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Fully Insured or Self Funded? by Brad Vernon

As a follow up to my last article, I thought I’d discuss the decision making process a group should go through when deciding whether or not to change its health benefits from a fully insured product to a self funded plan.  As I mentioned there are many reasons self funding saves money for most groups with the biggest one being the reduction in cost associated with transferring less of the risk associated with claims variability.  In other words, if you retain more of the risk and accept the variability in claims, your expected cost will be less.  There are other reasons to support self funding including increased plan flexibility and better claims data for use in wellness programs but most employers are going to focus primarily on the financial aspects.

So how does a group go about making this decision and how do they know how much additional risk they are taking on?  The simple method employed by many brokers and consultants is to show the employer the expected and maximum cost calculated by the reinsurance carrier.  There are a few problems I have with this method.  First, the reinsurance carrier is concerned with its risk not yours.  They are adequately pricing for the individual and aggregate stop loss that you are transferring to them.  Their concern is not a reasonable picture of the risk retained by the employer.  So there is going to be a slight bias towards conservative (high) estimates in the numbers produced by a reinsurance carrier.  This method also leaves little room for examining different potential programs as a reinsurer will quote you one or a few options and leave you to choose.  None of these might be the best fit for the employer’s risk tolerance but it is hard to know that if the options aren’t presented.

The method that I have used in the past, and that I now help brokers and consultants to provide to their employer clients, is a third party analysis of funding options.  This involves a review of historical claims to determine appropriate trend assumptions, modeling of large claims at the individual level, and modeling of aggregate claims retention by the employer.  Not only does this provide an unbiased estimate of expected and maximum cost under different self funding arrangement options, it also provides additional information including the probability of hitting the maximum cost and confidence intervals of where total cost will fall.  This type of analysis also provides for comparison to what the reinsurer says the cost should be and a basis to determine if their pricing is reasonable.  The analysis gives employers information on what it means to retain more risk and shows them the tradeoff in lower expected costs for increased claims volatility.  Then an employer can decide whether fully insured or self funding makes sense because they have a true picture of what exactly the differences are.

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