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Stop-Loss Coverage For Health Plans:
Pitfalls For The Unwary

By Mark Kinney
Lindquist & Vennum P.L.L.P.

The spiraling cost of health care in recent years has many employers scrambling for affordable coverage. In the rapidly changing world of health benefits, however, it is easy to lose sight of the fundamentals. One fundamental is that people get sick—very sick—and that the cost of health care in extreme cases can quickly reach into the millions. Small employers can cover this risk—for a price—by purchasing traditional group health insurance. Most mid- to large-sized employers, however, self-insure their group health benefits. These employers avoid catastrophic medical expenses by purchasing stop-loss insurance for claims that exceed a certain fixed level.

For many risk and human resource managers, stop-loss insurance is an afterthought in the design of their self-insured group health plan. Too often, the first time they read their stop-loss policy—really read it, that is—is after the insurer has turned down a large claim. On close examination, they learn that the policy contains numerous exceptions to coverage. Or they discover that the insurer has reserved the right to change the terms of its coverage due to the occurrence of certain events. Ultimately, the employer is responsible for claims that are not covered by insurance.

Stop-loss insurance is an essential and valuable component of every self-insured health plan. But it is also a complex form of coverage and limited in scope. The following are just a few of the risks that employers must consider when purchasing stop-loss coverage:

• Avoid gaps in coverage when changing carriers. Many employers change stop-loss carriers whenever they change third-party administrators. Replacement carriers, however, typically refuse to provide coverage for claims that were “incurred” before their coverage went into effect. Previous carriers, by comparison, typically refuse to provide coverage for claims that are “paid” after their coverage terminates. This leaves a gap in coverage for claims that are “incurred but not paid” in the months before the transition.

One way to eliminate this gap is to purchase a “tail” from the first insurer. Employers should demand coverage for claims that are not only incurred in the final year of coverage, but paid during a reasonable period thereafter (three to six months, for example). Employers should not try to make this bargain in the final year of coverage or the insurer will think the employer is aware of a large pending claim. It is best to negotiate a tail before entering into the contract in the first year.

• Be careful when offering health benefits to former employees. Most stop-loss insurance policies only provide coverage for claims that are incurred by “eligible participants.” Some policies expressly limit coverage to active employees (including qualified beneficiaries under COBRA). Employers, on the other hand, commonly extend health benefits to former employees in severance or early retirement packages.

When a large claim is submitted to a stop-loss carrier, the carrier will seek to verify whether the individual who incurred the claim was eligible for coverage under the employer’s group health plan. For this purpose, the “group health plan” is the plan on file with the carrier at the time coverage is issued. Any amendments to this plan, such as an amendment extending coverage to former employees, must be approved in writing by the carrier. If an amendment pertaining to eligibility is not approved in writing by the carrier, a claim arising from the newly eligible group will be denied.

• Stay alert to changes in claims experience and employee demographics. Some policies permit the insurer to change the terms of its coverage upon the occurrence of certain events. For example, if health claims paid in the last two months of the previous year exceed a certain level, the policy might provide that the insurer can change the “attachment point” in the following year. A similar clause may permit the insurer to change its coverage in the event that the number of covered employees increases or decreases by a certain percentage. This gives the insurer an enormous advantage: it can adopt a “wait and see” approach, collecting premiums while reserving the right to change the deal if it looks like it might have to pay.

Employers should require the insurer to spell out the impact that a change in claims or demographics will have on coverage. They should also limit the period of time in which an insurer can change coverage following a triggering event. Such provision will allow employers to seek alternative coverage, or at least to understand exactly what risks are uninsured.

In summary, stop-loss insurance has been and continues to be a useful tool for managing liability for group health plans. But it is not unlimited in scope. Employers must understand exactly what protection is offered by competing vendors and negotiate changes where necessary to control the risk of catastrophic claims. 

ABOUT THE AUTHOR

Mark Kinney, a partner with the Minneapolis law firm of Lindquist & Vennum, provides legal and business advice on a broad range of employee benefits including self-funded health plans, flexible benefit plans and qualified retirement plans. He has particular expertise in the design and implementation of defined contribution health plans.

riskVue | The webzine for risk management professionals
November 2002