The Great Contract Debate - Part 1

This is going to be fun 😎

Which do you prefer?

🔴 12/12 ➡️ 24/12 ➡️ PAID/12

OR

⚫️ 12/24 ➡️ 12/24 ➡️ 12/24 etc

But before we debate, let's explain!

In stop loss insurance, an employer and their consultant must decide on a “Contract Basis”.

This defines the timeframe in which the stop loss carrier will provide coverage.

The number before the / is the “incurred” period.  The number after the / is the paid period.

For example; a 12/12 means claims that are incurred in 12 months AND paid in the same 12 months.

Thinking chronologically, this might mean claims incurred AND paid from 1/1/2025 to 12/31/2025.

A 12/12 is known as an “immature” contract because of claims lag and the way claims accumulate toward the end of the plan year.

A 12/24 means, claims incurred in 12 months, but paid in 24 months. This is known as a "Run-Out" contract.

This would mean claims incurred between 1/1/2025 - 12/31/2025, but paid between 1/1/2025 - 12/31/2026.

This is considered a “mature” contract because it will likely cover the overwhelming majority, if not all, claims incurred in that 12 month period because there is an extra 12 months for those claims to be paid.

OK, for the debate:

Which is better?  The answer as always, is it depends!

If you start with a 12/12, you should look at a 24/12 in the second year because the first year immature contract will leave employers massively exposed on the back end for claims incurred later in the year.  The 24/12 in year two, “looks backward” for claims that were incurred in the previous 12 months but were not paid in those 12 months. This is known as a "Run-In" contract.

Pros:

1. Optics - a 12/12 is “cheap” and looks good on paper versus fully insured
2. Starting with a 12/12 may make the numbers look more palatable and encourage more employers to decide to self-fund
3. In year 1, if the employer budgets evenly, they can build up reserves due to claims lag the first few months, which can be used to offset the contract price increase in year 2

Cons:

1. If you don’t purchase Terminal Liability, and want to go back fully-insured, the employer is could be stuck with massive claims exposure with no stop loss protection
2. If they do stay self-funded, they should transition into a 24/12, which will be very expensive compared to their previous 12/12
3. If you don’t explain to the employer that they likely will see a 20-25% increase to premium and factors in year two BEFORE experience is factored in, they will have massive sticker shock.

Now let’s look at scenario 2, starting in a 12/24…

Pros:

1. This will provide adequate coverage for most circumstances
2. If the group wants to go back fully-insured at any point, they have a tail of 12 months of run-out
3. It is easier to switch stop loss carriers because they don’t have to calculate claims exposure on the front end from the previous carrier’s contract

Cons:

1. This is a very expensive contract, and might even be “too much insurance”
2. Employers will be less likely to self-fund because of the contract load, and optically their max liability will look very unattractive versus their fully insured premium
3. This becomes a massive “concept sale” and consultant must be able to explain the benefits of self-insurance when faced with terms that aren’t a slam dunk

So what do I think?

I think there is much greater risk for the employer in scenario 1, and the consultant must explain repeatedly ahead of time the necessary contract transition in year 2, which means a big price increase.

If faced with ONLY those two options, I am going with scenario 2 for max risk mitigation, BUT would know that fewer employers will choose this path because of the “price”.

But there actually is an Option 3 😉, which would be a 12/18 ➡️ 12/18 with a “Gapless Renewal” that finds the proper balance between the two strategies, in my opinion.

For an explainer video on the contract basis subject, 👉🏼 WATCH HERE

I will explain Gapless Renewals in “Part 2” of this discussion, but first let’s discuss in the comments below!

#stoploss #stoplosswithspencer #stoplossinsurance #selffunded #selffunding #consulting #broker #strategy