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By GEORGE F. O'DONNELL, senior vice president at Aon Consulting and leader of its Benefit Funding Strategies consulting practice; and MICHAEL J. BERMAN, assistant vice president at Aon Consulting in the Health & Benefits consulting practice.

A self-funded healthcare benefits plan may afford numerous advantages, including no premium taxes, risk charges, or profit loadings, and an exemption from state mandated insurance benefits. However, these advantages come at the price of additional claim volatility. Unless the employer is large (i.e., greater than 20,000 employees), actual claims experience under the self-funded health benefit plan may deviate substantially from projected experience.

ACTIONABLE ANALYSIS

Enter "Actionable Analysis." Actionable Analysis is a process for developing realistic loss estimates and attaching statistical probabilities to those loss estimates. The results of Actionable Analysis provide an objective and rigorous framework for assessing the relative attractiveness of risk retention vs. risk transfer.

Actionable Analysis develops a model, member-level, aggregate claims distribution for the company's health benefits program based on the program's actual underlying claims data. Hypothetical member-level claims are derived through a computer-based simulation program, which is repeated thousands of times until sufficient data has been generated.These claims data sets are then analyzed to determine the appropriate "action" steps.

This claims distribution and the simulation data is described as "actionable" because of its relevance in a number of practical, and vital, risk management decisions. For example, based on this information, risk management can ascertain, within specified risk tolerances, whether the self-insured health plan's losses can be accommodated by the employer's capital resources. The risk manager can thereby assess whether the company is purchasing too much, or too little, stop-loss coverage at prevailing premium rates.

If the company's Actionable Analysis concludes that all, or a portion, of the health benefits risk should be retained, the company can then consider whether the retained risk should be insured through the company's captive insurer. The Actionable Analysis claims distributions can then also constitute the foundation of the stop-loss premium rates for the company's captive.

WHY A CAPTIVE?

When using a captive for stop-loss coverage, premiums are paid to the employer's captive, which issues a policy to the employer indemnifying it for large individual or aggregate medical claim risks.

Although tax planning should obviously not be the cornerstone of a sound risk management program, tax mitigation is certainly an appropriate consideration in selecting a risk-financing strategy. If a captive insurer is treated as an insurance company under Subchapter L of the Internal Revenue Code, then the captive can generally take tax deductions for its claim reserves. This tax treatment is more favorable than the usual tax treatment for a company's claims reserves; in the absence of a captive, claims can generally be deducted only when actually paid.

(It is true that a Voluntary Employees' Beneficiary Association trust, or "VEBA", can also be used to deduct claims reserves in advance of actual payment of claims; however, it can be more convenient to use an already-existing captive for this purpose.)

In addition, the accumulation of funds within a captive is generally exempt from state taxation.

It is relatively easy, from a regulatory/ compliance standpoint, to add medical stop-loss to an existing captive. Medical stop-loss is generally not regulated by ERISA, and therefore no advance approval from the U.S. Department of Labor is required. From a regulatory perspective, the addition of stop-loss to a captive is generally comparable to the addition of a new P/C line of coverage.

THE WHYS AND HOWS OF RETENTION

Of course, let's not get ahead of ourselves. The threshold issue is whether risk should be retained in the enterprise-controlled group, or, alternatively, shifted to commercial insurance markets.This decision should be consistent with the company's risk tolerance, and informed by Actionable Analysis.

The most straightforward method of retaining volatility risk is to not carry stop-loss insurance coverage. Although a financial accounting reserve is generally established for incurred but unpaid claims, no tax deduction may be taken for claims until they are actually paid.

Stop-loss insurers shoulder losses, either on an individual or aggregate basis, in excess of negotiated "attachment points." Premium pricing in this market can be volatile from year to year for a variety of reasons, including claims leveraging, uncertainty of network provider discounts, demographic changes and new plan designs.The attached grid illustrates the impact of claim leveraging.

An underlying claim trend of 10 percent, for instance, can increase stop-loss reimbursements by 30 percent.This "attachment point leveraging", as well as the other items noted above, can result in significant pricing volatility for commercial stop-loss.

COMMON GROUND FOR RISK MANAGEMENT AND HR

Risk managers can play a vital role in managing the risks of self-funded health benefit plans. through the application of an "actionable Analysis" framework. Unfortunately, however, the financial risks of self-funded health plans often fall through the cracks, with human resources viewing "risk" as the bailiwick of risk management, and risk management viewing "employee benefits" as residing with human resources.

When risk management and HR do not communicate and collaborate, the organization may end up assuming different levels of risk for exposures that may be similar in terms of the expected frequency and severity of claims.

(The article is for informational purposes only and not for the purpose of providing legal advice.)

March 1, 2010

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