As all the high-profile political wrangling continues, one fact will undoubtedly remain unchanged: Health insurance in the United States will stay overwhelmingly employer-based. In 2014, over half the U.S. non-elderly population was covered by employer-sponsored health insurance; 92 percent of firms with more than 50 employees offer health insurance benefits to their employees.
90 percent of employers are facing health plan premium increases, and nearly a quarter are seeing double-digit increases. According to the Kaiser Family Foundation 2016 Employer Health Benefits Survey, annual premiums for employer-sponsored family health coverage reached $18,142 in 2016, with employees paying an average of $5,277.nd for many years, the cost of doing so has been increasing inexorably. According to a recent survey,
According to the Centers for Medicare & Medicaid Services (CMS), private business shoulders about 20 percent of America’s total annual health care bill, which reached $3.2 trillion in 2015. That means the employer’s share was roughly $640 billion, directly impacting expenses, wages and, ultimately, shareholder value.
Self-Funding vs Fully Insured
Clearly, the U.S. employer’s share of healthcare costs is not trivial; neither is it optional. By far, it is the most valued fringe benefit for employees, helping businesses attract and retain the best talent. Not offering health insurance benefits to full-time employees would place most businesses, large and small, in an untenable competitive position.
However, when an employer purchases a plan for its employees from a large insurer, not all the money it spends with the insurer goes to medical care, e.g., hospitals, doctors and other healthcare providers. A percentage goes to the insurer’s administrative expenses, marketing costs, enrollment activities, billing processes, customer service, and on and on. The difference between what insurers collect from businesses, and what’s left over after they subtract those costs and payments to providers, is the insurers’ margin, the profit that keeps the insurer and its shareholders (if it’s a public company) in business.
And business, for the most part, has been good.
For example, the nation’s largest health insurer, UnitedHealth Group, reported 18 percent year-over-year revenue growth in 2016, with adjusted net income (profit) up 24 percent. Kaiser Permanente, the nation’s second largest insurer, grew its adjusted net income to $3.1 billion in 2016, up from $1.9 billion the year before.
There are a host of factors contributing to these premium increases for employers (and therefore employees paying a larger share of premiums, often with higher deductibles), but the net effect is to make it increasingly common for large and midsize employers – those with the scale and resources to do so – to consider self-insurance. Today, self-insurance represents almost half of employer-based healthcare spending. Self-insurance (or self-funding) means that employers work directly with healthcare systems and providers to negotiate and develop robust, more affordable plans targeted specifically to their employees’ medical needs and financial resources. Improved plans can be used to attract better talent (sometimes at lower salaries, as potential employees may trade higher pay for more attractive benefits packages), and take a bite out of the healthcare line item on a business’ labor budget, which many CEOs are now saying is their single largest.
However, a self-funded healthcare benefits strategy can only be successful if girded by a comprehensive understanding of the employer’s employee base, achieved through analytics and population modeling, that enables stratification and supports the correct calibration of investments, contracts and coverage.
Self-Funding: The Strategic Advantage
In a nutshell, self-funding gives control to the sponsor: the employer. Many regulatory requirements do not apply to self-funded plans, which increases design flexibility. Self-funding allows employers to tailor plans specifically to the needs of their workforce by contracting directly with those providers best-suited to care for them. And rather than paying an insurance company, the money the employer and employees contribute to the healthcare fund maximizes the employer’s interest income, improving its cash flow as it is not pre-paying for its employees’ coverage (and the insurance company’s overhead).
In a self-funded (or self-insured) plan, an employer assumes the financial risk for providing healthcare benefits to its employees, paying claims as they arise instead of paying a fixed premium to an insurer, as they would in a fully insured plan. Of course, the choice whether to self-fund is a risk-reward decision, as the employer is assuming risks in a self-funded plan that otherwise would be assumed by an insurer. To mitigate those risks, and to be sure that it they can pay for needed care and their employees can afford it, employers must:
- Determine a benefit strategy consistent with their risk appetite
- Assess and evaluate plan rationalization opportunities
- Develop plans that will be attractive to their employees
- Negotiate price and contracts with optimal provider systems and networks
- Implement, govern, communicate and coordinate their benefits program
Companies contemplating creating a self-funded healthcare benefits plan need to engage third-party expertise and management capabilities to develop and administer processes such as plan development, financing and risk management, claims administration, healthcare management, and employee education and outreach.
Self-Insurance in Action
Let’s imagine a representative firm: Hedge & Hold, a private equity firm. Its business strategy is to buy undervalued firms, improve their financials through cost rationalization and sell them within three to five years.
At present, H&H’s portfolio consists of five standalone firms operating independently, with a total employee base of 10,000. Before H&H acquired them, each firm had its own traditional, fully funded plan with an insurer. H&H believes that bringing all its 10,000 employees under one self-funded health plan would:
- Allow for a significant consolidation of health network and service costs.
- Endow it with the necessary scale to negotiate with providers for the best and most affordable coverage for its employees.
- Provide a lower ratio between administrative and actual medical costs and thereby an increased return on investment.
Anything a company can do to bring down its overall healthcare expenses will drop to the bottom line.
First Step: Evaluate and Assess
H&H’s challenge is to develop a strategy and plan that will work across the geographies in its portfolio. Fortunately for H&H, its firms are concentrated in and around the Boston area, which has many large, competing health systems and a growing number of provider-owned health plans (POHPs). This gives H&H negotiating clout as the systems, hospitals, provider groups and POHPs will want H&H’s business and its 10,000 employees.
Large employers have become attractive to large healthcare systems; they want to market to them directly, cut out the big insurers and split the savings the employer and system retrieve. But first, H&H must look at its companies’ existing health plan data to see what’s missing in the current benefit plans offered by the five companies and what can be improved.
For example, individually, H&H’s firms wouldn’t have the scale to benefit from establishing “center of excellence” relationships for, say, coronary diseases, enabling it to better manage costs and ensure quality. But when combined, a center of excellence relationship becomes more feasible, as does reducing stop-loss costs and uncertainty in managing income statement risk.
Current plan assessment also means dissecting the data to see where the individual companies’ healthcare money has been spent, thereby identifying opportunities for savings as well as investment. To do this well, H&H must understand its healthcare market (Boston, for example, is the nation’s sixth most expensive market for employer-based healthcare, with a population that skews older and a high concentration of academic health centers) and benchmark its own plans against those currently being offered in its industry. This will ensure that H&H’s plan is sufficiently competitive to attract talent, as well as help the company find cost-reduction and plan improvement opportunities.
H&H needs to establish a financial target for its plan. How much does it wish to spend; does it need to offer a better plan than its competitors or does it just need to match them? H&H’s head of HR and its CFO must be prepared to engage in these discussions.
H&H also must strive to understand its employee base and their families to assess their needs. It must review where its healthcare dollars have been spent historically to develop a plan that fits the needs of today’s workforce – including ancillary benefits such as dental and optical services – while at the same time looking to reduce spend that has not been effective at achieving benefit objectives.
Once the employees’ health data has been collected, it must be analyzed and fed into a risk-based econometric model to negotiate equitable revenue-sharing arrangements with a potential provider. This will help H&H project its own costs so it knows what it will need to reserve (remember: in a self-funded plan, the employer is assuming risk that an insurer would in a fully funded plan), define a stop-loss program, and select and negotiate with targeted providers and systems.
H&H should understand that whatever plan it devises, and with whichever provider network or system it contracts, it is unrealistic (and certainly cost-prohibitive) to offer a plan in which any employee can walk into any physician’s office he or she would like. That’s why it’s important for H&H to understand its employees’ needs so it can find a network or system that best suits them. For example, if Massachusetts General hospital – a large academic institution with a host of sub-specialties and services – can provide for 97 percent of H&H’s employees’ historic needs, the employees who have different needs can be offered a plan-appropriate, out-of-network option.
Second Step: Identify Compatible Partners
H&H is not in the healthcare business, nor should it be. No one goes it alone in the healthcare world. Once it has evaluated and assessed its employees’ needs, benchmarked plans in its industry, set its financial targets and selected a healthcare system or provider for its plan, the company needs to find partners that can help it administer and manage its employees’ ongoing healthcare requirements. This means H&H will need (among other services):
- A third-party claims administrator, which will review the plan continually for network adequacy and handle employee complaints. If employees are unhappy with a provider, or if a provider is vocally unhappy with the plan, the administrator can drop the provider and recruit another.
- A pharmacy benefit manager, which can give H&H guidance. Pharmaceuticals are a large and growing expense, accounting for almost 10 percent of the country’s $3 trillion annual healthcare bill. Working with a pharmacy benefit manager, H&H can identify (thanks to its prior work evaluating its employee population’s needs) what drugs it must cover (for example, for its older workforce, diabetes and hypertension medications) and which ones it will not.
- A re-insurer, with which H&H can minimize the risk of a catastrophic course of care – such as neo-natal intensive care, which can run $12,000 per day – that might significantly deplete or even drain its reserves.
- A disease management partner, which can help H&H manage its chronic conditions, as well as help it institute wellness programs that, in turn, can reduce long-term costs.
Even with these and other partners, H&H should be aware that developing and funding a healthcare benefits plan is not a one-time activity. With its plan in place, H&H must review it frequently, revisiting its network and benefits to ensure they are both meeting the needs of its employee base and returning cost-efficiencies to the company.
Who Knew Healthcare Could Be So Complicated?
As a private equity firm, H&H is always considering new opportunities for growth. As it acquires new firms, it must conduct due diligence to review its benefits package and estimate the cost savings it can retrieve by bringing the newly acquired company’s workforce under its self-funded plan. Indeed, this review will become a part of H&H’s acquisition strategy and a part of its competitive advantage.
It behooves any company, in any industry sector, to consider the benefits and savings it could retrieve via self-funding. As we’ve illustrated, launching a successful self-funded plan is a complex endeavor requiring a variety of disciplines and experts: health economists, pharmacy experts, health actuaries and data scientists, among others. As we said, no one goes it alone in the exceedingly complicated world of healthcare. However, the potential savings that companies may retrieve from self-funding, as well as the competitive advantage it may confer, demand serious and thoughtful consideration.