Self-insurance: Boon or boondoggle?

Think twice about choosing this apparent tax- and premium-saver. Employee benefit-related errors could land you in prison.

By Roxanna Guilford

Self-insurance can be risky business. What looks like a strategy to cut costs and reduce red tape could end up costing you more than money.

Just ask Thomas Ball, CEO of Georgia suitmaker Private Line Group Inc., who was arrested in January. Officials with the Georgia insurance commissioner’s office allege that he deducted money from employees’ paychecks for health coverage that didn’t exist.

Doug Gaddis, an investigator with the Georgia insurance commissioner’s office, says the charges include insurance fraud, theft by deception and violation of the Georgia’s RICO (Racketeer Influenced and Corrupt Organizations) Act. Civil RICO charges were filed but later dropped.

And this isn’t a matter of mere government red tape. Ball was arrested and hauled off to jail (with the TV news cameras rolling). He is currently out on bond.

Gaddis admits the parent company (Genesse Group) subsequently posted a $300,000 cash bond to guarantee that employee health claims would be paid, but says this won’t change the status of the criminal charges.

Ball’s counsel, Atlanta attorney Jerry Froelich, expects the charges to be dropped. "We just want to get this matter behind us," he says.

What happened?

For Gaddis, the criminal intent is clear. "[Private Line] had been a profitable company. It was sold to an out-of-state company. The profits appear to have been diverted to the out-of-state company, which then put this company [Private Line] into a tail spin."

Private Line deducted insurance premiums for approximately 280 employees, Gaddis says. "They set up their own private insurance and continued to deduct premiums. When people put in claims, there was no coverage," Gaddis alleges. According to Gaddis, one woman had $120,000 in medical expenses. Total claims reached nearly half a million dollars and, after some employees filed a civil suit, the Georgia insurance commissioner’s office stepped in, Gaddis says.

Froelich offers quite another perspective. "There was absolutely no [criminal or fraudulent] intent," he contends, adding that all that happened was that claims were not paid right away. "There was just a shortfall in the company, and they missed on some of the payments on some of the claims," he explained.

Moreover, employees were apprised of the situation. Froelich maintains that Private Line kept them posted, acknowledging that the company was behind in the payments and guaranteeing that all health claims would be paid.

"In fact, there were memos sent out – saying that ‘we are going to pay all the claims.’"

This delay might not have generated significant concern, except for the fact that, during this time, Private Line happened to be selling one of its plants.

"There was a little bit of a panic situation," Froelich explains. "Everybody thought, ‘Oh, they are going to pack up and move out’." That panic ultimately led to the involvement of Georgia’s insurance commissioner. Froelich and many industry leaders who know Ball stress that he is above suspicion.

"He didn’t violate the law. I expect [all charges] to be dropped," says Froelich. "But if the state goes forward, we’re prepared to meet any charges."

Although the situation has yet to be resolved, the case may be a wakeup call to any apparel manufacturers unaware of the pitfalls of employee-benefit programs in general, and self-funded insurance in particular.

Fiduciary responsibility

Gaddis makes it sound so easy: "It’s not illegal to be a bad businessman, but it’s illegal to be a bad businessman and a crook." But as Froelich notes, intent isn’t always so clear-cut.

Susan Katz Hoffman, a partner at Pepper Hamilton, LLP, and senior member of that firm’s employee-benefits section, comments that most companies are unaware of how easy it is to commit fraud – even without intent. All it takes is diverting money intended for health insurance to some other purpose – whether or not you are self-insured. If you are collecting employee money for insurance, it better be contributed to that plan, or you are committing a crime.

"If they have two bills to pay and one is the Blue Cross bill and one is the light bill, they’d better pay the Blue Cross bill if they’ve got to choose," Hoffman warns. "Not paying the light bill will put them in bankruptcy, but not paying the Blue Cross bill will put them in jail – if there’s employee money they’re taking in."

The principle is simple, says attorney Alan Rolnick, of Constangy, Brooks and Smith in Atlanta. It comes down to fiduciary responsibility. "You’ve got to do what you say you are going to do," he explains. If you take employee money for a specific purpose, it must be directed to that purpose. "That’s a basic principle of law and business," he adds, and it’s not specific to any one aspect of your business.

It takes more than knowing the basics to set up a solid self-insurance program.

Know what you are getting into

Do you have the expertise to administer a self-insurance program? It may be more work and less savings than you anticipate.

"The company that chooses to self-insure should more or less do the same things that an insurer would do: have clearly defined benefits, develop sound pricing for those benefits, establish reserves where appropriate, and ensure that the necessary infrastructure exists to manage the program," advises Harold D. Skipper, Jr., Ph.D.

Skipper, professor of risk management and insurance at Georgia State University’s College of Business Administration, adds that business owners shouldn’t approach this task lightly.

"This is not a ‘seat of the pants’ exercise," he warns. "It needs professional advice, such as that which an actuarial consulting firm could provide."

Hoffman agrees. She advises companies considering self-insurance to use a good consultant ("not an insurance agent trying to sell you something") and a benefits attorney.

Once you have experts to help you, you must assess your risk – get accurate estimates on potential claims and other payouts. "Have your consultant run through a number of worst-case scenarios," she advises.

Even if you take all these precautions, are you prepared for catastrophic claims? Hoffman also advises purchasing stop-loss insurance – a policy that will handle claims over a certain amount. "Stop-loss insurance is essential," she says. "You want to provide real insurance, but you don’t want to expose yourself to an unlimited checkbook."

If you sign up for a stop-loss policy, read it. Make sure that everyone – including former employees on COBRA and those on disability – are covered. Get it in writing. In addition, keep in mind these plans only pay after you pay your share. If you default, the policy pays nothing.

Don’t get scammed

Be wary of anyone who tries to pitch you a multiple-employer arrangement in which the promoter puts together a number of small businesses to create a large self-funded plan. "It is often fraudulent," Hoffman warns. "Legitimate, fully insured multiple-employer arrangements are mostly offered through chambers of commerce or trade and professional organizations, so if you are approached with an uninsured, self-funded, multiple employer arrangement, walk away."

Day-to-day administration

Once you set up the program, you’ll have to manage it on an ongoing basis. Remember: a company that self-insures must function as an insurer. You’ll need employees or a third-party administrator to handle a variety of tasks. Your company must do the following:

• Settle claims.

• Provide accurate information to employees.

• Calculate appropriate contributions from employees (if contributory) and the employer.

• Estimate liabilities (especially for benefits that may involve pay-outs over many years or that entail post-retirement benefits, for example).

"Self-insurance offers the potential for tax and other savings, but the company should have sufficient expertise to manage the exercise competently," Skipper warns, adding that any company planning to self-insure "probably should be fairly large to be able to realize economies and to have credible experience."

"Any company in financial difficulty shouldn’t be using self-funding at all," Hoffman says. "It’s just too hazardous to the employees and to the company."u

(Disclaimer: Neither AIM nor the author professes to be a legal expert; consult your attorney.)

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