Medical Stop Loss Review

Healthcare reform, increasing costs and leveraged trends are causing many employers to reconsider their stop loss options. These include employers who are fully insured considering a move to self-insurance and current self-insured employers.

Healthcare reform together with a weak economy has led to many employers reviewing the cost of their medical insurance programs including funding alternatives. In many instances, the Accountable Care Act (ACA) is increasing employer costs providing further incentive for the employer to find savings.

Self-insurance with stop loss saves money through elimination of carrier premium taxes, improved cash flow as the employer holds on to the claim lag between date of service and date of payment, exemption from state mandates (though not from ACA mandates) and reduced administration fees as these are bifurcated from the claims costs.

As claim costs are not completely predictable, self-insured employers are usually able to budget fairly closely to actual costs through the purchase of a well-designed stop loss program. Claims unpredictability generally arises from variance in the number of large claims for any one claimant and the cost per large claim.

The purchase of specific stop loss insurance coverage protects from claims on any one individual exceeding a threshold amount, say $200,000, in a given year. Larger employers choose specific stop loss attachment points as high as $350,000 to $750,000 while smaller employers may choose stop loss levels of $30,000 to $100,000. An actuary can best recommend an appropriate attachment level to assure a small likelihood of claims exceeding a tolerable risk level, such as 110% or 125% of expected.

Stop loss rates typically increase well in excess of medical trend. So if your underlying program costs have gone up say 8% your stop loss costs are likely to go up well in excess, for example, 13%. The reason for this is the leveraging impact of the attachment point. This results from the fact that claims that were just under the attachment point in 2012 with regular medical trend will be over the attachment point in 2013 and these will be added to all the trended claims already over the attachment point. To counteract this, employers often regularly increase their attachment levels.

The most common stop loss terms cover claims on a paid basis. For self-insured first timers, moving from a fully insured program is typically 12/12 – incurred in 12 months and paid in 12 months. This first year is referred to as “immature” as there are fewer expected claims paid due to the claim lag. The second year “mature” terms might be 24/12 to cover the incurred claims run out from the first year. For an increased price, a terminal liability option may be offered, where upon termination, the employer can purchase additional protection to cover the remaining claim run out.

In the past, stop loss policies typically included a lifetime limit of $1-2 million. As employers can no longer limit their underlying plans it is important to have this lifetime limit removed from your stop loss policy if you have not already done so. Stop loss carriers may still look to impose annual limits. It is important that you make sure any annual limits coordinate with your underlying plan.

A crucial coverage for smaller employers is aggregate stop loss protection. The typical cost is $5.00 or less and protects against actual claims on amounts below the specific attachment point exceeding 125% of expected. Though the likelihood of hitting the aggregate attachment point is small, the cost for this sleep-well protection is cheap.

Aggregate stop loss should not be confused with another offering to lower price – an aggregating specific deductible. By way of example:

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Often the reinsurer will reduce premium one for one, or $100,000 in this example.

At time of purchase and annual renewal, most stop loss carriers ask for disclosure statements requiring the employer to disclose an adverse developing SMCe bid submission to the carrier. Typically they would like this about 30 to 45 days prior to the effective date. The disclosure statement asks for individual detail for potential large claimants based on past claim history, certain diagnosis, etc. If something adversely material shows up, the stop loss carrier may want to discuss options such as raising the price, putting in aggregating specific deductible or lasering (excluding certain individuals or using a higher deductible for certain individuals). Carriers willing to provide final rates earlier may build additional margin into their rates.

Typically, employers purchase stop loss on a single plan basis. Most coverage is purchased in the commercial market. Some employers purchase coverage from their owned captive reinsurer already providing insurance protections to other risks of the employer. This allows the captive to retain pricing risk margins.

As medical stop loss risk is generally uncorrelated to the remaining captive risk the overall employer risk profile is reduced through this approach. Furthermore, the stop loss program can be geared towards the needs of the employer including for example various risk sharing arrangements. The captive will typically purchase reinsurance protection to cover catastrophic claims and perhaps share in the claims risk. Generally carriers writing captive reinsurance protection are experts in this area and are not the usual direct stop loss writers.

More recently some like-minded employers are pooling together to create their own stop loss insurer to write the stop loss risk; thereby retaining stop loss pricing risk margins. The employer owned stop loss insurer purchases reinsurance protection as necessary.

Even more effective is when employers pool together for the purchase of administrative, network, medical management and wellness services. This not only creates administrative cost savings but also provides an opportunity to create wellness programs and plan designs best suited to like – minded employers assuring the health of their employees and their own wealth through lower claims costs. Typically, these groups can save 10% to 15%.

There are other alternative terms and provisions that may be included in your stop loss policy. These terms may vary between stop loss carriers. Now, with renewal season upon us, is a good time to review your policy.

Retiree Medical: Why Should I Prefund?

retiree medicalThe retiree medical marketplace is going through significant changes. For over a decade, employers have been addressing increasing healthcare costs for retirees by modifying or eliminating retiree medical benefits. Now, with the establishment of healthcare exchanges making insurance available for pre-65 retirees, as well as those eligible for Medicare, more employers are considering reducing or modifying benefits.

However, even with these changes, if an employer is still promising any benefit, they have a liability on their books and must decide to fund or not. While it may be tempting to leave the benefit unfunded, it can be cheaper in the long run to fund now.

A retiree welfare program is unusual in that it is a promise to provide future benefits, but it is not required to  be backed up with hard assets. The employer can choose to prefund, set aside assets in order to cover some part of future benefits, or follow a pay-as-you-go method, which involves only contributing funds for the current benefits of current retirees.* Given the lack of a requirement to prefund, why do some employers choose to use assets to prefund benefits?

To examine the question of prefunding, we must first fully exam ine what happens when an employee earns retiree welfare benefits. When an employee performs work for an employer, that employer immediately pays for it in the form of wages, health insurance, 401(k) contributions, and other benefits. Pension plans also require a cash contribution which is related to the employment during that year.

All of these involve the employer paying in the current year in return for the labor that the employee provides in that year. Retiree welfare benefits, however, only need to be funded with a promise. If the employer is using a pay-as-you-go method, the only cash required is for the current retirees, whose labor stopped benefiting the company long ago.

It may be easier to think about this situation in terms of a municipality rather than a corporation at first. If I live in a city that pays for retiree welfare benefits on a pay-as-you- go basis:

  • I should selfishly want my city government to offer lavish unfunded retiree benefits
  • The city will then hire lots of employees paying them with promises rather than my tax dollars
  • I will enjoy the benefits of quality garbage collection and police protection paid with promises
  • Before these promises come due, I will move to another city that made fewer promises, sticking the bill for the services I received onto the people who live there after me

Of course, I also have to hope that the generation before me did not figure out the same trick first. Although I say this is what someone should desire, we can probably agree this is not a good strategy in the grand scheme. Also, the fact that some local governments seem to have done this in reality does not make it a good idea.

To take the analogy to the corporate world, the payment of current labor with a promise rather than cash benefits the current stockholders at the expense of future stockholders. While the company currently pays an accounting cost on their profit & loss statement (P&L), the cash cost is deferred for decades.

If the company employs fewer people in the future due to increases in efficiency or decreases in the market, most of their labor cash costs adjust with the size of their labor force, but retiree medical payments do not. This company may find it hard to manage the smaller size if forced to pay for labor provided decades ago.

Retiree Medical

The discussion above is partially offset by the fact that a promise of retiree welfare benefits is not an unbreakable promise, in many cases these benefits can be cancelled at any time. However, in reality, many employers do not want to remove benefits for those in retirement or near retirement age. Additionally, we assume that the current benefit program represents the company’s expectation of future benefits, and it is appropriate to act on that expectation.

If the benefit is not prefunded, there is a large unfunded liability on the balance sheet representing the future obligations of the company. External analysts examine this liability when considering a company’s financial position. While some employers are planning changes to their retiree medical plan, including moving retirees to exchanges set up under healthcare reform, these changes do not remove the liability if the employer is still planning to make some form of payment.

Of course, funding retiree medical benefits in advance must benefit the company financially in order to be a viable option. Prefunding these benefits is generally cheaper than leaving it unfunded, due to the long term nature of the investments supporting the benefit. Spring can help a company examine the financial factors surrounding prefunding, including P&L benefits, as well as provide analysis of the most desirable funding vehicles, well known and rare, and their expenses, cash flow benefits, and tax management issues.

*The discussion in this article applies to most U.S. corporate employers. The situation described may vary depending on employer type (corporate, municipalities), bargaining status (Union/Non Union) and other situations (government contractors, public utilities, etc).