A Lesson in Self-Reliance

More and more small and midsize companies are looking to get off the insurance grid and cover their own employee health-care claims.

Want to save money on health-care insurance? Try this strategy: stop buying it.

While self-insurance is nothing new to large companies — some 90% of those with more than 5,000 employees have been doing it for years — a growing number of smaller companies are self-insuring to cut costs. According to data collected by PricewaterhouseCoopers, the percentage of employers with fewer than 1,000 people in their health-care programs that self-insure has almost doubled, from 29% in 2008 to 48% in 2010.

“In my view, self-insurance is a way for a company to save money, because you typically spend less on claims and reinsurance than you would on premiums,” says Ariann Lawhorn, human-resources manager for Mid-City Supply, a privately held wholesale distributor of plumbing and heating supplies in the Midwest. The 95-employee company (with a total of 250 people covered by insurance, including dependents) has been using self-insurance “on and off” since the mid-1980s, says Lawhorn, and during her entire six-year tenure with the firm.

Conventional wisdom has long held that self-insurance works best for larger populations, because the claims tend to be more consistent across bigger groups of people. The rule of thumb has been that it takes a minimum of 1,000 “covered lives,” or employees and their dependents, to make the strategy work.

Now, though, smaller companies are reevaluating this rule, in part because they want to take more control over rising health-care costs. “The reality is that companies with below 1,000 lives do experience more fluctuation [in cost] than [larger] ones,” says Michael Thompson, a principal in PwC’s human-resource services group, “but insurance companies don’t necessarily protect them any better, because they just base their rates on their past experience.” And while self-insured companies will still have to comply with the mandates of federal health-care reform, they may be able to avoid a layer of other regulations that fully insured companies face.

The basic principle of most self-insurance programs is this: the company agrees to pay for employees’ claims (minus whatever co-pay, co-insurance, or deductible is built into the arrangement) as they happen, rather than paying a preset, monthly per-employee premium to an insurance company. A self-insured company may still rely on an insurance carrier for some administration of the benefits, notes Thompson, and may also purchase stop-loss insurance through the carrier to cap its potential cash outflows. (Stop-loss insurance typically kicks in to cover claims above a certain amount, up to a preset limit.)

Among the immediate benefits of going the self-insurance route: avoiding state taxes on premiums that insurers pass along to clients, which run between 2% and 3% of premium costs; and avoiding certain state benefits mandates, which can add anywhere from 0.5% to 4% of premium costs, depending on the state. Using self-insurance also eliminates the profit and risk cushions that insurance companies build into their rates.

Companies that use self-insurance also tend to be wiser about plan design, Thompson says, looking harder for ways to control underlying medical costs. Mid-City, for example, has saved about 16% by creating higher co-insurance levels for using out-of-network providers, and another 10% by using a co-pay structure rather than a deductible with prescription benefits. Other progressive approaches include offering special incentives for employees to use medical facilities that have proven to excel in certain areas, and hiring company doctors.

Lawhorn says self-insurance is also a good way for companies to better target the benefits to participants. Her company, for example, covers some prescription drugs, such as growth hormones, that wouldn’t normally be covered by an insurance company.

Mid-City maintains some cash reserves to cover spikes in claims, and as a backup uses stop-loss insurance that kicks in both when an individual reaches a certain limit and when the aggregate volume of claims hits a larger limit. “We’ve never hit the aggregate limit, but it helps you sleep better at night knowing it’s there,” says Lawhorn.

Stop-loss insurance can be proportionately pricey for a small company, so some are looking at purchasing it as a consortium. The notion of a group stop-loss program is attractive to Jim Knutson, risk manager at Aircraft Gear Corp., a self-insuring car-parts maker in Illinois with about 100 employees and 300 covered people. “We have not had stop-loss for several years, but with new possibilities in the market, we expect to have it again soon,” he says.

To be sure, self-insurance does not completely shield a company from the ups and downs of medical-market trends. After five years of holding medical expenses flat, Lawhorn is expecting to see an increase of more than 25% in the coming year and following years, thanks to higher reinsurance rates and higher charges from health-care providers. “There’s so much uncertainty about health-care reform, [both insurers and providers] are trying to capture as much revenue as possible in the next four years [before the full impact of reform kicks in],” she says.

On average, stop-loss rate increases were “running in the upper teens to low 20s this spring” before adjustments that would somewhat lower the effective rates, says Carl Austin, assistant vice president at A.M. Best, which provides credit ratings for insurance companies. So far there’s “no firm evidence” that the increases will abate, although most carriers expect “the worst is over,” he adds.

Still, Lawhorn says, “I think self-insurance is the one thing that’s helping us, by allowing us to be more strategic with plan design and the cost-sharing structure.”

Occasionally, insurers will offer great deals to entice companies they deem as good risks back into their pools, says Thompson, something that can make switching an attractive option in the short term. Over the long run, though, self-funding will beat any deal insurers can offer, he says. “The question is, can the company absorb the risk in the short run?” says Thompson.

Which companies should not consider self-insurance? Those in industries where cash flows are scarce or unpredictable, for starters. Companies with big changes in the works, such as a major layoff or acquisition, should also refrain, since reshaping the employee group can change the cost dynamics.

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