Why Smaller Employers Will Shift to Self-Funding; Who Wins and Loses

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Richard Evans / Scott Hinds / Ryan Baum


203.901.1631 /.1632 / .1627

https://twitter.com/images/resources/twitter-bird-blue-on-white.png revans@/shinds@/rbaum@ssrllc.com


April 29, 2013

Why Smaller Employers Will Shift to Self-Funding; Who Wins and Loses

  • Affordable Care Act (ACA) provisions stand to increase smaller ( 100 employee) employers’ premium costs by 20 percent or more in 2014, before accounting for medical trend (+/- 6 pct)
  • The ACA provisions driving the premium increase for smaller employers (e.g. community rating, minimum essential benefits, excise tax on premiums) can be entirely avoided by shifting from fully-insured coverage to self-funding – self-funded plans are exempt from these ACA provisions.
  • We show that because of ACA, the average small employers’ cost of self-funding is on par with, or cheaper than, continuing with fully-insured coverage. For employers with healthier than average employees, self-funding may be far cheaper than fully-insured coverage; stop-loss premiums paid by self-funding employers can still vary according to the health of employees, where fully-insured premiums cannot
  • As an added motive, employers no longer face the risk of sharp increases in stop-loss premiums in a year following large self-funded claims – because they now have the option of reverting to the exchange for fully-insured, community-rated coverage if and when their employees’ claims rise
  • Roughly 40 pct of fully-insured commercial lives are sponsored by employers with 100 employees (Exhibit 4, pg. 4); we expect many of these lives will shift to self-funded plans. CVH is most negatively affected with more than 10 pct of members in small group risk plans; CI is least negatively affected with less than 0.1 pct of members in small group risk (Exhibit 5, pg. 5)
  • CI and UNH are best positioned to benefit from expansion of self-funding among smaller employers; both have relatively large shares of the ASO (administrative services only) service market for smaller employers (Exhibit 6, pg. 6), as well as the market for medical stop-loss insurance (Exhibit 7, pg. 7)
  • Taking all moving parts into account (decline in fully-insured, rise in ASO and stop-loss) CI is by far the best positioned and is a clear beneficiary (no meaningful small group risk exposure; strong presence in ASO and stop-loss); CVH is by far the least well positioned and stands to be negatively affected (relatively large exposure in small group risk; little or no exposure in ASO or medical stop-loss)

Beginning in 2014, the Affordable Care Act (ACA) subjects small employers’ (100 or fewer employees) fully-insured health plans to various small group market reforms, whether or not these plans are purchased through the state exchanges. These provisions stand to inflate smaller employers’ premiums for fully-insured coverage by 20 to 30 percent, before accounting for the underlying increase in medical trend (+/- 6 pct)

Using Milliman USA’s analysis of individual premiums in the California market[1], we can get a rough approximation of ACA impacts on small group premiums. Milliman estimates a +/- 14 pct increase in average individual premiums as the result of ‘ACA market changes’, such as limits on medical underwriting, compression of premium bands[2], and higher taxes and fees; and, a 17 pct increase in individual premiums as a consequence of the average beneficiary purchasing more coverage[3]. Taken together, these effects might raise average individual premiums (in the California market) by a bit more than 30 pct (Exhibit 1). To estimate potential ACA effects on small group premiums, if we eliminate the estimated 11.5 pct impact of beneficiaries buying higher average AVs[4], the remaining inflationary effects (ACA market changes, increases attributable to the minimum essential health benefits standard) would increase smaller employers’ premiums for fully-insured coverage by roughly 20 pct

Arbitrage #1: Risk Off, Risk On

Small employers can avoid the ACA’s coverage provisions by self-funding, and we expect many will

If a hypothetical small employer had intended to deliver ‘pre-ACA’ coverage for underlying medical costs of $100; ‘post-ACA’ the employer now has to provide coverage that funds underlying medical costs of $120. At an assumed MLR of 90, her costs are $133; at an assumed MLR of 85 her costs are $141 (Exhibit 2)

By self-insuring, the small employer can avoid the ACA’s small group reforms entirely[5], eliminating the associated 20 pct jump in underlying medical costs. Assuming she provides a benefit that covers the originally intended ‘pre-ACA’ underlying medical costs of $100, she can afford to pay a 7 pct (of claims cost) ASO[6] service fee[7], purchase individual stop-loss coverage of roughly $50,000 per contract (employee) at $25 / $100 of (expected) claims costs[8], and purchase aggregate stop-loss coverage limiting her liability to 125 pct of expected claims cost for about $1 per $100 of expected claims[9]. All in, her costs to fund $100 of underlying ‘baseline’ or ‘pre-ACA’ medical costs is $133 (Exhibit 2, again) – on par with, or slightly below, her costs of continuing on a fully-insured basis and falling subject to the ACA’s small group provisions. It’s a least a push, and probably a savings, which implies an expansion of self-funded (and contraction of fully-insured) plans in the smaller employee market


Arbitrage # 2: I’ve got it! I’ve got it! …. I don’t got it!!!

If the hypothetical employer’s employees have better than average health risks, she can almost certainly save even more by self-funding – since her stop-loss rates will be lower than the market average (self-funded plans are not subject to the ACA’s premium bands or medical underwriting restrictions). And, where self-funding historically was a potential trap (employers might be unable to find either affordable fully-insured coverage or affordable stop-loss coverage after experiencing large claims), employers with better risks can enjoy the lower prices in the self-funded market until and unless they experience large claims – at which point they can revert to the fully-insured market and enjoy the benefits of community rating. Smaller employers with younger and healthier employees are even more likely to self-fund than employers with older and/or less healthy employees, with obvious implications for adverse selection in post-ACA small group markets

In terms of beneficiaries, small employers are 40 pct of the fully-insured market – so if they shift to self-funding …

Very few smaller employers self-fund in the current market (Exhibit 3); as a result a very large proportion of total ‘full-risk’ lives are in smaller firms – we estimate just over 40 pct of full-risk beneficiaries are in firms with 100 or fewer employees (Exhibit 4)

Who Wins, Who Loses?

If more small employers self-fund, demand for ASO services and stop-loss coverage rises; correspondingly demand for fully-insured coverage falls. Of the larger publicly-traded insurers, Coventry (CVH) appears to have the most to lose, being the most exposed to the small group risk market. Being least exposed to small group risk, Cigna (CI) has the least to lose from a shift to self-funding (Exhibit 5). Conversely, CI is among the best positioned to exploit growth in small group demand for ASO services and stop-loss coverage. The market for ASO services in the ≤ 100 employee market is difficult if not impossible to characterize directly; however because self-funded firms above this number of employees are required to file Federal Form 5500, and at least some firms at or below 100 employees file this form, we estimated small employer ASO market shares by analyzing Form 5500’s for all firms with 250 or fewer employees. The results are in Exhibit 6; UNH, WLP, AET, and CI are the largest providers, with market shares ranging from +/- 4.5 pct (CI) to +/- 8.1 pct (UNH). Of the larger publicly-traded insurers only CI and UNH appear[10] to have significant presence in stop-loss; we estimate a 23 pct share of this market (across employers of all sizes) for CI, v. 11 pct for UNH (Exhibit 7)

CI is plainly a beneficiary of a shift to self-funding in the small group markets, and CVH would plainly lose from such a shift. Other names fall between these extremes; here we try to sort them broadly into win, lose, or draw – and we admit the distinction between lose and draw is subjective and highly dependent on how well firms execute in an expanding small group ASO / stop-loss market:


  • Cigna (CI) – very little small group fully-insured exposure; market leader in both the ASO service and stop-loss markets


  • United Healthcare (UNH) – 2.4 pct of members are in small group risk; however UNH can offset these losses by virtue of its leadership positions in both the ASO and stop-loss markets
  • WellPoint (WLP) – 3.1 pct of members are in small group risk; market share leader in ASO services but does not appear to have a significant presence in medical stop-loss
  • Humana (HUM) – 1.5 pct of members are in small group risk; minor presence in ASO services but does not appear to have a significant presence in medical stop-loss


  • Coventry (CVH) – 10.5 pct of members are in small group risk; apparently no offsetting ASO or stop-loss presence
  • Health Net (HNT) – 6.0 pct of members are in small group risk; apparently no offsetting ASO or stop-loss presence
  • Aetna (AET) – 5.7 pct of members are in small group risk. Market leader in ASO services, but appears to have a relatively minor share of the medical stop loss market

You Can Have it Both Ways …

A potential shift to self-funding by smaller employers is one of several shifts either driven or catalyzed by ACA; another major potential shift is that of employer-sponsored insurance to private exchanges[11]. We want to stress that these two shifts are not mutually exclusive – contrary to the conventional wisdom (and intuition) it is entirely feasible for private exchanges to sell self-funded coverage to employer sponsors. One example is Mercer Health Advantage. Part of the “Mercer Exchange Suite”, Mercer Health Advantage offers a private health exchange to self-funded employers with 3,000 or more employees, and plans to extend this option to smaller employers in subsequent benefit years

  1. Milliman USA, “Factors Affecting Individual Premium Rates in 2014”, March 28, 2013. We very much appreciate the risks involved in extrapolating from individual to small group, and from California to the nation as a whole; however in the absence of data precisely addressing small groups at a national level, we think the Milliman numbers on the California individual market very clearly identify the key moving parts of ACA-related premium inflation, and give us at least rough guidelines for how large these effects may be for small employers nationally
  2. E.g. the ACA sets a maximum 3:1 band for age-based premium adjustments, as compared to the prevailing 5:1
  3. E.g. typical plans become more generous to meet the ACA’s essential health benefits provisions; and, typical beneficiaries buy more coverage to cross the minimum essential coverage threshold, and/or as the result of subsidies lowering their out-of-pocket premium costs
  4. We’re assuming small group coverage is on average more generous than current individual coverage; and, that subsidies may drive average AVs higher in the 2013 individual market, but will not have this effect in the small group market
  5. Under Section 1301(b)(1)(B) of the ACA, plans exempt from state regulation under Section 514 of the Employee Retirement and Income Security Act (ERISA) of 1974 are exempt from the ACA’s small group provisions
  6. An ASO, or “administrative services organization”, offers access to provider networks and related administrative services for self-funded providers, but does not assume risk for medical costs
  7. We compared ASO service fees to ASO beneficiaries using the publicly-traded ASO managers’ SEC filings; ASO fees as a percentage of underlying claims costs range from about 6 to 8 pct
  8. Using market data from Aegis Risk, we estimate monthly per-employee fees of $150 for individual stop-loss coverage of $50,000. Using figures from Milliman USA and the Kaiser/HRET Employer Health Benefits Annual Survey, we estimate average contract size (beneficiaries per employee covered) of 1.94, and average medical costs per contract of $7,132. ($150/month × 12 months) / $7,132 = 25.2 pct
  9. Again relying on Aegis Risk, Milliman USA, and Kaiser/HRET, a $6 / month per employee premium covers an aggregate stop loss policy at 125 pct of expected claims costs; this translates to just less than 1 pct of annual expected costs
  10. The data in Exhibit 7 cover about 87 pct of the total medical stop loss market; we cannot rule out that companies other than CI and UNH may have significant shares of this ‘invisible’ 13 pct, and so may have non-trivial shares of the medical stop loss market
  11. “Private Health Exchanges: Why They’re Coming; What They Mean”, SSR Health llc, April 2, 2013
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