What Is a Self-Funded Health Plan and How Does It Work?

A self-funded health plan is an arrangement where an employer directly assumes the financial risk for providing healthcare benefits to its employees. Instead of paying fixed premiums to an insurance carrier, the employer pays for medical claims from its own assets as they are incurred. This approach gives the employer immediate control over the funds used for employee health benefits and allows them to act as their own insurer.

Understanding Self-Funding

A self-funded health plan operates on the principle that the employer directly assumes the financial risk for employee health benefits. The employer uses its own funds to pay for medical claims, prescription drugs, and other healthcare services as employees incur them. This provides direct control over healthcare spending.

In contrast, a fully insured health plan involves an employer paying a fixed monthly premium to an insurance carrier. This transfers the financial risk of healthcare claims to the insurance company, which then pays all covered claims. The employer’s financial commitment is limited to the premium paid, offering predictable costs.

The fundamental difference lies in who pays claims and bears financial risk. With self-funding, the employer acts as its own insurer, directly managing funds and often maintaining reserves for potential claims. For fully insured plans, the insurance company pools premiums from many employers to cover collective risk, insulating individual employers from high claim volatility.

This direct assumption of risk means the financial commitment in a self-funded model is variable, depending on employee healthcare utilization. Employers must project expenditures and ensure sufficient liquidity to meet claims.

Essential Elements of Self-Funded Plans

Self-funded health plans commonly integrate several operational components to manage benefits efficiently. These elements streamline the administration of healthcare benefits while allowing the employer to retain financial oversight.

Third-Party Administrators (TPAs) are frequently utilized by employers to manage the administrative tasks of a self-funded plan. TPAs handle day-to-day operations, including processing claims, maintaining eligibility records, providing customer service, and offering access to provider networks. TPAs do not assume the financial risk for claims; that responsibility remains with the employer.

Stop-loss insurance protects the employer from unexpectedly high claims. This insurance acts as a safety net, capping the amount an employer must pay for claims and protecting against catastrophic losses that could impact financial stability.

There are two types of stop-loss coverage: specific and aggregate. Specific stop-loss insurance protects against high costs from a single individual’s claims, reimbursing the employer once an individual’s medical expenses exceed a predetermined threshold. Aggregate stop-loss insurance provides protection against the total claims incurred by the entire group exceeding a set limit over a specific period.

Self-funded plans may integrate other specialized services. Pharmacy Benefit Managers (PBMs) are often employed to manage prescription drug benefits. PBMs negotiate drug prices, establish pharmacy networks, and process prescription claims, aiming to control pharmaceutical costs.

Additional services, such as wellness program providers, can also be incorporated. These programs aim to improve employee health and potentially reduce overall healthcare utilization. The modular nature of self-funded plans allows employers to select and integrate various vendors to create a customized benefits package.

Oversight and Compliance

Self-funded health plans are governed by federal laws, providing a consistent regulatory framework. The Employee Retirement Income Security Act of 1974 (ERISA) is the foundational federal law setting standards for most private-sector retirement and health plans. ERISA mandates that self-funded plans adhere to requirements regarding fiduciary duties, reporting and disclosure, and claims procedures.

A significant distinction for self-funded plans under ERISA is their general exemption from state insurance laws. ERISA’s preemption clause supersedes state laws related to employee benefit plans. This allows employers with self-funded plans to operate uniformly across multiple states without complying with varying state insurance regulations or mandated benefits.

The Consolidated Omnibus Budget Reconciliation Act (COBRA) requires self-funded plans to offer temporary continuation of group health coverage to employees and their families after certain qualifying events, such as job loss or reduction in hours.

The Health Insurance Portability and Accountability Act (HIPAA) also applies to self-funded health plans, particularly concerning the privacy and security of protected health information (PHI). HIPAA mandates rules for safeguarding sensitive patient data and establishes requirements for administrative, physical, and technical safeguards. Employers sponsoring self-funded plans must ensure compliance with HIPAA’s privacy and security regulations.