Self-funded short-term disability considerations

An employer’s decision regarding whether to insure its short-term disability (STD) plan depends on several factors, including the employer’s size, risk appetite, historical STD experience, desired plan design, cost considerations, and available resources. Milliman’s Tasha Khan provides more perspective in her article “Short-term disability: To be or not to be (self-funded)?

Here is an excerpt:

Employer size
STD plans typically pay a portion of lost income when an employee is disabled due to illness or injury. Usually STD covers the period of time between when sick leave/paid time off runs out and when long-term disability (LTD) benefits begin. Compared with life insurance or LTD insurance, STD is a high-frequency and low-severity benefit (i.e., there are many claims with relatively low benefit amounts, similar to most medical claims). This means that even smaller employers can quickly develop meaningful historical experience. Insurers generally consider STD claims experience to be fully credible at roughly 500 to 1,000 lives (varying by insurer and by benefit waiting period). This means that for a group with 500 or more employees, the insurance company will estimate the group’s future claims based primarily on that group’s past paid claims. This does not mean that future claims will be exactly equal to past claims; it means only that past claims are stable enough to be a useful predictor of future claims.

Due in part to this stability in claims experience over time, larger employers tend to be more likely to self-fund their STD benefits than smaller employers. For an employer with, say, 50 lives, STD claim payments could swing dramatically from year to year, making budgeting for these costs difficult. An employer with 5,000 lives, on the other hand, may expect claim payments to remain fairly stable from year to year.

Risk tolerance
Another consideration is the employer’s tolerance for risk. Even with a large and fully credible group, STD claims experience will change from year to year due to random volatility (as well as for other reasons, such as a particularly nasty flu season). With an insured plan, on the other hand, the premium to be paid is determined in advance, so the employer knows exactly what it will pay for STD coverage. The annual volatility risk is borne by the insurance company (although longer-term experience trends will ultimately be reflected in the premium rates charged by the insurer).

When choosing to self-fund, an employer should monitor its STD plan experience over time. Periodic experience studies help the employer understand how its plan is performing and make adjustments as needed. Such modifications may include revising the rates charged to employees or groups for the coverage, adjusting the liability calculations for claims that have been incurred but not yet fully paid, and reevaluating plan design and claim management practices. These types of studies may require the help of actuarial and financial resources. With an insured plan, the insurance company handles these functions….