How Group Insurance is Funded

There are four ways of funding a benefits plan. They essentially fall along a continuum of risk and reward. Fully pooled benefits are the least risky as if your group has a catastrophic claim, it does not impact your premium at all. The downside is that you have no idea if you are getting good value as your premiums may be much higher than the claims you incur. Prospectively rated benefits plans are the most common, they involve an annual review of claims incurred and premiums paid. Premiums tend to track closely to claims incurred. Rates are more volatile than pooled plans but Prospectively funded plans are often less expensive in the long run. Retention Accounting is more commonly known as Refund Accounting, having lost favor with the insurance carriers Refund is currently only offered by a selective few carriers. Refund provides, in my opinion, the best possible arrangement from the clients perspective. Premiums are calculated similar to Prospectively rated groups, however, if claims are lower than predicted, a refund of the difference is paid to the group. More frequently the refund is help inside a trust account and used to smooth future rate fluctuations. ASO plans offer the most possible savings as there is no "cost of insurance" however, they trade potential savings for certain risk. Only very large groups should consider ASO funding. ASO also brings with it certain other possible problems such as cost sharing, pay roll deductions and the treatment of a surplus or deficit.


FULLY POOLED BENEFITS (Less than 10 members)

The policyholder pays whatever premium is charged by the insurer. The premiums are pooled among all of the policyholders for the insurer, and all claims and administrative expenses are taken out of the pool. All renewals are based on how the whole pool does, each policyholder has no control or input as to how the premiums are allocated. Cost-containment measures available to policyholders are to add deductibles, reduce reimbursement percentages by the insurer, or reduce or eliminate particular benefits. The advantage of fully-pooled plans is that they help spread of catastrophic claim for smaller policyholders. This disadvantage of fully-pooled plans is the lack of control over the allocation of premium dollars.

PARTIALLY-EXPERIENCE RATED BENEFITS (PROSPECTIVELY RATED) (10+ Members)

This method is a hybrid to the experience-rated policy and the fully-pooled plans. Insurers like these
policies because they can use the policyholder’s own experience to determine the renewal rates, yet they do not have to disclose the individual charges in which their premium dollars are used. Partially-experience rated plans can run up deficits, but should expect to face renewal increases to ensure future deficits do not occur. The advantage of the partial experience-rated plan is that the policyholder may run a deficit and terminate without financial repercussions. The disadvantage of the partial experience-rated plan is the limited information provided by the insurer. Although a break-even or target loss ratio is often provided to the policyholder, this does not reveal all of the charges being levied.

FULLY EXPERIENCE-RATED BENEFITS (RETENTION & NON-RETENTION ACCOUNTING) (100+ Members, or $100,000 in annual premium)
Under this method, the insurer works out each policyholder’s premium rating, based solely on the
policyholder’s own past experience for the benefit. At renewal, the insurer takes the paid premium for the year and then allocates various expenses against it. Apart from the actual utilization, there are claims paying charges, administration fees, taxes, insurer profit and agent/broker commissions. There are also requirements to fund reserves to pay for all of the outstanding claims that have not been submitted, or processed, and which must be paid by the insurer. There can also be a claims fluctuation reserve in which the insurer puts excess premium, if there is any. The advantage of the fully experience-rated plans is that all of the charges are fully disclosed. If retention accounting is used, the policyholder participates in the financial results of the group. This means that the policyholder owns both the surplus and deficit over the policy year. On a non-retention accounting basis, the policyholder would not participate in the financial results. The ideal policyholder for fully experienced-rated benefits is generating approximately $100,000 in annual claims, this will ensure that the utilization is “credible”. To protect against catastrophic claims by any individual plan member, the policyholder can purchase stop-loss protection from the insurer.

ADMINISTRATIVE SERVICES ONLY PLANS (ASO) (100+ Members or $100,000 in Annual Premium)

With this funding method, a policyholder pays an insurance company or third-party administrator to provide only certain services (i.e., adjudication, booklets, and wallet certificates). All charges are fully disclosed and negotiable. Stop-loss coverage can be purchased by the policyholder to reduce the risk of catastrophic claims by any individual plan member. The savings being generated may not be substantial in light of the additional resources required to provide the identical level of communication to the plan members, but the policyholder will never forfeit surplus premium. The advantage of the ASO funding method is the amount of control gained by the policyholder. The disadvantage of the ASO funding method is the potential risk of deficit funding. Dental Care can often be ASO funded at a lower level of approximately 25 members or $25,000 in premium. These lower levels are possible due to Dental Care claims being non-catastrophic in nature.

Funding explanations taken from Advocis Best Practice Manual.