When an employee group goes to insurance company to cover its members, it has two basic types of contracts it can buy. The bells and whistles will change dramatically within the type, but there are only two types. The first type is a full insurance model where the insurance company takes on the medical cost risk. The insurance company defines the network, it defines payment rates, it defines the deductible amounts and co-pays (if the group is sufficiently large, there is a lot of wiggle room here, but Al’s Autobody with 3 employees will only get the standard otpions), and it defines the premiums. Those premiums are expected to be sufficient to cover the actual cost of care, overhead and kick into the general pool to cover the high cost individuals in a product line. The other type is a self-administered plan where the insurance company has far less say as it works primarly as an extension of the buyer’s finance/accounting and HR departments. The buying company takes on the medical risk, it takes on some network decisions, and it takes on benefit and cost configuration decisions. The insurance company handles regulatory compliance, customer services and claims payments.
Why the split and what are the advantages of each model?
The split is a function of the law of large numbers.
Full insurance models work well for small companies that are operating on thinner margins of error. If Al’s Autobody is hit with a $500,000 bill because Al Jr. has cancer, there is no where near enough cash flow through Al’s Autobody to make paying that bill anything other than a macabre fantasy. A full insurance model allows Al’s Autobody to absorb some of the cost of that $500,000 bill while also providing coverage to Florence the Florist and her 3 employees and Ronnie the Restauranter and her five employees. Full insurance spreads risk across a pool and this is neccessary when the individual groups of members that comprise a pool are small. A full insurance model is the basic model that is being used for all of the Exchange/Obamacare products. (and yes, Kid #1 had career day yesterday at pre-school)
Larger companies have different dynamics. Big companies with large employee bases have the ability to function as decent risk pools.
Initech with its 1,250 employees can spread the cost of a $500,000 bill across its population base and not go bankrupt. It can spread several quarter million dollar bills across its employees and still come out in decent shape. A self-insured model allows Initech to pocket the difference on most years when it does not have outlier expenses. It also allows Initech to include the CEO’s cardiologist and the development neurologist that treats the kids of the CFO when both of those specialists would normally be out of network. This is because the insurance company has to process payments to those out of network providers but the insurance company does not actually have to foot the bill, so it does not particulary care that both of those providers are getting two or three times the standard rate. The insurance company in this case works to pay claims, apply negoatiated discounts to regular network providers, and take care of the mundane tasks of insurance. The company gets a regular fixed fee per member per month to handle the back-end tasks.
There is a mild hybrid in self-insured companies can buy a second level of protection against outlier expenses in the form of stop-loss insurance. Stop-loss insurance is a type of reinsurance that we discussed a while back. The self-insured company would buy a policy where the self-insured company is on the hook for the first $500,000 of expenses per member but the reinsurance pays 80% above that OR if there was a series of outliers that pushed total costs to two standard deviations above projections, the reinsurance policy would kick in. These types of policies provide protection against a cancer cluster or an employee going postal or just plain bad luck.