A guide to stop-loss insurance - includes related article

Business & Health, May, 1990 by Joyce Frieden

A guide to stop-loss insurance

If your firm is self-insured, do you know which stop-loss option will give you the most bang for your buck? This guide can help you decide.

After seeing its corporate health insurance premiums rise more than 30 percent annually for three years, beleaguered Company X executives decided that the firm could do just as well--or better--by dropping its standard health insurance policy and, instead, paying for employee health claims itself.

For the first year, all was well. The company's health care costs actually dropped 10 percent. However, in June of the second year, a snag developed; one of Company X's employees developed severe heart problems that necessitated a transplant. The company didn't have enough money set aside for a claim that large. Instead, they had to borrow the money at high interest rates, thus weakening the firm's financial condition.

Why stop-loss?

In our hypothetical example, self-insurance worked well--until the firm was hit with a catastrophic expense. How do self-insured firms prevent such bills from rendering them bankrupt? By purchasing stop-loss insurance.

Stop-loss insurance takes some of the gamble out of self-insuring because it pays any claim that is more than the "deductible"--in other words, the amount that the company chooses to pay out-of-pocket.

The risk with stop-loss insurance is that a company may end up paying for a service it doesn't use. In fact, industry sources say, the insurance pays off for only 10 percent of firms that use it; the other 90 percent of firms never reach the "deductible."

How can you be sure you're not wasting money on stop-loss? Here's a guide to buying the stop-loss protection you need.

Types of stop-loss coverage

There are two types of stop-loss: specific and aggregate. Specific stop-loss insurance kicks in when a single covered person's claims go above a certain amount; aggregate stop-loss protects companies if their total health care bill goes over a certain set ceiling. Although each type can be purchased separately, many companies buy both. As with other kinds of insurance, the lower the "deductible"--that is, the less the company is willing to pay out-of-pocket--the higher the cost of stop-loss insurance. If the firm is willing to pay a higher deductible, the insurance premium goes down.

The rate of medical inflation has taken its toll on the cost of stop-loss insurance. In fact, inflation's effects get worse for employers as the deductible increases, explains Joe McErlane, president of National Benefit Resources in Minneapolis, an insurance management firm for stop-loss insurers.

Here's why. Take a company with a $15,000 claim. If it buys a fully insured specific stop-loss policy--that is, with no deductible--the carrier pays the entire $15,000. Say the next year, medical costs rise 18 percent. Therefore, the cost to the carrier for the same claim would be 18 percent more, or $17,700. To compensate, the carrier raises rates by at least 18 percent.

Sounds simple enough. But suppose another company with a $10,000-deductible policy had the same $15,000 expense the first year; the carrier paid $5,000 on that claim (the amount over the deductible). The next year, that same procedure costs $17,700, so the carrier has to pay $7,700--a 54 percent increase from $5,000. Therefore, the carrier would raise rates well in excess of the medical inflation trend in anticipation of such a claim. To lessen the impact of inflation, employers usually increase their deductibles each year; this lowers their starting premiums.

While some self-insured employers saw stop-loss rate increases as high as 70 percent in 1988 and the beginning of 1989, McErlane predicts lower increases in 1990--on the average of 20 percent to 45 percent. "I don't think costs will go down, but I do think [increases] will stay at a manageable level," he says.

Types of policies

Companies may choose from several types of stop-loss policies. One standard policy is called a "12/12" policy, in which claims are covered only if they are incurred and paid within the same 12-month period. For added protection, a "12/15" policy covers claims incurred within a 12-month period and paid within three months after the end of the covered period. "12/18," "12/24," and "12/36" policies provide similar coverage for longer periods.

Experts are divided

Experts are divided on the question of whether a "12/12" policy--the cheapest option among those listed--provides adequate coverage. Some contend that "12/12" is inadequate because a fair number of claims are incurred during the year and then paid after the year ends. Others note that during contract renewal, stop-loss carriers often will agree to cover late-arriving claims, and if it's a new policy, insurers can arrange to cover claims "in limbo" from the previous carrier.

For these and other reasons, stop-loss insurers offer policies to accomodate firms that want to cover claims incurred but not paid before the coverage begins; a "15/12" policy is one example.