Matt Drakeley on the long-term challenges of rising healthcare costs and why self-funded captives could provide employers with a more cost-effective alternative to traditional employee healthcare insurance plans.

Navigating rising healthcare costs has been a long-term challenge for employers. Over the last 20 years, the cost of medical care services has increased nearly twice as fast (78% faster) than the general rate of inflation, according to Consumer Price Index data from the Bureau of Labor Statistics.

Interestingly, the relationship has reversed more recently, with overall inflation rising 8.2% for the year ended September 2022 versus 6.5% for medical care services. Employers, however, would be wise to prepare for a return to the historical pattern, with medical care inflation catching up and exceeding general inflation due to underlying labour and supply cost trends in the healthcare system.

Even before inflation in the overall economy began persistently hitting historic highs, the impact for hospitals was even greater. Nationally, hospital labour costs increased by more than one-third from March 2019 to March 2022, according to Kaufman Hall.

Drug expenses also rose dramatically, increasing 36.9% on a per patient annual basis from 2019 to 2021, while medical supply costs jumped 20.6% over the same period, according to an American Health Association report that also cited Kaufman Hall data.

These considerable expense hikes for hospitals will compel them to pass on the costs to health insurers. As provider contracts approach the renewal date, renegotiations will take place in a very different economic climate than what existed a year ago.

Indeed, assuming costs increase significantly, employers must cope with another rising capital expenditure during this period of inflation. This conundrum makes it opportune for companies to consider alternatives to traditional health insurance plans for employees.

Chief among the opportunities is a self-funded plan that is supported by medical stop-loss insurance within a captive structure to absorb catastrophic medical costs above a certain threshold on a per-employee and aggregate-employee basis.

Keeping all or a portion of the medical stop-loss within a captive can help insulate the company from a potential spike in insurance rates as insurers contend with their own increased costs. A captive is a licensed insurance company owned by a corporate entity.

This alternative risk-financing option has many benefits, including significant tax advantages. But the primary reason for a company to form a captive is to address specific risk-management needs, hence the reason why approximately 90% of Fortune 500 companies have established wholly owned captive subsidiaries.

An increasing number of smaller businesses are also enjoying the benefits of captives by banding together to achieve the scale necessary to spread risk and operate efficiently in a group captive.

Overall, nearly 3,400 captives have been licensed in the US and insure a wide range of insurance risks. In the context of employer-sponsored health insurance plans, owners have greater visibility into the drivers of medical claims, insights that can assist more proactive and cost-effective healthcare. An example is an employee with kidney disease requiring dialysis treatments.

With traditional health insurance, the employer may not be aware that the employee has chosen to be treated in a high-cost hospital setting many miles from home.

With a self-funded captive alternative, the employer and its advisors have greater opportunity to consider thoughtful plan language that provides equal or better care often leading to better outcomes at a more favourable cost, such as arranging for a trained nurse to come to the individual’s home to provide treatment.

A captive may alleviate the sting of higher medical plan costs by reducing fixed insurance expenses and capturing underwriting profits and investment returns that ordinarily would revert to the health insurer.

Aside from pricing stability, other potential financial benefits include better control of cash flow and the sheer flexibility of plan and cost containment measures.

Stopping catastrophic losses

Despite these upsides, there are downsides to consider.

The chief risk in a captive health insurance programme is the possibility of catastrophic employee medical expenses. Both gene-based and cell-based therapeutical drugs used to treat or cure employees with rare cancers and genetic diseases may cost in the hundreds of thousands to millions of dollars range, on a per employee basis.

For this reason, companies may want to set a threshold of risk for the medical stop-loss insurance within the captive and transfer the remainder to a traditional insurer. The company’s insurance broker can assist with decisions on the appropriate level at which to insure these costs that align with the company’s risk tolerance.

Despite the benefits of this alternative risk-transfer approach, of the 90% of Fortune 500 companies that own captive subsidiaries, only a quarter have their stop-loss insurance in the captive.

Put another way, in the $30 billion stop-loss insurance market, captive medical stop-loss insurance accounts for approximately $1.5 billion to $2 billion of the total.

Certainly, a perfect storm is accumulating for employers to strongly consider the development of a risk-managed self-funded health plan backed by medical stop-loss insurance.

In an era of rising inflation, hospital costs and drug expenses are positioned to increase significantly in the foreseeable future, a prospect likely to make traditional employer-sponsored health insurance more expensive.