Group Insurance Funding Structures
Group Insurance
Funding Structures
What are the different funding structures for employee benefit plans?
There are many ways to structure your benefits program, financially speaking. But what’s the right way for you?
We are often asked about the different ways to fund a benefits program, and what is the ‘best’ way. The answer to this is not which is the ‘best’, but rather, what is the right funding structure for your particular organization.
If you’re unfamiliar with the term, a funding structure or pricing model is simply the way that the benefits administrator (typically an insurance carrier) applies their expenses to run your program, and it relates to the amount of ‘risk’ you take, as the plan sponsor.
But what is right for your company? There are a few key factors to consider including the size of your organization, demographic composition, industry, and the past claiming trends for your group. Another factor is simply your comfort level in assuming risk.
Here we break down the commonly used financial structures for benefit programs, some of their key features, and why it’s important to work with a trusted advisor to ensure you are implementing the best funding method for your organization.
Fully Insured Non-Refund Plan
A fully insured non-refund program, or a ‘traditional’ plan is the most common financial structure for a benefits program. The premiums are determined annually and remain in place for the renewal year. Under this set-up, premiums can increase or decrease depending on a range of factors.
For non-pooled benefits, the renewal rates are prospectively rated, meaning the goal is to have the renewal rates pay the anticipate claims plus the expenses of the plan, for the year ahead.
How does a renewal work with a fully-insured plan?
Pooled Benefits
For ‘pooled’ benefits (Life, AD&D, LTD, CI) claims do not impact pricing. Rather, the demographics of the group determine these rates; as the group shifts in composition, the rates adjust accordingly.
Experience-Rated Benefits
Pricing for experience-rated benefits (health, dental, Short-Term Disability) is determined each year based on the previous claims experience. Claims experience simply refers to the number of claims in dollars the insurance carrier paid to the members, based on the chosen plan design.
There are a number of additional factors that affect your pricing, which are summarized below:
- Inflationary Trend
Expected inflation (“Trend”) is applied, which is an estimate of the increase in the paid claims for the year ahead. Current industry inflationary trends are around 5%-8% for dental, and 10-17% for healthcare.
- Credibility
“Credibility” refers to the percentage of your group’s own claims experience applied to your renewal rates (in contrast to the experience of the insurer as a whole). Credibility is based on group size: the larger the group, the higher the percentage of credibility.
- Experience Weighting
Most insurers consider 2-3 years of claims when assessing pricing at renewal, with a heavier weighting typically applied for the most recent year.
- Target Loss Ratio
Each insured policy has a Target Loss Ratio (TLR), or break-even point, that the insurance company determines considering their expenses to run the program. The TLR is primarily based on the size of your group.
Determining the Program Renewal Rates
At the end of the renewal year, claims are compared to premiums, with the factors above included. The renewal rates are prospectively rated, meaning the intent is for them to cover the claims for the year ahead, including expenses.
If the Incurred Claims are above the Target Loss Ratio (TLR), the premiums are increased for the year ahead, in order to fund the anticipated claims. If the Incurred Claims are below the TLR, the premiums should reduce.
Pros
- Considered a “no risk” option; employers can terminate the program at any time without penalty.
- The rates are guaranteed for the renewal year and will not increase during this time even if claims are far above the Target Loss Ratio.
- Consistent, predictable monthly costs, for the renewal year.
- Available for any size of business.
Cons
- If claims are below the Target Loss Ratio, the cost savings are not realized until renewal
- Potentially higher administrative charges than other structures
Most SMEs operate using a traditional insured benefits program, and it’s often the only structure available to new groups or smaller organizations. In order to ensure you are in the loop on potential future rate increases, it’s important that your benefits advisor keeps you updated on the claims experience of your group. At Immix, part of our 7-Step Process is ensuring you are updated on claims. This allows you to plan ahead when it comes to your benefits costs.
How do you ensure you are not ‘over-paying’ for benefits with an insured plan?
Again, this is where a skilled and experienced benefits consultant is important. Benefits advisors understand the nuances involved in benefit program pricing, and they know how to analyze your program data to ensure your pricing is fair, based on the claims experience and demographics of your group.
When would a group consider moving away from a fully insured plan?
Refund Accounting or Administrative Services Only plans are alternative pricing models that make sense for certain groups.
At a certain size and level of claims stability, funding options become available, beyond a typical Fully-Insured Non-Refund plan. Many employers consider partially self-insuring their benefits program in order to potentially lower the insurance company’s administrative costs. Typically, this applies to health and dental claims, while other pooled benefits remain fully insured.
Administrative Services Only Plans
Administrative Services Only (ASO) plans leave the majority of the risk for claims with the employer; health and/or dental claims are self-insured with a fixed administrative charge paid on top of the claims that are incurred. Claims are still adjudicated by the insurer based on the employer’s plan design of choice.
In order to provide an element of insurance for potentially catastrophic claims (high drug claims or emergency travel claims for example), most ASO plans also include a per-person stop loss limit, which means claims above this dollar level are paid by the insurer (typically around $10-15K per employee). Pooling charges are included in the administrative fees in order to cover these potentially catastrophic claims.
How does a program renewal work with an ASO plan?
For the insured benefits (Life, AD&D, Disability, for example) the rates are adjusted based primarily on fluctuations to the demographics, just like with a regular insured plan.
For the self-insured benefits (usually health and dental) it works a bit differently.
Typically, most programs are set up with ‘deposit rates’ which essentially means pre-determined payments are made each month to (hopefully) cover the claims and admin. Based on the actual claims, the plan may be sitting in a deficit or a surplus, at any given time. When it’s time for the program renewal, the deposit rates may be increased or decreased depending on whether the plan has a deficit or a surplus.
Surplus’ can be withdrawn or reinvested into the plan, while deficits either need to be repaid as a lump sum or through higher rates. Some plan sponsors settle deficits more frequently, choosing not to have the plan accumulate a deficit.
For larger more established programs, claims are often paid in real time, meaning the plan sponsor pays for claims plus administration and pooling expenses, as they are incurred. While this of course means a fluctuating cost, for certain businesses, this is an appropriate arrangement.
Pros
- Pay for only what you use, with fixed administrative charges
- Potentially lower administrative charges than under fully insured plan
- Transparent, itemized cost breakdown
Cons
- Risk is with the employer (up to stop-loss level).
- Costs fluctuate as claims fluctuate meaning less cost certainty.
- At termination of the plan, employer owes insurer for outstanding dues.
Administrative Services Only (ASO) is often the arrangement of choice for large, stable organizations with predictable claiming patterns. Employers choosing this arrangement are comfortable with potential financial fluctuations and a certain level of risk, in order to potentially lower administration costs.
Generally speaking, these arrangements are appropriate when a company:
- Has very stable health and dental claims for several consecutive years
- Is very stable in overall size, with a consistent employee headcount of 100+ employees
- Has Extended Health and Dental claims over $150,000 annually
Keep in mind that while these are guidelines and situations vary; ASO could be appropriate for much smaller groups in certain situations.
Standard Refund Accounting
Some insurers offer Standard Refund Accounting, which falls between a fully insured program and a standard Administrative Services Only program on the risk spectrum.
Under this arrangement, surpluses are reinvested back into your program and/or refunded. In theory, this means you have the protection of an insured program, but you are provided the opportunity to directly share in the financial results, and potentially save money.
How does a program renewal work with Refund Accounting?
The renewal is calculated in nearly the same way as under an Insured Non-Refund plan, the primary difference being that expenses are specifically determined in advance and clearly itemized.
- Annually, the insurer compares premiums to claims, applies their expenses, and determines either a surplus or deficit
- A surplus is transferred to a Claims Fluctuation Reserve (CFR); the CFR is intended to pay potential future deficits
- When/if the CFR is fully funded (around 10-20% of annual premium), any excess surplus goes into a Refund Deposit Account (RDA)
- The Refund Deposit Account is available to be withdrawn at any time
- A deficit is paid off using the CFR or through increased renewal rates.
The renewal rates are determined used a similar methodology as an insured plan (they are prospectively rated, meaning the underwriters are producing rates they believe will cover the expected claims and expenses of the plan).
Pros
- Potential to ‘save your own money’ within your benefits program
- Typically, if a plan is terminated, there is no requirement to pay back a deficit
- Transparent, itemized cost breakdown, often with lower charges than a fully-insured program
Cons
- Groups must meet specific criteria to be offered this arrangement.
- Offered by limited insurers.
- Potentially higher rates due to base expenses in addition to CFR funding.
What is the right benefits funding method for your business?
Just like determining the right plan design should be done in collaboration with an experience benefits advisor, working with a qualified and experienced benefits consultant will help guide you in the right direction when it comes to ensuring the optimal financial set-up is implemented.
This means engaging in a thorough assessment of your program and business, rather than making assumptions. At Immix, our 7-Step Process (link) ensures we consider all factors, both qualitative and quantitatively speaking.
If you would like to discuss this aspect of your business in more detail, we are always happy to talk with you.
Any questions, please feel welcome to reach out to me at howard@immixgroup.ca.
Disclaimer: All organizations and groups are different and applicable strategies should be reviewed with a licensed benefits advisor to review your situation.
