 12 and make a monthly deposit into a trust. But Kinder of the Self-Insurance Institute suggests a more conservative approach. In a plan's first few years, he advises, a small firm should deposit enough money to cover claims as if they were expected to reach all the way to the level where aggregate stop-loss coverage would kick in. The employer would then be fully shielded from the unexpected, he points out, and would simply retain any unused funds for future use. Keep Employees Fully Informed When a company self-insures, workers may notice little if any difference. But that's no reason to keep employees on the sidelines.
Some small companies say that their workers reduce their use of unnecessary care once they are made aware that the company-not an outside insurance company-is paying the tab. In West Lafayette, employees at Arni's restaurants have also received some education about self-insuring-not only to make sure that they know the company is self-funded but also to assure them that the company is financially capable of paying claims. Cohen held an initial meeting with employees years ago to explain the concept, and workers get periodic updates about the plan in their paycheck envelopes.
The whole purpose of selfinsuring is simply to find a more-flexible and affordable way to offer workers health care in the first place, Cohen says. And such a plan can fulfill the purpose of attracting and retaining a reliable work force only when workers are confident that the bills will be paid.
"Health care is the most important benefit we offer-and the most expensive," Cohen says. And because healthcare benefits are also an imperative if a company is to be competitive, Cohen says he expects more small businesses will decide to self-insure.
Are You Ready To Self-Fund?
Carlton Harker, executive director of the Self-Funding Academy, a professional association based in Winston-Salem, N.C., says you're probably ready to selffund your health benefits if you can put a check in each of these seven boxes:
1. We have at least 50 employees among whom we can spread the risk of high claims, or otherwise feel we have the assets to withstand some unpredictability year-to-year for claims. We are financially able to withstand an occasional year when employee health-care claims may be higher than anticipated.
2. Our top managers are comfortable leaving behind the month-to-month cost stability of a fully insured plan and are prepared to withstand more volatility under a self-funded plan.
3. We want to self-fund because we are committed to the idea of being in greater control of our benefits offerings and their costs. Our motivation isn't simply to pick up some minimal savings that can come from being self-funded, such as escaping the state premium tax an insurer might charge us.
4. We have found trustworthy partners to help us handle the plan. These include a consultant or risk broker who can help us objectively examine whether to be self-funded or fully insured, an outside firm to handle administration of benefits, and a stop-loss-insurance carrier who can sell us affordable coverage.
5. We have purchased stop-loss coverage to insure us against the years when we will have a high level of unanticipated claims. We have coverage against losses stemming from any one person's illness, known as "specific" coverage, as well as "aggregate" coverage, which protects us against an overall level of annual claims that is higher than anticipated.
6. We are aware that we have many options under our plan. We know that we can pay the company's share of employee health claims as they come in, or we can set aside a fixed amount each month in a trust fund. We also know that under a self-funded plan, we may direct employees to use a managed-care network of doctors and hospitals, or let them choose any health care provider.
7. We have thought through any concerns our workers might have about self-funding. We are ready to explain the change to them thoroughly and to an swer any questions they may have. If we have a union, we have met any contractual obligations we have to involve the union in the process.
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