Being in the employee benefits space for the last 20 years, I’ve seen a lot of proposals come across my desk. As a previous advisor myself (I now coach advisors directly), I have come to understand all the gears and components behind an employee benefits plan, particularly its premium pricing.
I think today it’s more important than ever to understand how employee benefit plans are priced because premiums are getting expensive every year. In fact, aside from salaries, benefits are the highest "people expense" businesses will incur.
Before we dive in, it’s important to grasp the fundamental methodology to how insurers price Extended Health Care (EHC), Drug and Dental plans:
Premiums = Employee Claims + Insurer Fees.
Because these benefits are used on a regular basis, they are fairly predictable. In order to determine what your premiums need to be, insurers take a historical average of your employee claims and factor in their fees on top. It's more or less a budgeting and projection exercise.
So for small business owners out there that are looking to shop around for the best deal, I put together a detailed list of tricks insurers use to make their benefit plans appear more competitive than they actually are. Hopefully by the end of this article, you will be able to look closer at every proposal you receive and see how good the offering really is (or is not!).
1. Stop Loss/Pooling Level Changes
Stop loss coverage is an insurance product that is usually included with every Extended Health Care (EHC) and drug plan. This product provides protection against catastrophic or unpredictable EHC & drug claims. Basically this covers any claims an employee spends over a set amount - also known as the stop-loss level or pooling level. Therefore any claims that are under this stop-loss level are covered by the employer through the plan.
In the past years stop loss / pooling level were usually set between $5,000 to $10,000 per individual per year but insurers have recently been known to increase this to $12,500 and up to $20,000. By increasing this limit, it increases employer risk exposure by having them assume more EHC and drug claims. This is a big concern because over the last few years there has been a considerable increase in the use of high cost specialty drugs (ie, drugs that cost more than $10,000 per year). When the employer is on the hook to cover these high drug claims, the affordability of their benefits plan is significantly compromised.
Another way to look at this is the car deductible analogy. If your car deductible is $1,000 (aka stop loss level) then you are responsible to pay the first $1,000 in damages in the event of a car accident. If your deductible gets increased to $2,000 - you have just doubled your risk exposure.
When insurers raise your stop loss level, they can lower your premiums which may appear attractive at first but they inherently transfer more of the risk onto you in exchange. Next time you look at a new benefits proposal or your own renewal proposal, double check to see what the stop loss level is and and determine if it’s an acceptable level of risk to take.
2. Conservative Cost Trend Projections
For EHC, drug and dental plans there is inflationary pressure that occurs every year to account for the rising cost of services. This inflation rate is also referred to as the trend rate. For example, if a dental cleaning costs $100 today but the trend is projected to be 5%, then this same dental cleaning will cost $105 next year.
Insurers apply a trend rate to all EHC, drug and dental plans to account for this change in prices. However insurers tend to be ultra conservative and project trends that are higher than what usually occurs which will ultimately increase your premiums. For example, if they predict a dental trend of 10% and each dental cleanings will cost $110 but in fact it’s only $105, they now over-stated the true cost of your dental plan.
Every year the Ontario Dental Association publishes a suggested fee guide for Ontario dentists to follow. When reviewing the trend rate assumed by your insurer, double check to see if it falls within the suggested fee guide - if it’s not, challenge them on it and request an explanation for the discrepancy.
3. Higher Target Loss Ratios
Target Loss Ratio (TLR) is another fancy way of saying insurer admin fees or overhead expenses. They are typically represented as a percentage that range from 70-83%. If your TLR is 75% for example, that means 75% of your premiums are covering your claims while 25% are going towards insurer admin fees. The higher the TLR the better, as a lower percentage of your premium is spent on insurer admin fees.
Now, the TLR that you receive is largely attributed to the size of your group and/or premium volumes. The bigger the group or premium volumes, the higher/better TLR you will receive due to economies of scale. This is why larger employers can receive better rates per dollar on their benefit plans than smaller sized employers.
If you receive a quote that has an TLR of 84% or more, then check the trend rate - chances are the trend % will be higher than what would be considered reasonable. I call this stealing from one and giving it to the other.
4. Rate Guarantees and Rate Caps
Rate guarantees is a relatively new tactic employed by insurers - it has been particularly common during COVID as many businesses are struggling financially. They began to offer rate guarantees to employers as a means to “lock rates” for a period of time. However this tactic will usually hurt clients in the long run with huge increases when the guarantee expires.
Let’s assume you receive a rate guarantee of 24 months for EHC and dental. Usually the rates will either be kept the same for 24 months or the rate increase will be limited to 10-15%, depending on the insurer's offering.
Issue # 1 - If the claims experience over the 24 month period is very good whereby EHC, drug and dental claims and fees are less than the premiums, there will be extra profit that the insurer keeps. This is a big contrast to Beneplan’s refund model whereby we give back excess premiums back to members.
Issue # 2 - If the claims experience over the 24 months is not good and claims and fees are more than the premiums, eventually when rate guarantees expire there will be huge increases because they’ll want to cover this loss and account for the trend rate discussed earlier. If we assume that there is a 10% trend (inflation) per year on EHC, there will be more than 20% increase on month 25 as the rates for the past 24 months did not change to account for this cost increase.
5. Incurred But Not Reported (IBNR) Estimates
This may be the most technical trick in the book so bear with me.
IBNR stands for "Incurred But Not Reported" claims and they represent claims that have been made but not yet finalized in the insurer books. Insurers charge policyholders to fund for these “time delayed” claims. An example of “time delayed” claims is when an employer leaves their insurer on November 30th but they submit their October and November claims to the insurer in December. The IBNR fund is used to pay these “time delayed” claims.
Most carriers will base their IBNR estimate as a % of the claims from that year. For example, if there was $50,000 in “paid claims” an insurer may estimate that there is an additional 5% of those paid claims ($2,500) somewhere time delayed in the processing mill. A more conservative insurer could project and assume that there is 8% of claims of IBNR or $4,000 in delayed claims somewhere in the “processing mill.
The term paid claims are claims that have been fully paid and reported whereas incurred claims are paid claims + the IBNR estimate. Insurers usually base their renewals on incurred claims and not paid claims which increases employer premiums since it is now based on the higher “estimated” incurred claims amount. Conversely other carriers (like Beneplan) target IBNR to only 5% of paid claims and base renewals on paid claims which ultimately benefits the employer.
There are many other factors to consider when shopping the market but if you pay attention to these 5 core tactics you’ll be miles ahead in understanding real value and the differences between quotes provided by multiple insurers.