Self-funded vs Fully Insured - What's The Difference?

“Because the house always wins...”

- Danny Ocean, Ocean’s Eleven

If the deck is stacked, move to another table

Charlie Munger observed all human behavior is driven by incentives. Nothing is more true in healthcare than that simple observation. Insurance carriers are incentivized to take actions to limit their financial exposure, regardless of the impact to the end users. Fully insured employers are incentivized to limit year-over-year benefit expense increases. Hospitals and physicians are incentivized to capture ever increasing encounter volumes in parallel with reimbursement increases.

To break from this “virtuous” cycle of increasing costs and unhappy employees, many large employers are walking away from the fully insured health plan model and taking responsibility into their own hands.

These employers opt to take on the financial risk associated with health benefits offered employees in the hopes of reducing total annual benefit expense. These employers, typically with more than 200 employees, have the liquidity to pay incurred medical and pharmacy expenses on a monthly or bi-weekly basis. In exchange they benefit from flexibility to craft their health benefits in virtually any way they choose, avoiding the limited plan designs offered by commercial insurance carriers.

A self-funded approach can also be beneficial for companies with employees in multiple states, allowing them to offer a standard set of benefits in all locations. Offering employees a traditional fully insured benefit in each state often requires some variations in benefit designs to accommodate state level requirements.

But what is most interesting when comparing fully insured versus self-funded health insurance are the incentive shifts across the parties.

Fully insured – no risk/ no control

Fully insured large employers cede all financial risk to an insurance carrier in exchange for a monthly per member per month (PMPM) premium. The insurance carrier provides all administrative services required to fulfill the health plan, and pays all expenses associated with employee utilization. The average premium paid for large group health insurance in the Pacific Northwest in 2023 was about $500 PMPM. The specific premium varies by employer based on the benefit details, the provider network unit costs, and the demographics of the covered employees and dependents.

The primary incentive of fully insured employers is to control year-over-year total benefit cost increases. They do this by any combination of reducing benefits, increasing deductibles, passing on premium cost increases to their employees, or shifting to plans with narrower networks.

Insurers are incentivized by their financial interests to limit utilization, introducing friction into the system via prior authorizations, referral requirements, selectively narrow provider networks, and curated pharmacy formularies that limit covered drugs. The end result is often dissatisfied employees, and often frustrated employers.

Self-funded – employer skin in the game

Self-funded large employers take on the financial risk for all medical and pharmacy claims expenses, shifting their incentives in a fundamental and important way. These employers contract with a Third Party Administrator (TPA) to administer the health benefits offered to employees. The employers pay a fixed monthly Per Employee Per Month (PEPM) administration fee to the TPA, plus fund the cost of any claims incurred on a bi-weekly or monthly basis.

TPAs can be health insurance companies or independent, stand-alone plan administrators serving the self-funded market. These administrators may go by Managed Services Organization (MSO) or Administrative Services Only (ASO) – but in the end they are all basically TPAs.

No matter the name, TPAs provide the services required to administer the plan are provided in any combination of health insurance carrier, outside vendors, and pharmacy benefit managers (PBM). Employers work with a broker to request price proposals annually from multiple carriers and vendors seeking a combination for the coming year with the lowest total cost and best employee experience.

Self-funded employers limit their top end financial risk via stop loss insurance. This type of insurance sets a ceiling on total health plan benefit expense in total and at an individual employee level for the year. For example, a specific stop loss policy may have a $750,000 limit on health care expenses for any one employee during the plan year. Concurrent with that specific policy would be an aggregate stop loss policy limiting the total health care expenses for the entire employee population for the year to $2,000,000. Stop loss insurance is expensive and employers must balance the cost of the stop loss premium, and the dollar limits, with their appetite for risk.

In a fully insured model only the health insurance company is worried about limiting utilization and expenses. In a self-funded model, the employer has financial skin in the game and is incentivized to engage their employees in all kinds of health and wellness campaigns to target lower utilization, lower expenses, and indirectly better health.

This fundamental shift in incentives creates meaningful business opportunities for smaller and less traditional healthcare companies.

Self-funded employers typically offer additional “point solution” benefits to their health plans. These range from employee navigation to targeted chronic conditions programs to healthy activity challenges and more. Companies that offer a focused solution to common, costly health conditions are likely to gain traction in the self-funded space before they see adoption in the fully insured space. This is because in the fully insured space insurance companies focus is on controlling cost by limiting utilization, while in the self-funded space employers focus on avoiding costs by encouraging healthy activities.

Getting invited to the game

Self-funded employers renew and renegotiate their TPA agreements annually. This process is often 9-months or a year prior to the renewal data, which may fall any time during the calendar year. The renewal process often starts with a broker issuing a Request for Proposals to a handful of TPAs. The TPAs then prepare responses and presentations that include financial forecasts of what the employer will pay in the coming year for their services. The bulk of the expenses are pharmacy and medical claims costs, followed by the stop loss insurance premiums.

Brokers and self-funded employers are always looking for a new, cool “point solution” to offer their employees that will lead to lower utilization and expenses. This is where innovative companies that can prove their impact with data can gain traction.

Because self-funded employers have financial skin in the game, they are hungry to hear about new ideas that will shift the odds in their favor.

2itive 2024

2itive is a Portland based consultancy founded by Erik Goodfriend, offering a unique combination of market intelligence, knowledge of healthcare payment systems and creative business strategy insights. Feel free to contact us at info@2itive.com