Mehb is Chief Actuary at BCS Financial, and a Fellow of the Society of Actuaries.
Self-funding, a health insurance approach in which employers opt to pay for their employees’ health costs from their own pockets instead of purchasing health insurance for them, is a growing practice. According to the Kaiser Family Foundation, in 2023, 65% of covered workers were covered by a self-funded plan. Rather than pay traditional health insurance premiums (fixed monthly payments), self-funded employers will instead pay for the actual claim costs based on their members’ usage (a variable cost), along with some administrative costs.
Self-insuring health care costs can be a smart move for a variety of reasons. In the first year of self-funding, it can seem like a plan sponsor saved a lot of money. And while that may be the case, with many employers often seeing savings when switching to a self-funded plan, it is important to note much of these savings should actually be set aside for claims that have been incurred but not yet paid, through a process called “reserving.”
Why Reserving Is Important
Reserves are an outstanding liability attributable to the year the claims were incurred. In healthcare, there is often a lag from the time claims are incurred to the time the medical bills start rolling in.
For example, you may have a member go to the hospital on Dec. 1, 2023, for a procedure, returning home Dec. 5, 2023. These claim costs should hit your 2023 claims expenses because that is the year in which the claim occurred.
However, the hospital will not likely bill the payer for those services until January 2024, at which time an administrator may audit the bill for accuracy. By the time the claim is complete and finalized, the administrator may not pull funds from your company’s bank account until February 2024 for the claim incurred in December 2023.
By properly reserving for these lags, you can plan and account for the claims incurred in the calendar year.
Catastrophic and extremely high-cost claims (those over $1 million) can add significant lag between incurred dates and paid dates since they are more complex. These claims often take longer for hospitals to bill and for the administrator to review. In general, the more expensive the claim, the more levels of audit and scrutiny, and the more lag time between the claim being incurred and the claim being paid. If employers are not properly reserving for these liabilities, they can end up with a false sense of savings—and a big, unexpected expense.
Best Practices For Reserving
While many self-insured groups do see savings (in my experience as chief actuary of BCS, I typically see between 5% and 20% savings), it is important to make sure you are seeing the full picture through a proper and thorough reserving process. This becomes especially important at the end of the year when employers are closing out their books and planning for the upcoming fiscal year. Typically, this process follows four steps:
1. Access your data: First, you’ll need to get your claims data from your payer or third-party administrator. Typically, this will come in the form of a lag triangle, allowing actuaries to measure payment speed and estimate outstanding liabilities.
2. Add margin for claim volatility: It is not uncommon to add 5%-10% for margin, as monthly claims can fluctuate, particularly for smaller groups (those with fewer than 500 employees).
3. Consider stop loss and other variables: If your liability is being ceded away to a stop loss carrier, you might not need to set conservative reserves.
4. Add in fixed fees: It is important to set aside an accrual for administrative expenses associated with paying the incurred, but not yet reported, claims.
Working with a broker or actuary who understands payment lag and can help you through the reserving process is a great option for self-funded employers.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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