- Steve McEwan
Insurance for health, dental and vision, for the most part, is not true insurance
Most expenses are routine and not catastrophic expenses to the employee. For home insurance, we only insure items with high value that would cause financial hardship, not a toaster, for example. With group benefits, we have agreed on an arrangement that employers pay for employees’ routine health expenses, which is ok as it is a form of mutually agreed-upon compensation. If you have unlimited or very high drug coverage, that is true insurance and—not to be taken lightly—that’s fantastic insurance! For everything else in these categories, it is not insurance, even when you buy it from an insurance carrier. It is only a matter of who is funding the claims and when the funding arrangement gets re-calculated – let me break it down.
You have a benefit plan renewal every year, and it doesn't have to align with the calendar year. The goal for the renewal is to set a premium to cover claims for the next 12 months—an exercise in forecasting that insurers do. Once the premiums are set, the insurer takes these monthly payments from the employer and uses them to pay claims. The claims get paid as per the plan design, and then at the next renewal, the process reoccurs.
What happens at renewal:
There are experience rated benefits which include Health, Dental, and Vision. These, as the names suggest, are based on claims experience. Typical, non-experience benefits would be Life, ADD, and Long-Term Disability. Experience rated benefits will still make up the majority of your total benefit costs for now (see my predictions on LTD), so this is an important concept to understand.
Conceptually, most people understand what is done at renewal. How much did we pay in premiums vs what was paid out in claims? If you took out more than you paid, you expect to pay more. Not that simple? Let’s go a bit further.
Below is a graph of factors into the renewal process.
Claims Expense: This is the $ amount of claims incurred for the benefit reporting period—calculated as the Incurred Expense ratio.
Pooling Charges: This is the cost for the drug coverage. When you see unlimited drugs on a plan, that is an insurance product priced separately, and each group pays a premium to have coverage above X dollar amount (attachment level), which is typically $10,000. So, you pay to have this coverage. Without going too deep into it, perhaps a lack of transparency in the industry is causing this, as premium calculations are not shared with advisors to confirm if it is fair or not. So there are industry issues with carriers but a valuable product, nonetheless.
Trend: A weird name, but this is inflation for all the services and products covered. So, comparable to a consumer price index (CPI) used in economics, this is a similar concept applied specifically to health and dental costs. The problem with Trend is it is always very HIGH and much higher than CPI ever is—between 8-15% each year. I have never heard of or seen an insurer tell in detail how they come up with this percentage. To add to the suspicion, add in the insurers charge the same Trend which makes everyone question if this is not just another revenue stream.
IBNR: Incurred But Not Reported (IBNR) is just a fancy way of saying, “building a reserve of cash for when you cancel the plan, we will still be paying out claims and not collecting premiums, so we need excess cash up front.” I am not sure you need this as most companies will pay their bills, in my opinion. I always thought a better way would be to draft and sign a contract that states the employer agrees to fund claims incurred while benefits were in place. Then, you are not on the hook to build up cash in the insurers' bank account on the employer’s behalf.
Fees or Admin Charges: This pays the insurer and advisor their compensation, administer and make a profit. How much is charged? This is one of the most important things to understand to know what you pay with group insurance—it is based on the Target Loss Ratio (TLR). For many small businesses, it is typically around 75%. So, for every dollar collected, they will put $0.75 towards claims and $0.25 to pay for the administration of the plan. When they calculate what was paid in claims, (incurred loss ratio) and the TLR is 75% anything above TLR, one can expect their premiums to increase, but this is not the case as more factors discussed above increase the costs. A way to frame this is if their incurred claims ratio was 75% (claims were 75% of the premium collected) and their TLR is 75%, the renewal will still increase, in theory, because you have to add in IBNR + Trend + Pooling Charges. This scenario causes employers upset because they usually only think of a group in the simple premium vs claims scenario.
So, why Self-fund? Very simply, in theory, you can take out IBNR, Trend, and pay lower Fees to administer the plan. I did not take out pooling fees since you will most likely still need insurance for high-cost drugs. The industry calls these premiums; stop-loss premiums.
IBNR: You can build a reserve, but since the company is funding the claims and they will not cancel—so no need to have a built-up reserve for this specific need.
Trend: Since we do not know how it is calculated, it is removed. If someone wants to add their trend factor to help forecast expected claim costs, then it can be added at their discretion. Many will use something much lower than insurers, like <5% or match CPI.
Fees: The employer self-funding is taking responsibility to pay for the claims—so the fees to process claims are lower than 25%. This can vary in range, rarely above 10% and will include advisor payment, as well as claims processing.
Every client is different, and some may be a better fit with fully insured, but even when insured, you are still self-funding in a sense. As long as the client realizes this, I think it is important.
COO & Co-Founder