Most small business owners assume their only option for group health insurance is a fully insured plan — where you pay a fixed premium to an insurance company and they pay the claims. But there’s a growing alternative that can offer significant cost savings for the right businesses: self-funded and level-funded health plans. Once reserved for large employers, these arrangements are now accessible to businesses with as few as 5-10 employees in some markets. This guide explains how self-funded and level-funded plans work, the benefits and risks, and how to evaluate whether they’re right for your business.
What Is a Fully Insured Plan?
Before explaining self-funded plans, it helps to understand what you’re comparing against. A fully insured plan is the traditional model: you pay a fixed monthly premium to an insurance company, and the insurer accepts all the financial risk for employee claims. If your employees have a great health year with low claims, the insurance company keeps the excess premium as profit. If they have a terrible year, the insurer pays the claims regardless of how much you’ve paid in premium.
Fully insured small group plans are regulated by state insurance departments, which mandate minimum benefits that must be included in coverage. These mandated benefits add cost — in some states, mandated benefits add 20-30% to premiums. Fully insured plans also incorporate the insurer’s profit margin, administrative costs, and risk charge into your premium.
What Is a Self-Funded Health Plan?
In a self-funded (or self-insured) arrangement, the employer assumes financial responsibility for employee health claims directly rather than paying a fixed premium to an insurance company. Instead of paying a premium to an insurer, you pay employee claims as they occur. You’re essentially acting as your own insurance company for the routine, predictable costs of employee healthcare.
Of course, no small business can absorb the risk of a catastrophic claim without protection. Self-funded employers purchase stop-loss insurance — a separate policy that kicks in when individual claims or total claims exceed certain thresholds. Stop-loss insurance protects against individual catastrophic claims (specific stop-loss) and against aggregate claims exceeding a total for the year (aggregate stop-loss).
Self-funded plans are governed by ERISA (federal law) rather than state insurance regulations. This has significant implications: self-funded plans can be designed without mandated state benefits (potentially reducing costs), and they can be offered uniformly to employees across multiple states without varying the plan design to meet each state’s mandates.
What Is a Level-Funded Plan?
Level-funded plans are a hybrid between fully insured and self-funded that’s specifically designed for small businesses. With a level-funded plan, you pay a fixed monthly amount (the “level” payment) that includes: (1) an administrative fee to the TPA that manages the plan, (2) a claims fund contribution that accumulates to pay employee claims, and (3) stop-loss insurance to protect against catastrophic claims.
If actual claims for the year are lower than the claims fund, you may receive a refund of the surplus at year end — often called a “surplus sharing” or “claims credit.” If claims exceed the fund, the stop-loss coverage kicks in to cover the excess. The insurer cannot cancel the plan mid-year or raise rates during the plan year based on claims experience.
Level-funded plans behave like fully insured plans from an administrative standpoint (fixed monthly payment, no direct claims management required by the employer) but share the cost-savings potential of self-funded plans if your employee population has low or average claims. According to the Self-Insurance Institute of America (SIIA), level-funded plans are now offered by most major carriers and are accessible to businesses with as few as 5 employees in some markets.
Potential Cost Savings
The cost savings potential of self-funded and level-funded plans comes from several sources:
Elimination of State Mandated Benefits
Self-funded plans are exempt from state benefit mandates. In states with extensive mandated benefits, this alone can reduce costs by 10-20%. (Note: level-funded plans’ exempt status varies — some are structured as ERISA plans and qualify for exemption; others are structured as insurance products and remain subject to state mandates. Clarify this with any level-funded carrier.)
Access to Actual Claims Data
Fully insured plan premiums for small groups are based on community rating — meaning your rates reflect the average experience of all small businesses in your area, not your specific employees’ health claims. If your workforce is young and healthy, you’re subsidizing sicker small groups. With a level-funded or self-funded plan, your costs over time reflect your actual claims experience, not the community average.
Surplus Sharing
If your employees have a healthier-than-expected year, level-funded plans may return surplus funds to you. Fully insured plans simply keep the excess premium as profit. Over several good health years, surplus sharing can significantly reduce effective benefit costs.
Transparency and Control
Self-funded and level-funded plans provide claims data that fully insured small group plans don’t. You can see which diagnoses and services are driving costs, identify opportunities for targeted wellness programs, and make plan design changes to encourage cost-effective care.
The Risks and Considerations
Self-funded and level-funded plans aren’t right for every small business. Key risks and considerations:
Claims Volatility
Even with stop-loss insurance, self-funded employers bear more claims risk than fully insured employers. A bad health year for your employee population — multiple high-cost pregnancies, a cancer diagnosis, a serious injury — can result in higher costs than a fully insured plan. Stop-loss protects against the catastrophic, but there’s a band of risk between normal and catastrophic that the employer absorbs.
Administrative Complexity
Self-funded plans require more administrative infrastructure: a Third Party Administrator (TPA) to process claims, stop-loss carrier relationships, plan document maintenance, ERISA compliance, and annual Form 5500 filing. Level-funded plans simplify much of this administration, but still involve more complexity than a straightforward fully insured plan.
Population Size
The risk-pooling mathematics of self-funding work better with larger employee populations. A single catastrophic claim at a 5-person company represents 20% of the population; at a 50-person company, it’s 2%. Most advisors suggest that level-funded plans make the most financial sense for businesses with at least 10-15 employees, with traditional self-funding being more appropriate for 50+ employees.
How to Evaluate a Level-Funded Plan
When evaluating a level-funded proposal, compare:
- Total annual maximum exposure (what you’d pay in a worst-case claims year)
- Stop-loss attachment points (specific and aggregate thresholds)
- Surplus sharing provisions (what percentage you retain, when it’s paid)
- TPA quality and network breadth
- Carrier financial strength and stop-loss terms
- Renewal rate practices (how aggressively do rates change after a high-claims year?)
Frequently Asked Questions
Can I switch from a fully insured to a level-funded plan mid-year?
Generally no — most plan changes occur at the annual renewal date. Some carriers allow off-cycle enrollment with appropriate underwriting, but mid-year transitions are uncommon and administratively complex.
Do employees notice a difference between fully insured and level-funded plans?
Typically not, if the plan is well-designed. Employees receive the same ID cards, use the same network, and access the same benefits. The difference is in how the employer finances the plan, not in the employee experience.
Is my employee data private in a self-funded or level-funded plan?
Yes. HIPAA privacy rules apply to self-funded plans. The employer does not have access to individual employee claims data — aggregate data and de-identified information can be reviewed, but individual employee health information is protected.
What happens if my level-funded plan has terrible claims experience?
Stop-loss insurance limits your maximum exposure. At renewal, the carrier may increase rates significantly based on claims history, or may non-renew the plan. If your stop-loss carrier non-renews, you’d need to return to the fully insured market, potentially at higher rates. This is why carrier selection and stop-loss terms matter.
Self-funded and level-funded health plans offer real cost savings opportunities for the right small businesses — but require careful evaluation and the right guidance. At Garden State Benefits, Paul Z Olah helps small business owners across NJ and 25 other states evaluate all their health plan options, including level-funded alternatives to traditional insurance. Call 856-880-6340 or email paul@gardenstatebenefits.com to explore whether a level-funded plan could save your business money.