Group Health in Practice, Including Excess Loss
A group health sale turns on five decisions the carrier makes about the employer and one decision the employer makes about risk. The carrier decides how to price the group, whether enough employees will join, whether the plan design and the employer’s administration are sound, when people may enter, and what happens to a covered person when the employer changes carriers. The employer decides whether to insure the risk at all or carry part of it and buy excess loss coverage. Worked numbers carry each decision. Names and figures in the examples are invented and are not statutory figures.
Pricing a Group: Experience, Community and Adjusted Community Rating
Group underwriters price from one of three starting points.
| Method | What sets the premium | Who bears the group’s own claims |
|---|---|---|
| Experience rating | The group’s own claims, adjusted for trend and credibility | The group, through next year’s renewal |
| Community rating | The same rate for everyone in an area, whatever the group’s claims | The whole pool |
| Adjusted community rating | A community rate adjusted only by permitted factors such as age, area or tobacco use | The pool, apart from the permitted factors |
A large employer is usually experience rated, because its own claims are a reliable guide. A small employer’s claims in one year swing too widely on a few large claims to say anything dependable about next year, so a pure experience rate would only chase the last bad year.
A Worked Experience Renewal
Brightwater Tool and Die has 120 employees and is insured under a contributory plan. In the policy year just ended, it paid $480,000 in premium, and its incurred claims were $396,000. Incurred claims are the claims paid plus a reserve for claims that have happened but are not yet paid or reported. The insurer renews as follows.
- Experience loss ratio: $396,000 divided by $480,000 is 82.5%.
- Project the claims forward. The insurer assumes medical costs rise 7% by the next policy year, so projected claims are $396,000 times 1.07, or $423,720.
- Gross up for expenses and margin. The insurer wants 85% of premium to go to claims, which is its permissible loss ratio. Premium needed is $423,720 divided by 0.85, or $498,494 (rounded to the dollar). That is 3.85% above last year’s $480,000.
- Weigh the group’s experience by its credibility. Credibility is the weight an insurer gives a group’s own claims, and it rises with group size because a larger group’s claims are steadier. Suppose the insurer gives a 120-life group 60% credibility. The other 40% goes to the manual premium, the rate the insurer would charge a group of this size and make-up with no claims history. Assume the manual premium is $540,000.
- Blend: 0.60 times $498,494 plus 0.40 times $540,000 is $299,096 plus $216,000, or $515,096.
The renewal is $515,096, an increase of 7.3% over $480,000, or $42,925 a month. The group’s own experience was better than the manual rate, yet the renewal still rises because medical trend lifts both. If the group had 25% credibility instead, the blend would sit nearer the manual premium. Credibility is the lever that keeps a single large claim from setting a small group’s price.
Michigan’s Small Group Rules
Michigan does not leave small group pricing to this arithmetic. A small employer in Chapter 37 is a business with an average of 1 to 50 full-time employees (MCL 500.3701(q)), so Brightwater, at 120, is outside the chapter and is experience rated as above. For a small employer’s plan delivered, issued or renewed on or after January 1, 2014, the premium may be determined only by the rating factors in MCL 500.3474a (MCL 500.3705(2)(b)). That section lets the rate vary only by:
- whether the coverage is for an individual or a family;
- the rating area;
- age, with the rate not varying by more than 3 to 1 for adults; and
- tobacco use, with the rate not varying by more than 1.5 to 1.
The group’s claims history and health status are not on the list. A small employer is also billed one composite rate for the group. A carrier may not bill so that one employee in the group pays a higher premium than another, except for plan options, number of family members covered and Medicare eligibility (MCL 500.3705(4), (5)). The premium for a plan in a geographic area also may not vary from the index rate for that plan by more than 45% of the index rate (MCL 500.3705(2)(c)).
Here is how a carrier builds a small group’s composite rate. Take a base rate of $450 a month for the youngest age band, and an age curve whose top factor is 3.00, which respects the 3 to 1 limit. The curve is an example. A six-employee firm has employees in these bands.
| Employee | Age factor | Monthly rate at that age |
|---|---|---|
| 1 | 1.00 | $450 |
| 2 | 1.00 | $450 |
| 3 | 1.30 | $585 |
| 4 | 1.70 | $765 |
| 5 | 2.20 | $990 |
| 6 | 3.00 | $1,350 |
The factors sum to 10.2, so the group’s total is 10.2 times $450, or $4,590 a month. Divided by six employees, the composite rate is $765. Every employee is billed $765 under the plan, and the employer’s cost does not rise because one employee is older. The group’s own claims in the prior year do not enter the calculation. Suppose a second six-employee firm in the same rating area has the same ages, and its employees filed $10,000 of claims last year while the first firm’s filed $60,000. Both firms are quoted the same $4,590 a month. Under experience rating the second firm would have been quoted far less and the first far more. Under Michigan’s small group rules, the pool absorbs the difference.
Participation and Contribution Tests
A group plan needs enough healthy people in it to work. An insurer sets two tests to protect against adverse selection, which is the tendency of those with expected claims to enroll while healthy people stay out.
A participation test requires a minimum share of eligible employees to enroll. A contribution test requires the employer to pay at least a stated part of the premium. The two work together. A plan paid for by the employer is cheap to the employee and so draws nearly everyone, while a plan that costs the employee a great deal draws mostly those who expect claims.
Insurers commonly look for the employer to pay half or more of the employee premium, and for enrollment of at least 75% of eligible employees when the employer contributes. They commonly look for 100% when the employer pays everything. Those are practice, not law.
For Michigan’s small employers the law sets the ceiling. A minimum participation rule may require enrollment of up to 100% of the employees seeking coverage through the employer if it has 10 or fewer eligible employees, up to 75% for 11 to 25, and up to 50% for 26 to 50 (MCL 500.3709(2)). The test is applied to employees who are seeking coverage, so an employee who declines because a spouse’s plan covers them is not counted against the employer.
Compare two employers.
- Maple Ridge Dental has 24 eligible employees, in the 11 to 25 band. Twenty of them seek coverage. At the 75% ceiling, the carrier may require no more than 15 of those 20 to enroll.
- Harbor Machine Repair has 34 eligible employees, in the 26 to 50 band. Thirty want coverage. At 50%, the carrier may require no more than 15 enrollees.
Both come to 15, though the groups differ. A carrier that waives its participation rule for an employer cannot enforce it against that employer later (MCL 500.3709(1)).
The contribution test is simple arithmetic. If the employee-only premium is $765 a month and the carrier requires the employer to pay at least 50%, the employer must pay at least $382.50 for each enrolled employee. An employer that pays $300 does not qualify, and one that pays $400 does, which is 52.3% of the premium ($400 divided by $765).
Plan Design and Administrative Capability
The insurer looks at two matters beyond the group’s size, age and claims history.
Plan design. The more generous the plan, the more claims it draws. An underwriter checks whether the employer offers a plan with a low deductible alongside a high one. When the employer offers more than one plan, the healthy tend to choose the cheaper one, and those with expected claims choose the richer one, so the richer plan’s rates must rise. For the same reason the insurer may require a single plan or restrict how often an employee can switch. It also checks that the design fits the group: a rich design on a workforce that cannot afford the employee share produces low participation.
Administrative capability. A group plan runs on the employer’s records. The employer reports who is eligible, collects premium by payroll deduction, sends the premium on time and reports changes in status. An insurer asks whether the employer has someone who does this, whether the payroll system can do the deductions, and whether the employer can handle notice duties such as continuation coverage. A carrier will decline, or price for the risk, when an employer cannot show it can keep an accurate eligibility list. Billing errors in a group plan produce claims for people who are no longer eligible, and the insurer pays them. A common example is a terminated employee who stays on the eligibility list for three months because no one reports the termination. The insurer pays three months of claims for a person it never charged premium for, and recovering them is slow and often incomplete.
Entering the Plan and Annual Open Enrollment
A new employee may join when the plan’s eligibility rules are met. Anyone who is eligible and joins when first eligible enters without evidence of insurability.
After that, the plan is open only at set times. The principal one is the annual open enrollment, a fixed window each year in which eligible employees may join, drop or change their choices, with the new choices starting on the plan anniversary. An employee who skips the window and later wants in is a late enrollee. An insurer may delay a late enrollee’s coverage with an affiliation period, a stretch of time that must pass before coverage begins. Michigan bars a carrier from selling a small employer plan with a waiting period for new or late enrollees. It may instead use an affiliation period, for an employer that is not a sole proprietor, if the period is applied uniformly without regard to health status, does not exceed 60 days for new enrollees or 90 days for late enrollees, charges no premium and gives no coverage while it runs (MCL 500.3707(2)).
Open enrollment is not the only way in. An employee who loses other coverage, or who adds a spouse or child through marriage, birth or adoption, can enroll in a special enrollment period under federal law and, for small employers, MCL 500.3708.
Take Marcus, who waived coverage in October because his wife’s employer covered the family. In March her employment ends, and the family’s coverage ends with it. Marcus does not wait for the next annual open enrollment. A Michigan small employer carrier must let him enroll in a special enrollment period when he was covered elsewhere when coverage was first offered, and when his employer required a written statement of that reason and gave notice of the requirement when it first offered coverage (MCL 500.3708(2)(a), (b)). The plan must give him at least 30 days after the other coverage ends to request enrollment (MCL 500.3708(2)(c)).
Changing Insurers
An employer that changes carriers creates a hazard for each employee. If the new plan restarts the deductible and brings back waiting periods and exclusions, the employee is worse off through no fault of their own. Two ideas protect against that.
Carryover of deductible and coinsurance credit. The new carrier credits what the covered person already paid toward the plan year’s deductible and out-of-pocket maximum. Take a plan with a $1,500 individual deductible. Jorge has paid $1,200 toward it with the old carrier between January and June, and the employer changes carriers on July 1. If the new carrier gives full credit, Jorge needs $300 more to satisfy the deductible. If it does not, he must meet $1,500 again, and he has paid $1,200 for nothing. Whether the credit is given is a negotiating point for the employer. Carriers often agree, because without it the employer may stay put. The same question arises for the family deductible and for the out-of-pocket maximum. If Jorge’s family has paid $2,100 toward a $4,000 family out-of-pocket maximum before the change, a carrier that credits it leaves $1,900 to meet. A carrier that does not credit it leaves the full $4,000.
No loss, no gain. A replacement carrier should leave each person in the same position as before the change, no better and no worse. It does not impose a new exclusion for a pre-existing condition on someone who would have been covered under the prior plan. It does not give the person richer benefits than the new plan provides. A person who is totally disabled on the changeover date is commonly protected by an extension of benefits from the prior carrier for the disabling condition, while the new carrier takes the claims that arise after. This is how replacement coverage is commonly arranged.
The producer’s part is to ask, before the employer signs, whether the new plan credits deductibles, whether it waives waiting periods and pre-existing limits for those covered under the old plan, and how those in the middle of treatment are handled. An employer that does not ask learns the answers from its employees’ complaints.
Excess Loss Coverage
An employer can carry its employees’ health risk itself and not buy insurance. Under a self-funded plan, the employer pays claims out of its own money, often with a third party administrator handling the claims. That saves the insurer’s margin and premium tax, but one catastrophic claim could be a serious loss to a modest-sized employer. Excess loss insurance, also called stop-loss insurance, is the policy the employer buys to cap that loss. It reimburses the employer. It does not insure the employees, who are covered by the employer’s plan, and they have no claim against the stop-loss insurer.
There are two forms, and a plan commonly has both.
- Specific stop-loss pays when one person’s claims in the contract period exceed a stated attachment point, which is the dollar level at which the insurer starts paying. The insurer pays the amount above the attachment point on that person.
- Aggregate stop-loss pays when all the plan’s claims in the period together exceed the aggregate attachment point, which is commonly stated as a percentage of expected claims.
An insurer may set a higher individual attachment point for one person known to be a high claimant. This practice is called lasering.
A Worked Stop-Loss Claim
Oakmont Logistics, with 200 covered employees, self-funds. Its actuary expects $2,400,000 of claims in the year. It buys specific stop-loss with a $100,000 attachment point and aggregate stop-loss at 125% of expected claims, which is $3,000,000 (1.25 times $2,400,000).
For the year, the plan pays $3,350,000 in claims, including three large ones.
| Person | Claims | Over the $100,000 attachment | Specific stop-loss pays |
|---|---|---|---|
| A | $340,000 | $240,000 | $240,000 |
| B | $180,000 | $80,000 | $80,000 |
| C | $95,000 | none | $0 |
| Specific total | $320,000 |
Claims net of specific recoveries are $3,350,000 minus $320,000, or $3,030,000. That is $30,000 above the $3,000,000 aggregate attachment point, so the aggregate coverage pays $30,000. Oakmont’s total retained cost is the $3,000,000 attachment amount. Without stop-loss, it would have paid the full $3,350,000.
Suppose, instead, that the insurer had lasered Person A at $200,000 because A was known to be a heavy claimant when the contract was written. The specific recovery on A would have been $340,000 minus $200,000, or $140,000, not $240,000. The laser leaves $100,000 more of A’s claim outside the specific coverage. Whether that amount can count toward the aggregate coverage depends on the contract.
Michigan Rules That Touch Self-Funding
Michigan builds excess loss into its rules for the arrangements that run on self-funding. A third party administrator may not take on a plan covering fewer than 500 individuals unless it arranges excess loss insurance or the sponsor is liable for the plan’s liabilities and sponsors plans covering 500 or more in total (MCL 550.932(3), (4)). A multiple employer welfare arrangement must have a written commitment, binder or policy for excess loss insurance from an insurer authorized in Michigan before it can obtain a certificate of authority (MCL 500.7011(c)).
The guaranty association is also affected. The association’s coverage does not reach the part of a plan that is self-funded or uninsured, and that includes benefits payable under a stop-loss or excess-loss group insurance plan, with a narrow exception for the insured portion of certain stop-loss plans (MCL 500.7704(5)(d)(iii)). An employee of a self-funded employer whose stop-loss insurer fails ordinarily looks to the employer for benefits, not to the association.
Self-funding is not suited to every employer. An employer that cannot absorb the attachment points, or that cannot administer a plan, belongs in a fully insured plan.
Lesson summary
- Experience rating prices a group from its own claims after trend and a permitted loss ratio, then blends the result with the manual premium according to the group’s credibility. Community rating prices everyone in an area alike. Adjusted community rating allows only listed factors.
- For a Michigan small employer, a plan issued or renewed on or after January 1, 2014 may be rated only on family or individual coverage, the rating area, age (3 to 1) and tobacco use (1.5 to 1), and is billed as one composite rate.
- Participation and contribution tests guard against adverse selection. A Michigan carrier may require enrollment of up to 100%, 75% or 50% of the employees seeking coverage, by group size.
- Underwriters judge plan design and the employer’s administrative capability as well as the group’s size, age and claims history.
- Annual open enrollment sets the regular entry point. Late enrollees may face an affiliation period, and loss of other coverage opens a special enrollment period.
- On a change of carrier, deductible carryover and no loss, no gain keep covered people from being worse off.
- Specific stop-loss pays on one person’s claims over an attachment point. Aggregate stop-loss pays when all claims exceed a level set against expected claims. Excess loss reimburses the self-funded employer, not the employees.