Job Satisfaction
Self-funding is a hot topic for risk managers these days. At first blush, it provides what may seem attractive to companies who want to offer health insurance to their employees an alternative to rising premiums, high taxes and those pesky state mandatory-benefits laws. But, like everything else, it's best to take a closer look.
In a self-funded plan, a corporation essentially insures its employees itself. The contributions from the employees are placed into a fund, and used to pay claims, instead of being paid to an insurance company in insurance premiums. The fund is established in the name of the corporation, such as the "Corporation X Employee Benefits Plan." Typically, the corporation enters into a contractual relationship with a third-party administrator, or TPA - typically an insurance company - to perform the insurance-specific functions that are required. The TPA performs all of the functions that used to be thought of as an insurance company's job, such as approving and denying claims. The corporation also purchases various types of reinsurance, typically in the form of stop-loss insurance, to cover losses that exceed certain amounts.
Pro and cons
This structure offers many advantages, aside from savings in premiums and taxes. For example, corporations that self-fund are exempt from state laws, such as mandatory-benefit laws. Yet there are many disadvantages to self-funding.
For example, because the corporation essentially becomes the insurance company, it is legally responsible to its employees for such matters as wrongful denials of coverage. Self-funded corporations are in the front lines on all coverage decisions even though they may not be particularly qualified to make them.
To avoid getting in over their heads, corporations that are interested in self-funding should investigate the option thoroughly. Among other things, the decision of whether to self-fund at all should be made by corporation counsel, not by risk management alone. These corporations also should give thought to structures that may provide extra protection against the risks of self-funding, such as captive insurance that is set up correctly.
There can be real advantages to having a captive insurance company for companies that self-fund. For example, a company can take a current tax deduction for premiums paid (for 'insurance') prior to an actual occurrence of the risk insured against, whereas a self-funded programme may only take a tax deduction upon the actual occurrence of the self-funded event.
Meeting the taxman
But, for these advantages to become manifest, the company must make sure that it meets IRS requirements and the regulatory requirements of the captive's home jurisdiction. Just two points (of a number) to be considered is whether, in a substantive way, the corporation using a captive for health plans has, both in fact and in balance-sheet substance, 'transferred its risks'.
If the company doesn't do things right, then it will have the challenges of running a captive without the enjoyment of these advantages. Another point to be considered is whether a captive insures only parent risks which can be very problematical. Suffice it to say that in this area, captive planning has to be very careful to match an employer's needs and the provisions of tax law surrounding captives generally. Self-funding certainly isn't for everyone.
In fact, it may not be the right thing for many of the companies that currently self-fund. But the risks will be lessened for corporations that educate themselves, and that study all of their alternatives, like forming captives.
Rhonda Orin is the managing partner of the Washington DC office of Anderson Kill & Olick. She specializes in representing policyholders in connection with their insurance coverage needs, including corporations with self-funded health plans.
Phillip England is senior tax lawyer at Anderson Kill & Olick. He is a member of the New York and New Jersey bars and has lectured on various provisions of the Internal Revenue Code.
