ICHRAs Bring Cost Certainty to One of Most Business's Biggest Expense Lines

Employers gain more control over their medical-coverage budget line when they shift to an Individual-Coverage Health Reimbursement Arrangement.

Imagine you're a business owner. You hire the most competent finance and operations managers to keep your expenses low. They look for lower prices for raw materials, identify product and process improvements to minimize raw material usage, and negotiate effectively with current and prospective suppliers to keep prices in line.

Their efforts drive your company's profitability. Then, during a good financial year, thanks to their efforts, those savings evaporate instantly when you receive your medical renewal premium. On the one hand, you would have been worse off with the premium increase and no focus on cost reductions. On the other hand, you feel powerless when the savings that you and your team generate are erased by a line item over which you have little control.

Is there a solution? Perhaps. ICHRAs allow you to shift responsibility for medical claims, and thus your renewal premiums, from your budget to the nongroup or small-group insurance market in your region. Is this solution viable for your business? It depends. We'll break down the relevant factors below.

As a refresher, an ICHRA is an employer-funded account from which employees can withdraw funds to pay for medical coverage that they purchase in their local nongroup market. It's an alternative to the more traditional employer-sponsored model in which the company selects several options, usually pays a percentage of each plan's premium, and actively manages the enrollment process.

Small Group Pricing

Premiums for small companies (defined in most states as firms with 50 or fewer workers) aren't based on covered employees' claims. Instead, all claims are pooled with those incurred by all other small companies in the rating region. An insurer then calculates a single base rate for all small groups, regardless of any company's claims experience. The insurer sets premiums for each company by using this calculation and then factoring in the ages of employees and covered dependents (older people in general incur higher claims than younger ones, just as older cars on average require greater investment in maintenance than newer models) and location (employees living closer to expensive hospitals incur higher claims costs for the same services as workers who reside closer to providers with lower reimbursement rates).

Because of this pooling, a typical small fitness club can't capitalize on the superior claims experience of its employees with lower premiums. Similarly, the average small bar doesn't pay the full cost of its employees' claims in the form of higher premiums. Small-group premiums consist of a series of cross-subsidies that ensure that a small company with a sudden spike in claims (a premature baby or heart-lung transplant) doesn't receive a huge premium increase one year, then a sharp decline when it has a good year. Budgeting would be difficult in that scenario. And in the high-claim years, coverage would become unaffordable.

Large Group Pricing

Some Applicable Large Employers (ALEs) can reduce their (and their employees') spending on medical coverage through an ICHRA. Premiums in this segment of the market are based in whole or in part on employees and their covered dependents' projected claims, which are a function of their recent claims experience and an assessment of whether experience will continue in the future.

Example: Gugga Bump Shrimp Company covers 120 employees and paid $2 million in premiums last year ($1.70 million in claims and $300,000 in admin). This year, claims alone are projected to rise to $2 million, an 18% increase. If the insurer determines that this increase reflects the new claims level (versus high claims for one employee who has since died or become disabled and removed from the plan), the total premium for next year will be $2.36 million, or 18% more than last year.

Of course, in our example, Gugga Bump's benefits advisor can "shop" the plan by asking other insurers to bid on the business. Those insurers will require two years of claims, so the increase utilization won't be a secret. Another insurer may look at the case a little differently, but it's unlikely that Gugga Bump can find coverage that increases by only single digits year-over-year.

What's a company to do? Prior to 2020, it had little choice but to continue coverage and fund the increase through some combination of increasing employees' payroll deductions for premiums, increasing employee cost sharing, reducing other line items in the benefits budget (for example, training, tuition reimbursement, adoption assistance, celebrations, or annual bonuses), or finding the money in another budget area (perhaps reducing marketing or travel expenses).

A few fortunate companies may have cost-plus contracts with a captive customer (like a unit of government) that allow the company to pass the full increase to someone else. But those arrangements are rare. Most companies must find the means within their budgets to absorb premium increases that typically rise much faster than inflation and usually faster than revenue.

How ICHRAs Work

Employers who offer ICHRAs don't offer employer-sponsored insurance. Rather, they give each employee a tax-free stipend (usually adjusted for family size and age) to shop for coverage in the nongroup market. Pricing in this segment follows the small-group model: All claims are pooled to create a base premium, which is then adjusted for each policy based on family size and age (hence the frequent variation in employer's stipends to each employee).

Employees shop in the nongroup market to find the coverage that works best for themselves (and family, if applicable). These plans vary in premium, cost sharing (deductibles, coinsurance, and premiums), limits on financial responsibility, participating providers, and prescription drugs covered. Employees balance their preferences on these dimensions with the corresponding premium to choose the optimal plan. They then apply the monthly ICHRA stipend to their premium.

ICHRAs shift the traditional coverage model. Large employers no longer carry liability for employees' (and their families') claims on the company's books, nor are small companies responsible for claims within the small-group market. Employers simply provide a stipend to employees.

When Does Removing Claims Liability Work?

Let's examine the practical effect of shedding claims responsibility from the company's income statement.

Applicable Large Employer. A shift to an ICHRA can produce dramatic results in this segment of the market. The driver of savings is the company's claims relative to premiums in the nongroup market.

Example: Blanch's Ranches, a collection of alpaca and sheep farms, has 75 employees, so it's an ALE. Many workers are either seniors enrolled on Medicare or covered on a spouse's plan. These workers waive Blanch's Ranches' medical coverage, leaving only 22 workers on the plan. Still, regardless of enrollment, the company is rated as a large employer, so its claims experience drives renewal premiums. One of the employees is being treated for a rare cancer. Another survived a near-fatal vehicular accident and has been hospitalized for two months so far. These two employees' claims represent a huge absolute-dollar and percentage increase in the cost of care in a group with only 20 other workers covered. As a result, the renewal premium increase is 37%.

Blanch's Ranches can send the employees shopping in the nongroup market and give each an ICHRA. It can keep its total spending at this year's level (rather than absorb the 37% increase). Employees can then shop for coverage in the nongroup market and buy coverage that's either:

• similar to the company's expiring plan for less money out of their pocket (premium less the ICHRA stipend) than they're paying now, or

• imposes lower cost sharing (lower deductibles, coinsurance, and copays) than the company's soon-to-be-former plan for the same net premium that they pay today.

The claims responsibility shifts to the nongroup market, where the financial effect of these claims, spread over tens of thousands or hundreds of thousands of policies rather than attached to a pool of 22 enrollees, is minimal.

The company wins. Employees win.

The degree to which they win depends on the premium savings, the design of the plans available in the nongroup market, and the employee experience shopping for, choosing, and paying for nongroup coverage. In an extreme case like Blanch's Ranches, these considerations are weighed against large premium savings. When the premium differences aren't as great, plan design and the shopping experience loom larger as factors.

Small group. The effect of the shift to an ICHRA is different here because small-group claims are already pooled. If Blanch's Ranches in the illustration above employed 50 or fewer workers and had two employees experience the same high claims, the company wouldn't bear the financial chock of those claims. Instead, the expenses would be distributed across all small groups participating in the small-group pool.

So, is an ICHRA still a good option to consider?

Yes! Definitely worth considering. Here are the factors to consider:

• What are the relative premiums in the small-group and nongroup markets? If base nongroup premiums are, say, 6% lower than small-group premiums, moving to an ICHRA may allow the company and most workers to spend less in total for comparable coverage. Employers have no control over base premiums in either market.

• What do the plans offered in the nongroup market look like? If they have limited networks and high cost-sharing, those design features may make the coverage less attractive to current and prospective employees. The company may save a few bucks at the expense of incurring much higher costs through vacant positions, recruiting, and training new employees. Employers have no control over the products offered.

• How is the shopping and administrative experience of the ICHRA? Do employees have access to the right shopping tools and a payment system that makes monthly payment of their premiums simple? Some ICHRA platforms are more comprehensive than others (and are priced accordingly). Employers have total control over this experience.

The Bottom Line

ICHRAs offer many benefits to employers and workers - more cost certainty and less administration for the company, more plan options and more permanent coverage to employees. Every company should weigh this option at renewal. Employers who already have high base premiums or are facing large premium increases owe it to themselves and their employees to seriously consider this shift.

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The content of this column is informational only. It is not intended, nor should the reader construe the content, as legal advice. Please consult your personal legal, tax, or financial counsel for information about how this information applies to you or your entity.

ICHRA Insights is published (approximately) biweekly.