THE MILES ORGANIZATION, INC.

Employers Have Choices In Funding Health Plans: Alternatives Explored, Self

Funding Detailed
Employers sponsoring medical or dental plans can finance such plans fully through insurance,
through self funding (or self insurance), or through some combination of the two. The following
summarizes various forms of funding, and details many of the questions to be asked by an employer
that is considering some degree of self funding.

Employers have several choices in financing their employees' health care coverage, and these choices range from fully
insured to fully self insured (or self funded). Alternative financing methods include these options:

z Fully-pooled insurance —“Fully insured” (prospective premium) is the traditional, fully insured financing
arrangement. An insurance company determines a premium rate per covered person and, in return, pays benefits and
provides other services related to the plan (for example, actuarial, legal communication, and underwriting services).
The rates are determined before the beginning of the plan year, hence, the term prospective premium. These rates may
be determined based on the employer's own claim experience, the insurer's “book of business,” or a combination of the
two.

z Minimum premium (partial self insurance) through an insurance carrier. This method reduces many of the elements
found in the retention component of the premium. Instead of paying the insurance company the full premium, the
employer pays a “minimum” premium each month. This monthly premium generally is equal to the retention
component. The employer also opens a bank account that the insurer uses to pay claims; each time a benefit payment is
paid, the employer funds the account for the amount of the payment. In a variation of this method, the employer may
negotiate with the insurer so that the reserves will be held as employer assets rather than with the insurer.

Because the money used to pay claims never goes through the insurance company's accounts, premium taxes do not
have to be paid on claim amounts. This eliminates about 90% of the premium tax payable. A minimum premium
contract is still an insured plan, and therefore, all state mandated benefits still apply. The insurer continues to provide
the same services that it provides a fully insured policyholder. If actual claims exceed the protected amount, the insurer
pays for this excess. If the insurer does pay for an excess, they may carry forward the payment to future years just like
any other conventionally insured funding method.

z Partial self insurance with stop loss reinsurance through an insurance carrier or third party administrator (TPA).
Stop-loss insurance for health care takes several forms. An employer can purchase specific stop loss insurance, which
reimburses for individual claims over a specified amount, aggregate stop loss insurance, which reimburses for group
claims that exceed a specified amount, or both specific and aggregate stop loss insurance. In addition, the stop loss
insurance will cover either the plan, in which case the reimbursement is made to beneficiaries, or the stop loss can
cover the employer, in which case reimbursement is made to the employer. If the stop loss is carried by the employer
and not the plan, the plan will be considered to be completely self funded for Form 5500 purposes.

z Complete self-insurance, in which the employer assumes all of the financial risk for providing health care benefits
to its employees. Typically, a self-insured employer will set up a special trust fund to earmark money (corporate and
employee contributions) to pay incurred claims. As noted above, self-insured plans with stop loss insurance that
reimburses the employer but not the plan are considered fully-self funded for Form 5500 purposes, because the plan
remains at risk for all of the incurred claims.

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Why Self Fund?

According to the Self Insurance Institute of America, employers are most likely to consider self insurance because of
the following reasons:

z The employer can customize the plan to meet the specific health care needs of its work force, as opposed to
purchasing a “one-size-fits-all” insurance policy.

z The employer maintains control over the health plan reserves, enabling maximization of interest income —income
that would be otherwise generated by an insurance carrier through the investment of premium dollars.

z The employer does not have to pre-pay for coverage, thereby providing for improved cash flow.

z The employer is not subject to conflicting state health insurance regulations/benefit mandates, as self insured health
plans are regulated under federal law (ERISA).

z The employer is not subject to state health insurance premium taxes, which are generally 2-3% of the premium's
dollar value.

z The employer is free to contract with the providers or provider network best suited to meet the health care needs of
its employees.

Although self-insured plans escape state insurance laws and regulations, they nonetheless must comply with these
federal laws: the Employee Retirement Income Security Act (ERISA), Health Insurance Portability and Accountability
Act (HIPAA), Consolidated Omnibus Budget Reconciliation Act (COBRA), the Americans with Disabilities Act
(ADA), the Pregnancy Discrimination Act, the Age Discrimination in Employment Act (ADEA), the Civil Rights Act,
and various other budget reconciliation acts such as Tax Equity and Fiscal Responsibility Act (TEFRA), Deficit
Reduction Act (DEFRA), and the Economic Recovery Tax Act (ERTA).

Copyright © 2006, CCH INCORPORATED. All rights reserved.

Questions Employers Should Ask

Knowing the answers to the following questions will help employers decide whether or not to self fund:

z Is the plan an insured contract or some form of administrative services only (ASO)?

z Who settles claims?

z What is the minimum/fixed cost and what is the maximum claims liability (have you checked to see that the same
costs are included in each contract and the same census data is being utilized)?

z Are the minimum/fixed costs guaranteed? If not, how is final retention calculated?

z What is the maximum cost (or minimum fixed plus maximum claims liability)?

z What are the incurred and paid dates utilized in the specific and aggregate stop-loss? When changing insurance
carriers, there are always some claims still not received and processed by the current insurance carrier on the date
plans change. These claims must be processed by either the current carrier or the new insurance carrier or TPA.

contract settlement periods include —

z 12/12 (12 Months Incurred/12 Months Paid): Claims incurred and paid within the plan year.

z 12/15 (12 Months Incurred/15 Months Paid): Claims incurred within the plan year and paid within the plan year plus
three months following.

z 15/12 (15 Months Incurred/12 Months Paid): Claims incurred within the plan year plus three months prior, and paid
within the plan year.

z 14/12 (14 Months Incurred/12 Months Paid): Claims incurred within the plan year plus two months prior, and paid
within the plan year.

z 24/12 (24 Months Incurred/12 Months Paid): Claims incurred within the plan year plus 12 months prior, and paid
within the plan year. Second year (renewal) contracts become 24/12 or paid contracts.

z What is the level of the specific/pooling agreement? Are specific/pooling claims reimbursed, or does the carrier and
TPA assume payment responsibility as soon as the level is reached?

z Is the specific/pooling agreement based on one claim and is there an additional aggregating provision in the
agreement?

Assume a contract provision calling for a $35,000 specific stop loss with a $50,000 aggregating additional specific stop
loss. The reinsurer would not reimburse for a claim until the corporation has reached an additional $50,000 specific
stop loss incurred by one or more insureds who are over their $35,000 specific stop loss. All claims must be incurred
during the contract period.

z On what corridor is the aggregate stop loss/maximum claims liability based? The reinsurance or insurance carrier
will determine what it believes expected claims will be. It will use past claims and trend (inflation) to reach this
number. It will then inflate this number by 20%, 25% (most typical), 30%, or 35%, and this new number will become
the maximum claims liability or attachment point. For example, if expected claims are $1.2 million, a 25% corridor
increases the employer's maximum liability to $1.5 million.

As soon as claims reach $1.5 million, the employer would not have the liability, and the insurance company would
have liability for all claims in excess of $1.5 million. The employer would obviously like the lowest corridor (20%) so
the point where the insurance company gets involved will be lower. The lower the corridor the higher the premium.

z Can the corridor be increased and the fixed/ minimum cost decreased?

z Are aggregate/maximum claims liability reimbursed and do the carrier and TPA assume payment responsibility as
soon as the maximum is exceeded? Do the aggregate/maximum claims liability contracts contain a monthly rolling
aggregate?

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z Can a claim deficit on the aggregate/maximum claims liability be applied to next year's contract if the contract is
renewed? If yes, how much and how is the carry forward amount arrived at? Can a claim deficit on the
aggregate/maximum claims liability be applied to next year's contract if the contract is terminated? If yes, how much
and how is the carry forward amount arrived at?

z Who holds and sets the amount for reserves or is there a terminal liability/run-out protection? The latter refers to
coverage the plan sponsor may purchase for claim run-off —if the plan sponsor terminates a partially self-funded plan,
it must still pay for claims incurred under the contract, but not paid by the end of the plan year. Under a fully insured
contract, the insurance company is liable for these claims.

z Can claims deficits be taken from terminal liability?

z Must the terminal claims liability be funded at termination or as claims are incurred? Must the terminal
administration charge be funded at termination or each month?

z If total liability is funded at termination, is the excess over claims incurred and paid returned to corporation, and if
yes, when are funds returned? Is interest credited?

z Does stop loss apply for disabled employee at termination (extension of benefits) and who has liability for claims?

z Must a terminal liability/run-out provision be exercised for extension of benefits to apply? If the employer purchases
a minimum premium contract through an insurance company, it is really purchasing a form of a fully insured contract.
Usually when there is a fully insured contract, disabled employees are still uninsured upon termination under the
“extension of benefits” provision. The company being terminated will continue (6 to 12 months depending on the
insurance company) to insure claims for the condition that disabled the employee, but claims not related to the
condition will not be covered. Please note the insurance company accepts liability and pays the claims out of their
funds. Is extension for 3, 6, 9 or 12 months? Is extension of benefits applicable to totally disabled claimants or must the
claimant be hospitalized? Is extension of benefits applicable for only employees or for dependents also?

z If there is a “run-out”/terminal liability provision, is there a charge to adjudicate run-out claims and if yes, what is
the charge? If there is a “run-out”/terminal liability provision, what is the length of the run-out?

z Who incurs the cost to defend suit of disgruntled employees? Who has liability if corporation is found guilty when
sued by a disgruntled employee?

z Who has liability for state premium tax if law changes?

z What is the claims service turn-around time on a clean claim, and is this time frame guaranteed?

z What is the method used for billing and changes?

Copyright © 2006, CCH INCORPORATED. All rights reserved.