High Benefit Cost vs. Affordable Employee Benefits
The second danger that small business owners face is designing an expensive benefit plan that achieves results at a higher cost than other available methods.
Benefits can be thought of as indemnity contracts in which the employer agrees to pay the employee certain amounts in certain circumstances. For example, you might provide drug coverage and reimburse employees for the cost of prescription drugs. In order to ensure confidentiality of private health information the adjudication and payment of benefit claims would be outsourced to a benefit administrator.
The three factors that influence the cost of health benefits are: claim payments, markup for administration and benefit funding method. The way you manage each of these components will impact the cost of your benefit program both now and into the future.
- While the initial cost of your benefit plan might be based on the demographics of your group (age, sex, occupation, family status), your benefit costs in subsequent years will be based on the history of claims paid to your employees. A benefit plan design that does not encourage wise consumerism will result in high claims and high costs.
- The markup that benefits suppliers charge varies from 33% for big insurance companies to 10% for specialty claims paying services. The markup is often expressed in terms of a target loss ratio. For example, an insurance company with a 75% target loss ratio charges premium rates that are high enough for them to earn a 33% markup on every dollar paid out in claims.
- The funding method you choose for your benefit plan depends on your risk tolerance and the degree of cash flow fluctuation you are comfortable with.
- An unfunded plan requires that you pay the actual cost of claims plus expenses every week or two.
- A funded plan requires level monthly payments with adjustments every quarter based on actual costs.
- An insured plan requires a monthly payment per employee which is adjusted annually based on projected claims.
With both unfunded and funded plans the employer is financially responsible for the claims plus administration fees, whereas with an insured plan the employer is only responsible for the monthly premiums. Unfunded and funded plans provide the lowest sustainable cost since they reflect actual claims rather than potential claims. The prices of insured plans are adjusted every year to reflect potential claims based on the claims history of your group, plus reserves, as well as projected inflation. The prices of insured plans usually include a 2-3% risk charge to reflect the possibility that claims turn out to be worse than projected.
To ensure your benefit plan is affordable you need to manage the: claims, markup and funding method.
- You can design your plan to manage claims with formularies, coinsurance, maximums, limits and exclusions that encourage employees to make prudent purchase decisions while limiting your liability.
- You can choose a benefit administrator with a competitive markup.
- You can select a funding method that matches your risk tolerance and the degree of cash flow fluctuation you are comfortable with.
The decisions you make while designing your plan, choosing an administrator and selecting a funding method will influence the cost of your benefit plan for years to come.
