Advantages and Disadvantages of Offering a Level-Funded Group Health Plan
While level-funded group health plans are not entirely new, their adoption has expanded rapidly over the last few years, particularly among small to midsized employers. According to an annual KFF survey, among employers with less than 200 workers, 42% reported offering a level-funded plan in 2021, compared with only 13% in 2020. The main reason for this rapid expansion is that level-funded plans typically are less expensive—the same way traditional self-funded plans can be less expensive—when compared to fully insured plans. However, unlike with traditional self-funding, level-funded plans are designed to provide cost stability through predictable monthly payments.
Such stability is generally achieved by utilizing stop-loss insurance with lower-than-normal attachment points (i.e., thresholds for when a stop-loss policy begins to reimburse claims) and setting monthly contributions rates at levels needed to fund all claims for the year up to those lower attachment points. If actual claims for a given month exceed the estimated claims upon which monthly contributions were based (but such claims are still below the stop-loss policy’s aggregate or individual attachment points for the year), then the stop-loss policy will often include a mechanism whereby the policy can be tapped to cover the short-term deficit, essentially as a loan to the plan sponsor. The loan and all other monthly surpluses and deficits are reconciled at the end of the year. This design helps many employers that wish to self-insure but lack the size traditionally needed for a self-insured plan to make economic sense. It allows these small to midsized employers to enjoy the same cost savings that can come with a traditional self-insured plan, while also mitigating the risk of potential cash flow issues and maintaining a more predictable monthly cost structure.
Level-funded plans, however, also come with their share of disadvantages, and it is important for employers to be aware of these disadvantages before implementing a level-funded plan. Although level-funded plans often are designed to mimic fully insured plans in terms of their relative cost stability, level-funded plans are still considered to be self-insured (aka, self-funded) for most compliance purposes. Accordingly, they are subject to a number of additional legal requirements that are not applicable to fully insured plans. Furthermore, as a practical matter, the cost stability of a level-funded plan is only possible to the extent that the plan’s actuarial forecasts are relatively accurate. If a plan’s service providers use inaccurate and/or aggressive actuarial assumptions when determining a plan’s fixed monthly contribution rates for an upcoming year, then it is possible that the level-funded plan could become significantly underfunded by the end of that year. This could require the employer to have to remit a large, unexpected payment to the stop-loss carrier at year-end or, alternatively, for the plan’s fixed contribution rates for the next year to be substantially inflated in order to recoup funds needed to cover the prior year’s deficit.
Additional Compliance Requirements for Level-Funded Plan Sponsors
PCORI Fees: Level-funded plan sponsors are required to report and pay the Patient Centered Outcomes Research Institute (PCORI) fee by July 31st each year using IRS Form 720. The fee is an applicable dollar amount multiplied by the average number of covered lives during the preceding plan year. Various methods are available under the regulations for calculating the average number of covered lives.
ACA Reporting: Because level-funded plans are considered self-funded for compliance purposes, employers sponsoring level-funded plans must file and distribute ACA employer mandate returns (Forms 1094/1095), even if the employer is not an applicable large employer (ALE). If the employer is an ALE, then it will complete the reporting using “C” forms. If the employer is not an ALE, then it will complete the reporting using “B” forms. A level-funded plan’s third party administrator (TPA) may complete the ACA reporting on the employer’s behalf, but it is ultimately the employer’s responsibility to ensure that the reporting is completed when the employer sponsors a self-funded plan. Therefore, level-funded plan sponsors will want to confirm with their plans’ TPAs whether the TPAs will be completing the ACA reporting on their behalves each year.
COBRA Premiums: For employers that are subject to COBRA (because they have 20 or more employees and are not otherwise exempt), the rules for determining applicable COBRA premium rates are different for self-funded plans versus fully insured plans. For self-funded plans, the COBRA premium is determined based on either (1) a reasonable estimate, on an "actuarial basis," of the cost of providing coverage for similarly-situated non-COBRA participants in the current plan year, or (2) the cost of providing coverage for similarly-situated non-COBRA participants for the same period occurring during the preceding plan year. Regardless of which method is used, it is important to note that the resulting rate likely will be different from the plan’s then-current fixed monthly contribution rate for non-COBRA participants.
105(h) Nondiscrimination: Self-funded (including level-funded) plans are subject to nondiscrimination testing under Section 105(h) of the Internal Revenue Code, which prohibits the plan from discriminating in favor of highly compensated individuals (HCIs). These nondiscrimination requirement do not apply to fully insured plans. An HCI includes any individual who is one of the five highest paid officers, a more-than-10% shareholder, or among the highest-paid 25% of all non-excludable employees. Certain plan designs that purposely or inadvertently favor HCIs may cause 105(h) testing failures, which potentially jeopardizes the tax-exempt status of benefits the HCIs receive.
RxDC Reporting: Self-funded (including level-funded) plan sponsors are responsible for completing annual prescription drug data collection (RxDC) reports pursuant to the Consolidated Appropriations Act, 2021 (CAA). RxDC reports must be filed electronically through CMS’s HIOS portal by June 1st each year. As a practical matter, the plan’s TPA and/or pharmacy benefit manager (PBM) will have to prepare the substantive portions of the reports, but unlike with fully insured plans, self-funded plan sponsors are ultimately responsible for ensuring that RxDC reporting requirements are met, even if the plan’s TPA or other third party has agreed to submit the reports on the plan’s behalf.
Potential Regulatory Risk
The Departments of Labor, Treasury, and Health and Human Services (the “Departments”) published proposed regulations (available here) in July of 2023, which addressed several different issues affecting the health insurance industry, including the growing prevalence of level-funded plans. The proposed regulations did not include any new rules or guidance with respect to level-funded plans; rather, the Departments merely explained some of the concerns that have been raised by interested parties with respect to certain level-funded plan designs and practices, and they solicited comments from the public “to better understand the prevalence of level-funded plans, such plans’ designs and whether additional guidance or rulemaking is needed to clarify a plan sponsor’s obligation with respect to coverage provided through a level-funded plan arrangement.”
Although the Departments have yet to issue any new guidance on level-funded plans, it is clear from their comments in the proposed regulations that some form of official guidance may be on the horizon. Any new regulations or other guidance the Departments promulgate in the coming years—depending on how restrictive such regulations are—could end up limiting level-funded plan designs in a way that severely diminishes the advantages of offering such plans. Employers with level-funded plans are advised to stay up-to-date on any forthcoming regulatory developments in this area. Our firm, along with your consultants, will keep you apprised of any major developments with respect to level-funded plans in future articles or other client alerts.
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