Most companies offer health insurance in one of two ways: fully insured or self-funded. The difference comes down to a simple question: Who pays the medical bills?

In a fully insured plan, the company pays a fixed premium to an insurance carrier. Think of it like a subscription. The employer pays the same amount each month, and in return, the insurance company takes on the financial risk of paying for employees' medical claims. Whether claims are high or low, the company's cost is predictable.

A self-funded plan, also known as a self-insured plan, works differently. Instead of paying a premium to an insurer, the employer pays for each employee's medical claims directly out of its own funds. They are, in effect, acting as their own insurance company.

While the employer handles the payments, they don't typically manage the claims process themselves. They hire a separate company, called a Third-Party Administrator (TPA), to handle administrative tasks like processing claims, issuing ID cards, and providing customer service. To employees, it often looks and feels just like a traditional insurance plan.

Companies choose self-funding for several key reasons, but most boil down to greater control and potential cost savings.

First, employers can save money. In a fully insured plan, the premium includes not just the expected cost of claims but also administrative fees, taxes, and profit for the insurance carrier. With self-funding, employers avoid these extra charges. If employees have a healthy year and claims are low, the company keeps the savings.

Second, self-funding offers flexibility. Employers aren't stuck with the one-size-fits-all plans offered by an insurer. They can design a health plan from the ground up, tailoring benefits to meet the specific needs of their workforce. This could mean offering more generous mental health coverage, unique wellness programs, or different cost-sharing structures.

Finally, employers gain access to valuable data. Self-funded companies can see detailed, anonymous data about how their employees are using the health plan. This information can highlight trends, such as a rise in diabetes cases or a need for better preventive care, allowing the company to introduce targeted wellness initiatives that improve health and lower long-term costs.

The biggest advantage of self-funding, cost savings, is also tied to its biggest risk: unpredictability. A healthy year can save the company money, but a bad year with several large, unexpected medical claims could be financially devastating.

Imagine a small company with one employee who needs a sudden organ transplant. The cost of that single procedure could exceed what the company budgeted for the entire year's healthcare expenses. This is the primary risk of self-funding—the potential for catastrophic claims.

To protect against this, most self-funded employers purchase a special type of insurance called stop-loss insurance. This policy doesn't cover regular, predictable claims. Instead, it acts as a safety net, kicking in only when claims exceed a certain high-dollar amount.

There are two main types of stop-loss coverage:

1. Specific Stop-Loss: This protects against a single individual's claims getting too high. For example, the policy might cover any costs for one person that go above $100,000 in a year.
2. Aggregate Stop-Loss: This protects against the total claims for the entire group exceeding a set amount. For instance, if total claims are projected to be $1 million, the aggregate stop-loss policy might cover anything over 125% of that, or $1.25 million.

With stop-loss insurance in place, a company can get the benefits of self-funding while limiting its exposure to unpredictable, high-cost claims.

Now that you understand the basic structure of self-funded plans, let's test your knowledge.

This approach gives employers more control over their healthcare spending, but it also brings new responsibilities.