Shopping group health for your team
Level-funded health insurance is a hybrid funding model marketed specifically as the optimal middle-ground alternative for employers who want the cost-control, data transparency, and structural benefits of self-funding, without exposing their balance sheet to volatile monthly claims risk.
In a traditional fully insured arrangement, the insurance carrier sets a premium, takes the money, and keeps 100% of the profit if your employees are healthy. In a traditional self-funded arrangement, the employer pays claims as they occur, which means a catastrophic hospital visit can result in an unpredictable, massive invoice in any given month. Level-funding solves this tension. The employer pays a strictly fixed monthly amount that covers administrative fees, stop-loss insurance premiums, and an estimated claims fund. If claims run higher than the fund, stop-loss insurance covers the difference—you never pay more than the fixed monthly rate. If claims run lower than the fund, you receive a refund at the end of the year.
For California employers, level-funding represents a profound strategic shift. Because these plans are technically classified as self-funded under federal law, they preempt state-level insurance mandates, allowing businesses to escape the regulatory density of fully insured California group markets. The intended audience for this model is typically small-to-mid-sized enterprises; companies with enough employees to spread moderate risk but lacking the massive capital reserves required to self-fund outright.
This guide provides a comprehensive, mechanics-first breakdown of how level-funded health plans operate, the financial and legal frameworks that govern them, and the specific decision points Human Resources leaders and executives must evaluate before transitioning their workforce.
To understand how a level-funded plan manages risk and capital, you must understand how its monthly costs are constructed. When you purchase a fully insured plan, your premium is a “black box.” The carrier does not tell you what percentage of your payment goes to hospital claims, what percentage goes to administrative overhead, or what percentage is pure profit.
Level-funding unbundles this black box into three distinct, transparent buckets. Your fixed monthly payment is simply the sum of these three components:
This is an escrow-style account used solely to pay your employees’ day-to-day medical and pharmacy claims. Actuaries calculate your expected claims for the year based on your group’s demographics, location, and health history, and divide that total by twelve. You pay this predictable amount into the claims fund each month. When an employee visits an in-network doctor, the Third-Party Administrator (TPA) pulls money from this specific bucket to pay the provider.
Because you are technically self-funding, you are no longer buying “insurance” in the traditional sense; you are renting services. The administrative bucket pays for the structural operation of the plan. This includes fees for your TPA (who processes the claims, answers the customer service lines, and mails the ID cards), access fees for leasing a carrier’s PPO provider network, fees for your Pharmacy Benefit Manager (PBM), and broker commissions. These are fixed costs.
This is the critical safety net that makes level-funding predictable. Stop-loss insurance is not health insurance for your employees; it is financial insurance for the employer. You pay a premium to a stop-loss carrier to cap your liability. If an individual employee incurs a catastrophic claim, or if the group as a whole exceeds the claims fund, the stop-loss carrier pays the excess.
Because the maximum monthly payment is contractually capped, the Chief Financial Officer or HR Director knows exactly what the highest possible healthcare expense will be for the fiscal year.
| Feature | Fully Insured Plan | Level-Funded Plan | Traditional Self-Funded |
|---|---|---|---|
| Monthly Cost | Fixed and inflexible. | Fixed maximum, potential for refund. | Highly volatile based on actual claims. |
| Claims Risk | Carrier bears all risk. | Employer bears risk up to a cap; stop-loss covers the rest. | Employer bears direct risk up to a high attachment point. |
| Surplus Funds | Carrier keeps 100% of profit. | Employer receives a refund of unused claims. | Employer keeps all unused funds in real time. |
| Data Transparency | None or extremely limited. | Full, de-identified claims reporting. | Full, granular claims reporting. |
| State Mandates | Subject to all CA mandates. | Exempt under ERISA. | Exempt under ERISA. |
The most attractive feature of a level-funded plan is the potential for a year-end refund. However, this is not a simple transaction. The refund process involves strict accounting rules, run-out periods, and contractual surplus splits.
Medical billing is notoriously slow. If an employee visits the emergency room on December 28th, the hospital might not send the bill to your TPA until February 15th. In the insurance industry, this is known as IBNR (Incurred But Not Reported) claims.
Because of IBNR, your level-funded plan does not audit its claims fund on the last day of the plan year. Instead, contracts include a “run-out” period, which is a designated window of time after the plan year ends during which the TPA will continue to pay claims that were incurred during the active plan year.
Standard industry contracts are often written on a “12/15” basis. This means the contract covers claims incurred during the 12 months of the plan year and paid within 15 months (the 12 months of the year plus a 3-month run-out period). Other common structures include 12/18 or even 12/24 contracts.
Once the run-out period concludes, the TPA conducts a final audit of the claims fund.
If the audit reveals that your group’s total claims for the year (including those paid during the run-out) were less than the amount you deposited into the claims fund, a surplus exists.
How that surplus is handled depends entirely on your specific contract:
If an employer receives a cash refund, those funds must be handled carefully under ERISA guidelines. If employees contributed to the plan premiums (e.g., through payroll deductions), a proportional amount of the refund may belong to the plan participants, not the employer. The employer must use that portion to enhance benefits, reduce future employee contributions, or distribute it back to the employees.
If your group experiences a terrible year for health—perhaps multiple complex surgeries, expensive specialty drug prescriptions, and high emergency room utilization—your claims fund will be depleted before the year is over.
In a traditional self-funded plan, the employer would have to write a check to cover those excess claims immediately. In a level-funded plan, the aggregate stop-loss insurance automatically activates. The stop-loss carrier steps in and pays all remaining claims for the year. The employer is never billed beyond their fixed monthly maximum. There are no “cash calls,” and the employer does not have to pay back the deficit in the following year (though a high-claims year will certainly impact your renewal rates).
Stop-loss insurance is what transforms a highly volatile self-funded arrangement into a safe, predictable level-funded arrangement. It operates in two parallel layers: Specific (Individual) Stop-Loss and Aggregate Stop-Loss.
Specific stop-loss protects the employer from catastrophic claims incurred by a single individual. When you establish the plan, you choose a “specific attachment point”—a financial threshold per member.
For example, a mid-sized employer might select a specific attachment point of $30,000. If an employee is diagnosed with cancer and incurs $150,000 in medical bills, the employer’s claims fund is only responsible for the first $30,000. Once that individual crosses the $30,000 threshold, the specific stop-loss policy pays the remaining $120,000. The individual’s catastrophic illness does not bankrupt the group’s claims fund, preserving the fund to pay for routine care for the rest of the employees.
Aggregate stop-loss protects the employer against a high frequency of moderate claims across the entire workforce.
Actuaries determine your expected annual claims. The aggregate stop-loss attachment point is customarily set at a percentage above that expected amount—typically 120% or 125%.
If the actuaries expect your group to incur $500,000 in claims over the year, a 120% aggregate attachment point would be $600,000. The employer funds the account up to that $600,000 maximum liability (spread out over 12 level monthly payments). If a severe flu season hits and a large portion of the workforce requires moderate medical care—none of which trigger the individual specific stop-loss, but which collectively total $700,000—the aggregate stop-loss policy pays the final $100,000.
When evaluating level-funded renewals, HR leaders must watch closely for a practice known as “lasering.”
During the underwriting process for renewal, the stop-loss carrier reviews the group’s ongoing medical claims. If the carrier identifies an employee who is currently receiving expensive, ongoing treatment (such as dialysis or specialty infusions), the carrier knows this individual will hit the standard specific attachment point immediately in the new plan year.
To protect their own margins, the stop-loss carrier may “laser” that individual, setting a separate, much higher attachment point specifically for them. For instance, while the rest of the group has a $30,000 specific attachment point, the lasered individual might be assigned a $150,000 attachment point. This forces the employer to absorb significantly more risk for that known condition.
Some level-funded contracts come with a “No Laser at Renewal” guarantee, which is a highly valuable contractual provision that protects employers from being punished for utilizing the plan exactly as intended.
To understand why level-funded plans are so aggressively marketed in California, you must understand the regulatory landscape of the state.
Fully insured health plans in California are governed by two primary bodies: the Department of Managed Health Care (DMHC), which regulates HMOs under the strict Knox-Keene Health Care Service Plan Act of 1975, and the California Department of Insurance (CDI), which regulates PPOs and traditional life/health products.
California has some of the most robust, expensive, and expansive state-level insurance mandates in the country. Fully insured plans must cover a massive list of specific treatments, providers, and procedures. These mandates undeniably increase the baseline premium cost for every fully insured group in the state, regardless of whether the employees actually utilize those specific mandated services.
Because a level-funded plan is legally a self-funded plan, it is governed by federal law: the Employee Retirement Income Security Act of 1974 (ERISA), overseen by the U.S. Department of Labor.
Under the ERISA preemption clause, self-funded plans are exempt from state insurance laws. A level-funded plan in California does not have to comply with Knox-Keene. It does not have to include state-mandated benefits. The employer, acting as the plan sponsor, has complete freedom to design the plan according to the actual needs of their workforce and the constraints of their budget.
This preemption is a massive cost-control lever. It allows employers to strip out coverage for high-cost, low-utilization mandates, customize their pharmacy formularies, and design specific wellness incentives that would be strictly regulated or prohibited under a fully insured California contract.
The freedom of ERISA preemption comes with a severe legal trade-off. In a fully insured plan, the insurance carrier is the fiduciary responsible for claim decisions and regulatory compliance.
In a level-funded (self-funded) plan, the employer is the legally designated Plan Administrator and the fiduciary. You are legally obligated to operate the plan solely in the best interest of the plan participants. If a claim is wrongly denied by your TPA, the employee’s ultimate legal recourse is against the employer, not the TPA. While TPAs handle the day-to-day administration and assume delegated administrative duties, the ultimate fiduciary liability rests on the employer’s shoulders.
Level-funding is not a universal solution. It is a highly specific financial tool that works brilliantly for the right demographic and fails painfully for the wrong one.
The general consensus places the “sweet spot” for level-funding between 20 and 250 employees.
Because you are essentially betting that your claims will come in under the maximum funded amount, level-funding requires a relatively healthy workforce.
During the initial quoting process, underwriters will aggressively evaluate your group’s risk. For smaller groups, this often requires employees to fill out Individual Medical Questionnaires (IMQs). For slightly larger groups, the carrier will perform “GRx” underwriting—pulling de-identified prescription drug histories for the workforce to identify chronic conditions and predict future medical costs.
If your workforce has multiple severe, ongoing chronic conditions, the actuaries will simply set your claims fund and stop-loss premiums extraordinarily high. In these cases, it is often mathematically superior to remain in the fully insured, community-rated ACA market (for groups under 100 in CA) where carriers cannot underwrite based on the specific health history of your group.
A level-funded plan requires a company to have stable, predictable cash flow. While the monthly payments are fixed, an employer must be prepared for the reality of renewals. If your group has a terrible claims year, your fixed maximum payment for the following year will increase significantly.
Employers must view level-funding as a multi-year strategy. In a three-year cycle, you may have one year with a massive refund, one year where you break even, and one year where claims exceed the fund (and stop-loss covers the deficit). The overall three-year cost will likely beat a fully insured plan, but the employer must be financially mature enough to weather the varying renewal increases.
When an employer moves to a level-funded arrangement, they transition from buying a pre-packaged product to assembling a team of service providers. The quality of your plan is entirely dependent on the quality of your vendors.
The TPA is the engine of your health plan. They do not insure your risk; they process your data. Their responsibilities include:
Prescription drugs often account for 25% to 30% of a group’s total healthcare spend. In a level-funded plan, you have the option to “carve out” your pharmacy benefits and contract directly with a PBM.
The PBM manages the formulary (the list of covered drugs), negotiates rebates with pharmaceutical manufacturers, and establishes clinical management programs (like requiring step-therapy before approving an expensive biologic drug).
In traditional fully insured plans, the carrier keeps all pharmacy rebates. In a transparent level-funded/TPA arrangement, the employer can negotiate a contract where 100% of those manufacturer rebates are returned directly to the employer’s claims fund, creating massive cost savings.
Because you are no longer bound by fully insured state mandates, you have immense flexibility in how you build the actual coverage your employees experience.
You can design a plan with any deductible, out-of-pocket maximum, or copay structure you desire, provided it still meets the federal standards for Minimum Essential Coverage (MEC) and Minimum Value under the Affordable Care Act (ACA).
For example, an employer in the manufacturing sector might know their employees struggle with high deductibles. They can design a plan with a $500 deductible and a robust first-dollar coverage structure for generic drugs, knowing that this will drive adherence to maintenance medications and prevent larger hospital claims down the line.
Because you are paying the claims out of your own fund, you have a vested interest in where your employees seek care.
A level-funded plan allows you to implement “steerage” strategies. If an employee needs a knee replacement, they can go to the standard hospital in the PPO network and pay their normal deductible. However, the employer can carve out a “Center of Excellence” agreement—perhaps negotiating a direct cash rate with a highly rated orthopedic surgery center. If the employee chooses the Center of Excellence, the employer waives the employee’s deductible entirely. The employee gets free surgery, and the employer pays a $15,000 bundled cash rate instead of a $40,000 network-discounted hospital rate. Both parties win.
Employers frequently bolt-on zero-cost telemedicine or Direct Primary Care (DPC) memberships to their level-funded plans. By encouraging employees to use a $0 virtual visit for a sinus infection, the employer prevents a $150 urgent care claim from hitting the claims fund. Over a year, redirecting low-acuity care away from expensive physical facilities generates massive savings, increasing the likelihood of a year-end surplus refund.
The regulatory burden of managing a self-funded/level-funded plan is significantly higher than managing a fully insured plan. HR teams must be prepared to handle federal compliance filings.
Under ERISA, employers sponsoring welfare benefit plans with 100 or more participants at the beginning of the plan year must file an annual Form 5500 with the Department of Labor. This form details the financial condition and operations of the plan.
The Patient Protection and Affordable Care Act established the Patient-Centered Outcomes Research Institute (PCORI). Self-funded and level-funded plan sponsors are required to pay an annual PCORI fee, calculated based on the average number of covered lives (employees plus dependents) on the plan. This is reported and paid annually using IRS Form 720.
You are legally required to maintain and distribute a Summary Plan Description (SPD) to all participants. The SPD is the ultimate legal governing document of the plan, detailing exactly what is and is not covered. You must also distribute a Summary of Benefits and Coverage (SBC), a standardized matrix that helps employees understand their costs. Because you are the fiduciary, errors in the SPD or SBC fall on the employer.
Applicable Large Employers (ALEs)—those with 50 or more full-time equivalent employees—must report the terms of their health coverage to the IRS to demonstrate compliance with the employer mandate. Fully insured employers rely on the carrier to do some of this reporting. Level-funded employers must ensure their TPA is equipped to handle the granular data required for 1094-C and 1095-C filings.
Moving a company from a fully insured HMO or PPO to a level-funded chassis is not a decision to be made in the final 30 days before renewal. It requires a strategic timeline.
The process begins with data gathering. The broker will submit the group’s census data to multiple level-funded carriers or independent TPAs. The group will undergo medical underwriting (either via IMQs or GRx data pulls). The broker will present proposals comparing the fixed maximum level-funded costs against the guaranteed fully insured renewal rates.
Once the financial feasibility is confirmed, the employer selects the stop-loss carrier, the TPA, and the PPO network. The HR team works with the TPA to draft the custom Summary Plan Description, deciding exactly which procedures will require prior authorization, how the pharmacy formulary will be tiered, and what the deductible structure will look like.
This is the critical failure point for many transitions. From the employee’s perspective, a level-funded plan looks and feels exactly like a traditional PPO. They get an ID card, they have a network of doctors, and they pay a copay.
However, because the employer is now paying the claims, HR must actively communicate the importance of consumerism. Employees must be educated on why utilizing the standalone imaging center for an MRI is better than using the hospital’s imaging center, and how to utilize the zero-cost telemedicine benefits. A level-funded plan only succeeds if the employees are educated on how to use it efficiently.
Use this framework to determine if your enterprise should pursue a level-funded strategy:
Speak with a licensed advisor to evaluate whether your group's demographics and risk profile align with a level-funded strategy.
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