What Is Self-Funding Health Insurance?

Self-funded health insurance is an alternative to traditional fully insured plans. In this model, an employer directly assumes the financial responsibility for their employees’ healthcare claims, rather than transferring that risk to an insurance carrier. This means the employer pays for medical services, prescriptions, and other covered benefits as employees incur them.

Core Concept of Self-Funding

Self-funded health plans mean the employer directly pays for healthcare claims incurred by employees and their dependents. This contrasts with fully insured plans where an employer pays a fixed premium to an insurance company, and the insurance company then takes on the financial risk of paying claims. In a self-funded arrangement, the employer retains all financial risk for the actual claims costs.

An employer essentially becomes its own insurer for healthcare benefits. Instead of predictable monthly premiums, costs fluctuate based on employee healthcare utilization. If claims are lower than anticipated, the employer benefits from the savings, as those funds remain with the company. Conversely, if claims are higher than expected, the employer is responsible for covering the increased costs.

Eligibility and covered benefits are outlined in a plan document, similar to a traditional group health insurance policy. The employer funds the plan directly, often setting aside money to cover expected healthcare expenses. This allows for greater control over plan design and offers cash flow advantages, as funds are disbursed only as claims occur rather than through upfront premiums.

Operational Structure of Self-Funded Plans

A self-funded health plan involves a direct financial flow from the employer to cover healthcare expenses. Instead of fixed premiums, the employer maintains control over funds for healthcare benefits. These funds pay for claims as they arise.

To manage the financial aspects, employers often establish a dedicated claims fund or reserve account. This account holds contributions from the employer and, if applicable, employees, earmarked for medical, dental, or vision claims. The employer ensures sufficient liquidity within this fund to meet claim demands.

While financial risk rests with the employer, day-to-day administrative tasks are typically outsourced. These duties include receiving claims, verifying eligibility, processing payments, and issuing explanation of benefits (EOB) statements. The employer oversees these outsourced functions.

Key Service Providers and Protection Mechanisms

Self-funded health plans often rely on specialized service providers and financial protection mechanisms to function effectively. Third-Party Administrators (TPAs) play a central role in handling the administrative functions of the plan. TPAs manage tasks such as claims processing, eligibility verification, customer service, and access to provider networks. They act as the operational backbone, allowing employers to focus on their core business while ensuring claims are processed efficiently and accurately.

Stop-loss insurance is a critical protection mechanism for employers with self-funded plans. This is not health insurance for employees; rather, it is insurance purchased by the employer to protect against unexpectedly high claim costs. Stop-loss insurance limits an employer’s financial exposure to catastrophic individual claims or exceptionally high aggregate claims across the entire employee group.

There are two main types of stop-loss coverage: specific and aggregate. Specific stop-loss protects against high costs from a single individual’s claims, reimbursing the employer once a predetermined threshold for that individual is met. Aggregate stop-loss provides a ceiling on the total amount of claims the employer will pay for the entire group over a policy year, reimbursing the employer if total claims exceed that limit. Beyond TPAs and stop-loss, self-funded plans may also engage pharmacy benefit managers (PBMs) to manage prescription drug benefits and benefit consultants to provide strategic advice on plan design and cost containment.

Regulatory Landscape

Self-funded health plans are primarily governed by federal law, specifically the Employee Retirement Income Security Act of 1974 (ERISA). ERISA sets minimum standards for employee benefit plans in the private sector, including self-funded health plans, to protect the interests of plan participants and their beneficiaries. This federal oversight ensures uniform expectations for employers, regardless of where their employees are located.

A significant feature of ERISA is its preemption clause, which generally exempts self-funded plans from state insurance laws. This means that state mandates, such as specific benefit requirements or premium taxes that apply to fully insured plans, typically do not apply to self-funded arrangements. The intent of ERISA preemption is to allow employers to manage their plans consistently across multiple states, simplifying administration and reducing regulatory burdens.

Despite ERISA preemption for the health plan itself, state laws can still apply to the stop-loss insurance policies purchased by self-funded employers. Those who manage and control plan assets under a self-funded plan are considered fiduciaries under ERISA. Fiduciaries have a legal obligation to act solely in the best interest of plan participants and their beneficiaries, ensuring prudent management practices and adherence to plan terms. ERISA also mandates specific documentation and reporting requirements for self-funded plans, including providing a Summary Plan Description to participants and filing annual reports with the Department of Labor.