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Self-funded health care (also known is self-funded insurance, self-insurance, or, more colloquially, self-funding) is a type of insurance coverage that is accomplished without the risk transfer by which traditional insurance is defined. Self-funded health care is a concept involving an employer providing certain benefits – generally health benefits or disability benefits – to its employees and funding claims from a specified pool of assets rather than through an insurance company, as the term is traditionally used. In self-funded health care, the employer ultimately retains the full risk of paying claims, in contrast to traditional insurance, where all risk is transferred to the insurer.

Health Plans
A self-funded health plan is generally established by an employer as its own legal entity, similar to a trust. The health plan has its own assets, which, under the Employee Retirement Income Security Act of 1974 (“ERISA”), must be segregated from the employer’s general assets. The health plan’s assets are derived from pre-tax (in most cases) contributions made by employees, and sometimes additional contributions made by the employer.

The contributions to the health plan’s assets are required to be immediately segregated from the employer’s general assets. Any claims incurred by plan members in excess of the amount contained within the health plan’s pool of assets are the sole responsibility of the employer. The employer, in that case, must deposit its own funds into the health plan’s trust account sufficiently to fund any outstanding claims liabilities.

Health plans that cover dependents as well as employees collect contributions for dependents from the employee’s payroll deductions. Similar to in traditional insurance, the plan sponsor determines the cost of health coverage and generally requires different payroll deductions depending on whether an employee elects self-only coverage, self plus spouse, self plus spouse plus child(ren), or certain other permutations as determined by the plan sponsor.

Self-funded health care allows some flexibility in structuring a benefit plan; some plans allow fewer options, for example only a choice between self-only coverage and full family coverage, with two contribution tiers.

Affordable Care Act
The Affordable Care Act has had huge ramifications on self-funded health plans; market reforms have invalidated many plan designs that were previously used, and now that employees are required to have health insurance and many employers are required to offer health benefits as well, the self-funded industry has enlarged.

ERISA
ERISA is a federal law that sets minimum standards for employee benefit plans, including pension plans and health benefit plans, in private industry within the United States. ERISA neither requires an employer to establish a pension plan, with few exceptions, nor dictates what benefits must be offered; instead, it requires that employers who establish plans meet certain minimum standards. The law is designed for the protection of plan participants, and to ensure a uniform statutory body of law regulating applicable benefit plans, throughout every jurisdiction in the country.

Plan Sponsor vs. Plan Administrator
There are two primary entities involved in the formation and administration of a health plan – the Plan Sponsor and the Plan Administrator. These terms are defined separately and the difference is important.

Plan Sponsor
The Plan Sponsor (also known as the “employer” or “group”) is the entity that sponsors, crafts, offers, maintains, and funds the plan. While Plan Administrator duties may be delegated to an entity other than the Employer, the law invariably requires that the Employer be considered the Plan Sponsor.

Plan Administrator
The plan administrator is the entity charged with general plan administration duties, similar to a trustee in the case of a trust. The plan administrator is always a plan fiduciary; the plan administrator can share the fiduciary duty with other entities, but the plan administrator is required to assume some fiduciary duty and cannot disclaim that duty. In general, the plan administrator is the employer – but new trends in the industry are seeing more and more groups outsourcing plan administrator duties to TPAs or other entities for a fee.

Employers that sponsor self-funded insurance plans often contract with a Third-Party Administrator (TPA), which is an entity that provides ministerial services on behalf of the health plan and the plan sponsor. Traditionally, TPAs do not make discretionary claims determinations; if a determination requires interpretation of the governing plan document, most TPAs do not make it but instead require the plan administrator to provide its own determination. This is because a fiduciary duty is incurred by any entity that exercises discretion over plan assets or in connection with making a binding determination under a health plan. According to ERISA, no matter which entity is identified as a fiduciary within the health plan, any entity will be considered a fiduciary if that entity acts as a fiduciary in a given case. Plan sponsors contract with their chosen TPA by means of an agreement known as an Administrative Services Agreement, which outlines the TPA’s duties, generally including administering payment for claims, issuing benefit determinations, and distributing documentation. This agreement generally contains provisions that provide for the TPA’s access to the employer’s claims funding bank account, and TPAs generally charge on a per-employee-per-month fee.

Contrast to Traditional Insurance
Traditional insurance is, in general, a way for individuals to manage the risk of their health care expenses. Individuals pay a set premium to an insurer, and in turn the insurer agrees to pay that person’s eligible healthcare claims. All risk transfers to the insurer; no matter how much is racked up in eligible claims, the insurer bears the risk of paying those claims and the insured can rest easy knowing that he or she will not be responsible.

In self-funded health care, plan sponsors have broad discretion to determine what terms will be used in the plan, as well as to decide which entities will have the authority to make benefits determinations, factual determinations, appeals determinations, and language interpretations. In traditional insurance, those responsibilities (and risks) are all borne by the insurer.

Part of every insurance premium is allocated to the payment of health claims, and part is allocated to profit for the insurance company. Profit generated by a traditional insurer comes directly from the policyholders, while a self-funded health plan is, or is funded by, a trust, and a trust cannot, by definition, be a for-profit entity.

Funding Mechanisms
Self-funding involves a transfer of risk from the employee and his/her dependents to the employer directly. Self-funded health plans pay health claims out of plan assets; there is no element of traditional insurance on these programs, and the employer assumes all additional liability for claims that have not been paid by plan (trust) assets. Some health plans have no plan assets; known as an unfunded plan, a plan with no assets is funded solely from the general corporate assets of the plan sponsor.

Plan assets can never inure to the benefit of the plan sponsor. Once funds become plan assets – whether through payroll deductions from employees or employer contributions to the plan – those assets invariably belong to the plan.

Stop-Loss Insurance
Stop-loss insurance is a form of reinsurance that insures self-funded plans and their assets.

Due to the limited assets at the disposal of an average employer as compared to an insurance company, an employer could easily bankrupt itself if its employees incur a large number of high-dollar claims and the employer is unable to fund them all. This risk is where the concept of stop-loss insurance comes into play. Fully insured policies have no use for stop-loss insurance, because while insurance companies assume all the risk of paying claims, they have a virtually unlimited pool of assets from which to garner the funds. Most employers, however, have a tangibly limited pool of assets.

As state legislatures become more and more hostile to self-funding, it has become apparent that one of the only ways state law can effect a self-funded plan that is immune to state law by virtue of ERISA preemption is through the health plan’s purchase of stop-loss. Many states have passed laws that attempt to regulate or limit the issuance of stop-loss insurance to certain groups, either by prohibiting the sale of stop-loss insurance to “small groups” or by setting a statutory minimum attachment point. A 2013 Kaiser Family Foundation study revealed that 59% of self-insured groups’ employees are members of plans that have purchased stop-loss insurance – but that statistic appears to be a function of groups responding to the self-funded witch hunt, and simply being hesitant to admit that they have stop-loss.

In a traditional fully insured health plan, the employer regularly pays a premium, which is a fixed rate for a given time period, and the covered employees pay a monthly contribution to the employer designed to partially offset the employer’s premium. In general, the premium does not change except in certain specific instances, such as, most commonly, a change in the number of covered employees. The insurer collects the premiums and pays the health care claims based on the benefits in the health insurance policy that was underwritten and purchased. The employees are responsible to pay any deductibles or co-payments required under the policy.

A self-funded plan has fixed components similar to an insurance premium; but to contrast, the self-funded plan pays the claims incurred by the plan participants, and the employer’s risk is not capped. Even with stop-loss insurance, the employer still retains one hundred percent of the risk of claims payments, in a purely self-funded scenario. Stop-loss insurance reimbursements are made if the claims costs exceed the catastrophic claims levels in the policy, but if a stop-loss carrier became defunct or simply breached the contract, there would be nothing alleviating the self-funded plan from responsibility for the full amount of claims.

State Regulation
While ERISA preempts some state laws that relate to self-funded employee benefit plans, ERISA does not regulate stop-loss insurance, since stop-loss insurance does not protect employees but instead protects a health plan itself or the employer.

Benefits and Risks
One of the main benefits of self-funding is that the group is able to customize the benefits it offers and tailor the plan to its employee base. With this in mind, the sponsor can craft plan provisions to cover certain benefits and exclude others as it sees fit. Less is sometimes more, a Plan which covers the services its employees will likely need and excludes the others will have much lower cost.

Another major benefit is that employee contributions are not increased to create profit. A percentage of all insurance premiums is allocated to pure profit – but with self-funding, employees pay a nominal amount for health benefits coverage and in general plan sponsors do not make a profit on self-funding. From the participant’s point of view, this is certainly a benefit.

As described above, employers that choose to sponsor a self-funded health benefits plan truly do so at their own risk. To be self-funded, the employer necessarily retains one hundred percent of the risk of the payment of the health benefits claims of plan participants. The practical effect of that is that many small groups simply cannot afford to self-fund; a common theory is that groups with too few employees are unable to collect a contribution sufficient to allow the employer to pay health benefits claims without bankrupting itself. While the practical solution to this is simply to charge a higher and higher contribution as necessary, both the Affordable Care Act and the general business considerations prevent raising the employee’s required contribution amount above a certain level.

Another major risk of self-funding is that the obligation to make claims determinations falls upon the Plan Administrator, which is most commonly the employer. While the employer’s chosen TPA pays or denies claims when the SPD is clear on how a given claim should be treated, dubious claims are referred to the Plan Administrator for final decision, because most ASAs specify that the TPA is not permitted to make claims determinations (which protects the TPA and Plan Administrator alike).

Sponsoring a self-funded plan has its risks, but it also has its rewards. While the group may incur unexpectedly catastrophic claims amounts, stop-loss is designed to mitigate those claims.

Size of Self-Funded Market
A recent study has reported that as of 2014, about 81% of workers covered by healthcare through an employer were in a partially or completely self-funded plan, which is up 21% since 1999. According to the Department of Health and Human Services, over 82% of employers with over 500 employees offer a self-funded health plan, and over 25% of firms with between 100 and 499 employees, and over 13% of employers with fewer than 100 employees also offer a self-funded health plan.

It is apparent from these statistics, and from the nature of self-funding, that it is easier to self-fund with a larger employee base; while it is true that a larger employee population involves the potential to incur more claims, larger employers simply have more money. To contrast, an employer with 50 employees can bankrupt itself fairly easily if one of those employees incurs catastrophic medical bills.

Co-ops
A Co-op is broadly defined as any type of benefit that is offered to employees in conjunction with other employers. The distinguishing aspect of a co-op is simply that it is not a single-employer plan; regardless of which employer employs a given individual enrolled in a co-op health plan, that employee’s health care costs under the plan are covered by the pooled assets of the co-op. Co-ops pool employer contributions from a large number of employers, and use those contributions to pay for the health care costs of all covered employees and their dependents.

The employers participating in a co-op generally agree on benefits that are offered across the board to all employees – although such an agreement is not necessary. For instance, the Department of Labor has indicated that benefits offered to different employees can differ even within the same plan as long as the difference isn’t based on a health factor; the DOL states that the permitted differentiation must be based on a “bona fide employment classification.” The plan participant’s employer is one of these bona fide employment classifications; the plan can contain separate schedules of benefits, exclusions, and other provisions depending on who the participant’s employer is. In practice, a co-op plan can act like separate plans for each employer, although jointly offered and funded.

Because of the nature of a co-op, it is not uncommon for the constituent employers of a co-op to create agreements among themselves to determine which employers pay for what. For instance, if a co-op is made up of three employers – one with two employees, one with seventy employees, and one with five hundred employees, the employers sometimes agree among themselves that the smallest employer will be reimbursed a certain percentage of what it has contributed if the claim was paid for an employee of the larger company. An outside arrangement like this has no effect on the actual governance of or provision of benefits by the co-op.

Co-ops can purchase stop-loss insurance like any other plan. The premiums would be paid pursuant to whatever arrangement the constituent groups created.

MEWAs
A Multiple Employer Welfare Arrangement, or MEWA, is a vehicle through which more than one employer can come together and offer a self-funded plan to employees – a type of co-op. MEWAs are useful for small groups that on their own would not be able to self-fund; for instance, a number of local small businesses, each with a dozen employees, can pool their assets, form a MEWA, and offer a self-funded plan as successfully as one company with the same number of total employees.

ERISA defines a MEWA as:

The term “multiple employer welfare arrangement” means an employee welfare benefit plan, or any other arrangement (other than an employee welfare benefit plan), which is established or maintained for the purpose of offering or providing any [welfare benefit] to the employees of two or more employers (including one or more self-employed individuals), or to their beneficiaries…

The definition goes on to except rural telephone and electric cooperatives, and any plan established or maintained pursuant to a collective bargaining agreement.

The benefits included as welfare plan benefits are broadly described and wide-ranging. Virtually any type of health, medical, sickness, or disability benefits will fall into this category, regardless of whether the benefits are offered pursuant to a written instrument or informally, funded or unfunded, offered on a routine or ad hoc basis, or limited to a single employee-participant.

If it is determined that qualifying benefit is being provided, a determination then must be made as to whether the benefit is being provided by a plan “established or maintained by an employer or by an employee organization, or by both.” For example, MEWAs provide medical and hospital benefits, but MEWAs generally are not established or maintained by either an employer or employee organization, and, for that reason, do not constitute ERISA-covered plans.

There are certain requirements of a MEWA, and many benefits; MEWAs are governed by state insurance law, rather than ERISA, regardless of whether the MEWA’s constituent groups would separately be governed by ERISA if they were to sponsor separate plans.

Section 514(b)(6)(A)(ii) of ERISA provides that in the case of an employee welfare benefit plan which is a MEWA, any law of any state which regulates insurance may apply to the extent not inconsistent with Title I of ERISA. Accordingly, if a MEWA is self-funded rather than fully-insured, the only limitation on the applicability of state insurance laws to the MEWA is that the law not be inconsistent with Title I of ERISA.

In general, a state law would be inconsistent with the provisions of Title I to the extent that compliance with such law would abridge an affirmative protection otherwise available to plan participants under Title I or would conflict with any provision of Title I, making compliance with ERISA impossible. For example, any state insurance law which would adversely affect a participant’s or beneficiary’s right to request or receive documents described in Title I of ERISA, or to pursue claims procedures established in accordance with Section 503 of ERISA, or to obtain and maintain continuation health coverage in accordance with Part 6 of ERISA would be viewed as inconsistent with the provisions of Title I. Similarly, a state insurance law that would require an ERISA-covered plan to make imprudent investments would be inconsistent with the provisions of Title I.

Conversely, a state insurance law generally will not be considered inconsistent with the provisions of Title I if it requires ERISA-covered plans constituting MEWAs to meet more stringent standards of conduct, or to provide more or greater protection to plan participants and beneficiaries than required by ERISA. The Department of Labor has expressed the view that any state insurance law which sets standards requiring the maintenance of specified levels of reserves and specified levels of contributions in order for a MEWA to be considered, under such law, able to pay benefits will generally not be considered inconsistent with the provisions of Title I. The Department of Labor also has expressed the view that a state law regulating insurance which requires a license or certificate of authority as a condition precedent or otherwise to transacting insurance business or which subjects persons who fail to comply with such requirements to taxation, fines and other civil penalties, would not in and of itself be considered inconsistent with the provisions of title I.

School Trusts
School trusts are MEWAs, but some states impose slightly different requirements upon MEWAs established solely by a group of public schools. It is unclear whether some states treat these particular MEWAs differently due to the government funding of the schools or the public interest served, but some states have lowered the enforcement or standards or other requirements for these MEWAs.

Captives
Rather than a co-op, as each of the previous sections has described, a captive is a subsidiary created to provide benefits to its parent company or companies – although when a captive is offered by more than one employer, the captive is a form of co-op. Captives present risk-management resources for employers who provide self-funded health plans to their respective employees. As is the case with all self-funding arrangements, when a self-funded health plan is offered by a captive, the captive, as opposed to any one particular employer, bears the risk.

In October 2006, the International Association of Insurance Supervisors published an “Issues Paper on the Regulation and Supervision of Captive Insurance Companies.” The Issues Paper defines a captive as:

an insurance or reinsurance entity created and owned, directly or indirectly, by one or more industrial, commercial or financial entities, the purpose of which is to provide insurance or reinsurance cover for risks of the entity or entities to which it belongs, or for entities connected to those entities and only a small part if any of its risk exposure is related to providing insurance or reinsurance to other parties.

Shock loss is the direct loss that is borne by a self-funding entity; if a self-funding entity has purchased stop-loss, amounts of shock loss that rise above an amount known as the specific deductible are covered by the applicable stop-loss policy. Under the captive model, the parent companies do not themselves offer health plans. Instead, the captive is the only entity offering, sponsoring, and maintaining the self-funded health plan. Accordingly, the captive bears the risk of shock-loss.

A captive increases the ability of a group to properly manage risk. Self-funding is simply not an option to some employers; in order to be able to efficiently fund shock losses from the general assets of the Plan Sponsor, members of a group must contribute enough to the Sponsor’s general assets, in the aggregate, that the Plan Sponsor is able to pay claims incurred by participants of the plan.