By: HUB’s EB Compliance Team

As employers explore strategies for addressing health care costs, many consider level funded plans. Increased interest comes from both smaller employers looking for more flexibility in plan design or better rates than the small group market offers, as well as larger employers who use level funding as a steppingstone to traditional self-funding. While level funded plans often feel like a fully-insured plan to the employer, there are significant differences. Employers should understand these differences and how to avoid potential pitfalls.

What is Level Funding?

At its core, level funding (sometimes referred to as partial self-funding) involves the employer accepting more financial risk for claims than a fully insured plan. However, it provides more predictability and less financial risk than paying claims directly compared to a typical self-funded plan.

Under a level funded plan, a third-party administrator (“TPA”) actuarially determines a funding amount for the year based on the employer’s prior experience, just like a self-funded plan. The funding amount is paid as a set amount through a combination of employer and employee contributions to the TPA every month to cover expenses including claims, fixed costs (including administration and stop loss coverage), and administrative expenses. This regular, equal payment is why the product is called a “level” funded plan; in contrast with a self-funded plan where claim payments fluctuate and vary from month to month.

After the end of the year, the TPA compares the claims paid to the amount contributed by the employer. If the total claims, costs, and expenses are less than the employer’s contributions for the year, the employer gets a refund. However, if the total claims, costs, and expenses are more than the employer’s contributions, the stop loss coverage covers the shortfall. The greater financial predictability and lower dollar threshold makes level funding particularly attractive to smaller employers.

Potential Advantages of Level Funding

Level funding has two major strengths compared to traditional fully-insured plans. First, level funding may be financially attractive because it allows the employer to share in any potential refund due to positive claims experience. With a fully-insured plan, if the plan performs well, the carrier retains the upside.

Second, level funding allows for more plan design flexibility than fully-insured plans. This is because fully-insured plans are filed with state departments of insurance and are subject to state mandated coverage requirements. Level funded plans are generally considered self-funded for compliance purposes and thus are not subject to state mandates and do not have to be filed with the state. Note however that level funded plans do not have quite the level (no pun intended) of flexibility in plan design as self-funded plans.

Pitfalls

Employers looking at level funded plans are often accustomed to fully-insured plans. While a level funded plan may feel like a fully-insured plan since the monthly cost is level, there are important compliance differences (including ACA reporting) pitfalls that do not exist in the fully-insured space that employers should be aware of. Being aware of these potential pitfalls may help avoid unexpected surprises down the line.

Stop Loss Lasers

As previously mentioned, stop loss coverage is used to limit the downside risk for the employer. Without stop loss coverage, the employer could potentially share in any upside, but have to cover any downside should claims exceed projections. To protect the employer from having to do this, stop loss coverage will bridge any gap between the actual and budgeted claims. While employers with self-funded plans are likely familiar with stop loss coverage, those coming from fully-insured plans may not be.

Lasers are provisions in stop loss agreements that impose a higher deductible for specific individuals or groups of individuals. For example, the plan may have specific stop loss coverage with a deductible of $50,000. This means the plan is responsible for the first $50,000 in covered claims for a specific individual and the stop loss coverage reimburses claims greater than $50,000. For specific individuals who may be likely to reach the $50,000 deductible, the stop loss agreement may require a higher deductible, such as $200,000.

Since fully-insured plans do not have lasers, these can be surprising to some plan sponsors. Lasers can also vary from year to year. Thus, it is possible for a plan to be level funded for years before ever having a laser. Likewise, laser amounts can vary from year to year as the expected claims for an individual with a laser can also change. Plan sponsors need to make sure they are comfortable with the financial risk associated with lasers before implementing a level funded plan.

State Continuation Coverage

Employers considering level funding must also be aware that a change in funding will impact the availability of state continuation coverage. Medical plans are subject to COBRA if the employer employs 20 or more employees on a typical business day in the prior calendar year. This applies regardless of how the plan is funded.

State continuation coverage (when available) is similar to COBRA, in that it allows certain individuals who lose eligibility for employer sponsored coverage to continue coverage for a period of time. It often applies to employers who are under the employee threshold for being subject to COBRA, however state continuation only applies to fully-insured plans. Smaller employers to whom COBRA does not apply may be surprised to learn that moving to a level funded plan means state continuation is no longer applicable, and thus their plans cannot offer any type of continuation benefit.

Stop Loss – Terminal Liability

Stop loss coverage procured by a level funded plan may include terminal liability coverage (“TLO”) either as part of the policy, or as a separate rider. TLO provides additional coverage upon termination of the policy for claims that have been incurred during the policy term but reported after the term. These provisions exist due to the lag in time between when the claim is incurred and reported and paid. Without such coverage, employers may have gaps in which certain claims are not covered by the stop loss policy.

Although the stop loss agreement may include TLO coverage, sometimes this coverage may be subject to certain restrictions. Namely, these restrictions may limit the ability of the employer to move to another plan which is considered self-insured (including another level funded plan) and also keep the existing TLO coverage. Effectively, the TLO coverage may only be effective if the employer keeps the current level funded plan or moves to a fully-insured plan. Employers are urged to work with their counsel to understand.

Conclusion

While insured plans have limited risk to the employer as long as the premium is paid, self-funded plans including level funded plans have inherent differences. This article is designed to highlight certain pitfalls that employers with or considering level funded plans need to be aware of. These pitfalls may be brand new to those who are only familiar with fully-insured plans and should be considered as part of the decision to change plan funding. Knowing about these ahead of time can potentially avoid issues down the line.

If you have any questions, please contact your HUB Advisor. View more compliance articles in our Compliance Directory. 

NOTICE OF DISCLAIMER 

Neither Hub International Limited nor any of its affiliated companies is a law or accounting firm, and therefore they cannot provide legal or tax advice. The information herein is provided for general information only and is not intended to constitute legal or tax advice as to an organization’s or individual's specific circumstances. It is based on Hub International's understanding of the law as it exists on the date of this publication. Subsequent developments may result in this information becoming outdated or incorrect and Hub International does not have an obligation to update this information. You should consult an attorney, accountant, or other legal or tax professional regarding the application of the general information provided here to your organization’s specific situation in light of your or your organization’s particular needs.