Self-insurance is increasingly becoming the cost containment strategy of choice among Taft-Hartley Trust Funds providing health and welfare benefits to their participants and their qualified dependents. Successful implementation of this popular strategy requires full understanding of all the risks that will be assumed by the self-insuring Fund and a self-evaluation of the Trustees’ ability to effectively manage those risks. The Fund’s size and financial strength will be key determinants in this regard.
Trustees considering self-insurance will generally seek to achieve efficiencies in the following areas:
(1) Savings in plan costs
(2) Improved cash flow
(3) Benefits to be provided
(4) Greater control over the plan
In this issue of LIFELINES, the first two areas will be assessed. Sections three and four will be addressed in the next issue.
1. Savings in Plan Costs
The costs of an employee benefit plan can be broadly classified into benefit charges and expenses of administration. Self-insuring is not considered to have an impact upon the claim component (benefit charges) of plan costs, yet a considerable amount of risk is assumed by the Fund in the self-insured arrangement.
If a group is not large enough to be considered 100 percent credible for experience-rating purposes, then the question of whether it would save on claim costs by self-insuring depends upon whether its experience is significantly better or worse than the average experience assumed by the insurer in determining expected losses for the group in the experience-rating process. Additionally, the possibility of chance fluctuations in claims experience and the consequent financial risk to the Fund must be considered in evaluating the decision to self-insure. Fluctuations in experience caused by statistically random events (bad luck) and by non-independent statistical risk (catastrophic events localized to the signatory employers or community) will have significant financial ramifications to the self-insuring Fund. The size, along with the financial strength of the Fund, will be the principal factors associated with the Trustees’ ability to assume and manage this risk.
With respect to savings in plan costs, most of the attention has focused on possible savings in administrative expenses. Savings could be achieved in the areas of insurers’ commissions and other acquisition costs, risk charges, premium taxes and any contribution to the insurers’ profit or surplus.
The largest component of savings here is probably in the area of premium taxes and profit margins. Generally, insurers’ commissions and acquisition costs are small. Risk charges saved through self-insuring, to the extent that the risk charges are intended to protect against adverse contingencies (reserves), should be provided for by the prudent self-insuring Fund. The net result of such reserving will be to diminish any advantage to be gained by self-insuring.
2. Improved Cash Flow
The concept here is that the self-insuring Fund retains the use of reserves that would otherwise be held by the insurer in a fully-insured arrangement. The Fund would then have the advantage of the time value of money on these reserves, and in the case of qualified contributions to a Voluntary Employee Benefits Account (VEBA), these reserves would accumulate income tax free, adding to savings.
The temptation for the self-insuring Fund is to eliminate all reserves, thus increasing the chance of incurring the losses against which the reserves were intended to provide security. This is particularly true for the small Fund whose operations critically depend on cash flow on a daily basis. Solvency and preservation are strong motives for raiding the reserves of the health benefits fund, thereby jeopardizing the benefit program.
Other reasons to consider self-insurance include savings through benefit design and more control over the plan. These will be addressed in the next issue of LIFELINES.
[James Conlon is Principal and Consulting Actuary at Milliman, Inc., an employee benefits consulting firm. He is the Fund’s national health care consultant.]