When it comes to self-funding health plans, businesses often face a critical decision: choosing the right payment arrangement. Two of the most common options are level funding and pay-as-you-go. But which one is better for your organization? Each approach has its advantages and disadvantages, making it essential to understand how they work before making a decision.
Level Funding
Advantages
- Predictability and Budgeting: Level funding means you fund the plan at the maximum liability each month. This method offers easy budgeting and predictability, making it straightforward to track expenses.
- No Downside Risk: Since you are already funding the plan at the maximum liability, there’s no risk if claims are higher than expected. Large shock claims are easier to process with stop-loss coverage due to the reserves that accumulate over time.
- Financial Settlements: At the end of the year, a financial settlement occurs. If claims are higher than expected, no additional money is owed because the plan is already funded at the maximum liability. If there is a surplus, 100% of it is returned to the plan via monthly funding credits.
Disadvantages
- Cash Flow Impact: Level funding can be less favorable for cash flow, as funds need to be held in a separate trust account.
- Time-Consuming Settlements: Additional time is required to work through the financial settlement at the end of the year.
Pay-As-You-Go
Advantages
- Improved Cash Flow: This approach can improve cash flow during periods when claims are lower than expected. You pay claims as they are incurred and invoiced on a weekly basis.
- Control and Transparency: With pay-as-you-go, you have more control over where the funds are held, how much money is reserved, and how it is invested. This method also provides greater transparency, as you view claims weekly when being invoiced.
Disadvantages
- Greater Fiduciary Responsibility: This method requires careful reserving and budgeting. The plan must be prepared to fund high-dollar shock claims, which can sometimes take months to process for reimbursement through stop-loss coverage.
- Potential Cash Flow Issues: Cash flows can be negatively impacted during periods of high claims. Employers need a solid handle on their finances to meet the fiduciary requirement of timely claim payments. Failure to do so can lead to legal challenges and employee relations issues.
Choosing between level funding and pay-as-you-go depends on your organization’s financial situation and risk tolerance. Level funding offers predictability and no downside risk but impacts cash flow and requires time for settlements. Pay-as-you-go improves cash flow and control but demands greater fiduciary responsibility and can lead to cash flow issues during high-claim periods. Carefully assess your company’s financial health and risk management capabilities to determine which payment arrangement best suits your needs.
