Exploring Funding Options.

Alternate ways of funding group medical plans may make sense for employers, if their cash flows are dependable.

Professionally underwriting a group medical plan includes designing the plan and matching the rates to the risk inherent with the plan. In most cases, the 'underwriting" stops there. But for some plans, there's an additional step-helping the plan sponsor decide the funding arrangement.

Traditional, or conventional, group medical insurance is simple and meets the needs of most plan sponsors. They know their obligation for funding the plan: It's the monthly premium. The result is minimal risk for the plan sponsor and ease of budgeting, because they know their monthly and annual expenses in advance. But these arrangements limit access to the money allocated to the group medical plan and the investment return.

But some traditionally funded plans come with a slight twist: Plan sponsors are eligible for premium refunds based on claims experience. Plans that go that route have higher premiums, perhaps by as much as 5%, but they offer the opportunity to share the benefit of good plan experience while limiting risk to the premiums due.

Options for funding group medical plans that are not conventionally insured are known generally as alternate-funding plans. Alternatively funded plans offer both advantages and risks. Insurers and third-party administrators offer different kinds of alternate funding with a variety of names--administrative services only, minimum premium, etc. The bottom line, though, is it's all about cash flow for the plan sponsor.

There are two specific reasons why an employer may consider an alternate-funding plan: The possibility of improved cash flow is a strong advantage, and the plan sponsor may generate premium tax savings and reductions in administrative or risk expense.

Administrative Services Only

Administrative-services-only (ASO) plans are often called self-funding. With ASO plans, sponsors assume the risk for all claims, but they hold all plan funds until the administrator needs them for claims payment. Plan sponsors have to weigh the benefit of increased cash-flow premium savings vs. the potential for higher-than-normal claims. Generally, the larger the group, the more predictable the claims liability. Claims also are more predictable when considered over several years.

With ASO arrangements, plan sponsors can reduce their risk through excess loss insurance options. These options limit risk by placing maximums on individual claims, overall yearly claims, or both. There is a premium associated with excess loss coverage, but it's much lower than regular insurance premiums.

ASO plan administrators provide a variety of services other than claims administration. These services include drafting plan documents, administrative manuals, booklets for employees; providing enrollment services and materials, ID cards, administration forms, personalized benefit summaries, claims reports and plan cost projections; or offering other customized services.

Conventional/ASO Blend

A typical minimum-premium funding arrangement is a blend between conventionally-insured and ASO plans. In general, they include these features:

* sponsors can make funds available monthly to the insurer to cover estimated claims costs and expenses.

* A reserve may be set up to cover claims incurred before the policy terminates, but they are paid afterward. Plan sponsors may hold the reserves until needed, or the money may be deposited with the insurer.

* The plan sponsor's claim liability may be limited through individual and overall claim maximums. if claims exceed the maximums, the insurer absorbs the loss. If claims are less than the maximums, the plan sponsor keeps the difference.

* Deficits (claims in excess of the maximums) may either be forgiven by the insurer or carried forward to be recouped in future years, depending on how the funding arrangement is set up. Different premium or interest charges apply to each arrangement.

Alternate-funding plans bring another element into plan underwriting: determining whether the plan sponsor is a good candidate for the funding method. If money is tight, a plan sponsor may not be able to handle the monthly fluctuations that are common with alternate funding. Insurers generally will not accept groups with poor financial positions for alternate funding because of the risk of the sponsor defaulting on claims and leaving the insurer with unintended liabilities.

Gary Cain, a Best's Review columnist, is senior vice president, Group Life and Health, at the Principal Financial Group, Des Moines, Iowa.