Level-Funded: The Complete Guide to Maryland

A level-funded health plan is a hybrid insurance model that allows employers to capture the cost-saving benefits of self-insurance without exposing their balance sheet to unpredictable claims risk. For a Maryland employer, a level-funded arrangement requires a fixed monthly payment that covers administrative costs, stop-loss insurance, and a pre-funded claims account. If your employees’ actual medical claims run lower than the funded amount, your business receives a refund. If claims exceed the funded amount, your stop-loss insurance covers the overage, meaning you never pay more than your established monthly maximum.

This structure is explicitly marketed as the middle-ground alternative. It is designed for companies that are frustrated by the rising premiums and “black box” lack of data in fully insured plans, but lack the capital reserves or risk tolerance required to fully self-fund their employee benefits. While technically available to employers of nearly any size, the practical sweet spot for a level-funded plan is the small-to-mid market—typically organizations with 20 to 250 employees. Enterprises large enough to self-fund outright generally skip this step entirely, as they have the scale to absorb direct claims risk without paying the higher stop-loss premiums baked into a level-funded model.

Evaluating a level-funded plan requires a deep understanding of its internal mechanics, compliance frameworks, and risk-shifting strategies. This guide deconstructs exactly how level-funding operates, how it compares to alternative group health structures, and how an HR leader or executive can determine if it is the right financial move for their workforce.

The Anatomy of a Level-Funded Plan

To understand why a level-funded plan is advantageous, you must first unbundle the monthly payment. In a traditional, fully insured plan, an employer pays a single, non-negotiable premium to a carrier. That carrier pools your risk with thousands of other companies. If your employees use less healthcare than expected, the carrier keeps the profit. If they use more, the carrier absorbs the loss (and subsequently raises your rates the following year).

A level-funded plan breaks your monthly payment into three distinct buckets, providing total transparency into where your corporate healthcare dollars are actually going.

1. Administrative Fees (Fixed)

The first portion of your monthly payment goes toward administrative expenses. This pays the Third-Party Administrator (TPA) or the carrier acting in an Administrative Services Only (ASO) capacity. This fee covers the operational engine of your health plan: adjudicating and paying medical claims, managing member enrollment, providing customer service, granting access to a provider network (like a PPO or EPO), and managing pharmacy benefits. Because this is a fixed operational cost, it does not fluctuate based on how many doctors your employees visit.

2. Stop-Loss Insurance Premium (Fixed)

The second bucket pays for stop-loss insurance. Because a level-funded plan is technically a self-insured arrangement, the employer is legally responsible for paying the claims. Stop-loss insurance is the financial safety net that prevents a catastrophic medical event from bankrupting the company. The premium you pay for stop-loss is a fixed, sunk cost. It ensures that if an employee requires a $500,000 organ transplant, your company’s liability is capped at a much lower, predetermined threshold (the “attachment point”).

3. The Claims Pre-Fund Account (Variable, but Paid on a Fixed Schedule)

The final, and largest, portion of your monthly payment is deposited into a claims fund. Based on underwriting data, the carrier or TPA estimates the total medical claims your employee population will generate over the next 12 months. They divide that total by 12, and you pay that exact amount into the fund every month. As your employees go to the doctor, fill prescriptions, or visit the hospital, the TPA draws money from this account to pay the providers.

This is where the magic of the level-funded model happens. By pre-funding the expected claims through a fixed monthly payment, the employer experiences smooth, predictable cash flow—exactly like a fully insured premium. However, at the end of the year, if the money remaining in the claims fund exceeds the actual claims paid, the employer is entitled to the surplus.

The Financial Mechanics of Surplus Refunds

The defining feature of a level-funded plan is the potential to receive a refund for a healthy year. In a fully insured arrangement, a healthy workforce simply translates to higher profit margins for the insurance carrier. In a level-funded arrangement, those unspent dollars belong to the employer.

The Year-End Audit and Reconciliation

At the end of the plan year, the TPA conducts a final audit of the claims fund. Because medical billing is notoriously slow, this audit typically occurs a few months after the plan year ends, allowing time for “run-out” claims (medical services rendered during the plan year but billed afterward) to process.

If the total funded amount was $500,000, and the actual adjudicated claims for the year only totaled $400,000, there is a $100,000 surplus.

How Employers Receive the Surplus

The mechanism for returning this surplus is defined in the initial contract, and it varies between TPAs and carriers. Common distribution methods include:

• Direct Cash Refund: The employer receives a check for the surplus amount, which can be reinvested into the business, used to fund wellness programs, or distributed to employees.
• Administrative Credit: The surplus is rolled over into the next plan year and applied as a credit against future administrative fees or the upcoming year’s claims fund, effectively lowering the overall budget for the next cycle.
• Shared Surplus: Some contracts dictate that the carrier or TPA retains a percentage of the surplus (e.g., a 50/50 or 70/30 split) as a condition of providing the initial stop-loss coverage at a favorable rate.

It is critical for benefits consultants and HR leaders to negotiate and understand the exact terms of the surplus return before signing a level-funded contract. If you leave the carrier at the end of the year, do you forfeit the surplus? These contractual nuances dictate the true ROI of the plan.

Stop-Loss Insurance: The Protective Barrier

If the surplus refund is the upside of level-funding, stop-loss insurance is the mechanism that eliminates the downside. Without stop-loss, self-funding would be corporate suicide for a mid-sized company. Stop-loss comes in two distinct forms, both of which are embedded into a level-funded contract.

Specific (Individual) Stop-Loss

Specific stop-loss protects the employer against catastrophic claims incurred by a single individual. When setting up the plan, the employer and the underwriter agree on a “specific deductible” or “attachment point”—for example, $25,000.

If Employee A undergoes ongoing chemotherapy that totals $150,000 in a plan year, the employer’s claims fund pays the first $25,000. Once that individual threshold is crossed, the specific stop-loss policy pays the remaining $125,000. The employer’s maximum liability for Employee A is rigidly capped at $25,000.

Aggregate Stop-Loss

While specific stop-loss protects against one catastrophic event, aggregate stop-loss protects against a high volume of everyday claims. What happens if no single employee hits the $25,000 specific deductible, but everyone in the company gets the flu, requires minor surgeries, and uses expensive maintenance medications, draining the claims fund entirely?

Aggregate stop-loss acts as a ceiling for the total claims across the entire company. Typically, aggregate stop-loss is set at 120% or 125% of expected claims. If the underwriter expects your company to incur $1,000,000 in claims, the aggregate attachment point might be set at $1,200,000. The level-funded monthly payment is calculated to cover this maximum $1,200,000 liability. Therefore, if total claims reach $1,500,000, the aggregate stop-loss policy absorbs the $300,000 overage. The employer never receives a bill for the difference.

Terminal Liability and Run-Out Coverage

One of the most complex aspects of group health insurance is the timeline of medical billing. A doctor’s visit on December 28th may not be billed, adjudicated, and paid until February or March of the following year.

When establishing a level-funded contract, you must ensure you have run-out coverage. You will frequently see contracts described as “12/12”, “12/15”, or “12/18”.

• 12/12 Contract: The stop-loss policy only covers claims that are both incurred and paid within the 12-month plan year. This is risky, as December claims won’t be covered.
• 12/15 Contract: The policy covers claims incurred during the 12-month plan year, as long as they are paid within 15 months (providing a 3-month grace period for late billing). This is the standard for well-designed level-funded plans.
• 12/24 Contract: Covers claims incurred in a 12-month period and paid within a 24-month period.

Terminal liability protection ensures that if you terminate the level-funded plan and return to the fully insured market, you are not suddenly exposed to three months of lingering, unpaid medical bills with no claims fund to cover them.

Evaluating Candidates: Comparative Market Analysis

Level-Funded vs. Fully Insured

For a mid-sized employer, the leap from fully insured to level-funded is primarily about data and margin. In a fully insured plan, you are subjected to annual “trend” increases. If your carrier demands a 15% rate increase at renewal, and you ask them to justify it with claims data, they typically refuse, citing HIPAA or proprietary pooling algorithms. You are forced to shop the market blindly.

Level-funding solves this by providing monthly, granular claims reporting. Because you are technically self-insured, the TPA must show you how your money is being spent. You will know exactly what percentage of your healthcare budget is going to pharmacy costs, emergency room visits, or specific chronic conditions (with individual identities protected by HIPAA compliance). If you receive a rate increase at renewal, you will have the mathematical proof to understand exactly why it happened.

Level-Funded vs. Traditional Self-Funded

If an employer wants transparency and surplus retention, why not skip the hybrid model and move directly to a traditional self-funded structure? The answer is cash flow volatility and administrative burden.

In a traditional self-funded plan, the employer pays claims as they occur. If four employees have catastrophic events in February, the company’s healthcare expenses for that month will skyrocket, potentially creating a severe cash flow crisis for the business. While stop-loss insurance eventually reimburses the employer, the business must float the cash in the interim.

Furthermore, traditional self-funding requires the employer to unbundle every service—negotiating separate contracts for a TPA, a Pharmacy Benefit Manager (PBM), specific stop-loss, aggregate stop-loss, and network access.

Level-funding pre-packages all of these components into a single, predictable monthly invoice. The cash flow remains as smooth as a fully insured plan, and the carrier or TPA handles the complex integration of stop-loss reimbursement behind the scenes. This is why enterprises with 5,000 employees prefer traditional self-funding (their massive scale naturally smooths out monthly volatility), while a company with 80 employees is vastly better suited for the safety of a level-funded model.

ERISA Preemption and State Mandate Avoidance in Maryland

One of the most significant, yet frequently misunderstood, advantages of a level-funded plan involves regulatory compliance. The legal framework governing health insurance in the United States is bifurcated.

Fully insured plans are governed by the state in which they are written. In Maryland, fully insured small group plans are subject to the regulatory authority of the Maryland Insurance Administration (MIA). The state legislature frequently passes laws requiring fully insured plans to cover specific treatments—these are known as state mandates. Maryland has a robust list of state mandates, including requirements to cover certain fertility treatments (like IVF), specific autism therapies, hearing aids for minors, and various chiropractic and acupuncture services.

While these mandates provide comprehensive coverage for members, they drive up the baseline cost of fully insured premiums for every employer in the state, regardless of whether their specific workforce needs or utilizes those services.

Level-funded plans, however, are legally classified as self-insured plans. As a result, they fall under the jurisdiction of the federal Employee Retirement Income Security Act of 1974 (ERISA). A core tenet of ERISA is that it preempts state insurance laws.

Because a level-funded plan is governed by ERISA, it is legally exempt from Maryland’s state-specific coverage mandates. This gives the employer immense flexibility in plan design. An employer can choose to cover IVF, but they are not legally mandated to do so. By stripping away non-applicable state mandates, employers can design leaner, highly customized benefit packages that target the actual needs of their demographic, stripping out the hidden bloat of state-mandated cross-subsidization.

Note on Fiduciary Duty: The tradeoff for ERISA preemption is that the employer assumes the role of a fiduciary. Under ERISA, the plan sponsor (the employer) has a strict legal obligation to act in the best interest of the plan participants (the employees) and to manage the plan’s assets prudently.

Navigating the Underwriting Process

Because level-funded plans are priced based on the specific health risk of your unique employee population, the underwriting process is significantly more rigorous than purchasing a fully insured ACA-compliant small group plan (which relies on community rating).

To obtain a firm quote for a level-funded plan, the carrier or TPA must assess the risk profile of your group. They do this through medical underwriting.

Medical Questionnaires

Historically, employees were required to fill out lengthy, invasive Individual Medical Questionnaires (IMQs) detailing their past health history, surgeries, and chronic conditions. While some carriers still use this method, it is administratively burdensome for HR teams to collect and secure this protected health information.

GRx (Prescription History) Underwriting

Modern level-funded carriers rely heavily on GRx (Group Prescription) underwriting. The employer provides a census of the employees (names, dates of birth, ZIP codes, and genders). With employee consent, the underwriter pulls data from national pharmacy benefit clearinghouses to view the prescription drug history of the group over the past 12 to 24 months.

Because prescription data is a highly accurate proxy for medical conditions (e.g., if an employee is taking insulin, the underwriter knows they have diabetes; if they are taking expensive specialty biologics, the underwriter can project a high-cost claimant), the carrier can generate a highly accurate risk profile and price the stop-loss premiums without requiring a single medical questionnaire.

The Reality of Denials and High Premiums

Level-funding is not a guaranteed option for every business. If the underwriting process reveals that your 50-person company has three individuals currently undergoing active cancer treatments, several uncontrolled diabetics, and a history of premature births, the carrier will recognize that the group is virtually guaranteed to exceed standard claims projections.

In this scenario, one of two things will happen:

1. The carrier will decline to quote the group entirely, forcing the employer to remain in the fully insured market where community rating prevents them from being singled out for their specific risk.
2. The carrier will offer a quote, but the stop-loss premiums and the aggregate attachment point will be priced so aggressively high that the plan is no longer economically viable compared to a fully insured alternative.

Level-funding works best when transitioning a generally healthy workforce that is currently overpaying for the bloated, community-rated premiums of the fully insured market.

Renewal Dynamics and “Lasering”

Understanding how a level-funded plan operates in year one is critical, but understanding how it operates at renewal is where long-term strategy is tested.

If you have a great year, claims run low, and you receive a surplus refund, your renewal for year two will likely be highly favorable. The carrier has actual, positive claims data proving that your group is a profitable risk.

But what happens if you have a terrible year? Suppose an employee suffers a severe heart attack in October, blowing past the specific stop-loss deductible and draining the aggregate fund. The stop-loss insurance functions exactly as promised—you do not pay a dime out of pocket beyond your monthly premium.

However, at renewal, the underwriter now knows they have a high-risk individual in the pool. To protect their margins, the stop-loss carrier may employ a practice known as “lasering.”

What is a Laser?

A laser is an underwriting maneuver where the carrier assigns a much higher specific stop-loss deductible to a known high-risk individual, while keeping the rest of the group at the standard deductible.

For example, your standard specific stop-loss deductible is $30,000. At renewal, the carrier states they will maintain the $30,000 deductible for 49 of your employees. However, for the employee who suffered the heart attack, they are imposing a $100,000 laser. This means the employer’s claims fund is now liable for the first $100,000 of that specific individual’s medical bills before stop-loss kicks in.

This shifts a massive amount of financial risk back onto the employer’s balance sheet. If an employer is heavily lasered, they may be forced to abandon the level-funded arrangement and retreat back to the fully insured market, where lasering is prohibited.

Strategic Note: When negotiating a level-funded contract, sophisticated brokers will prioritize carriers that offer a “No Laser Guarantee” at renewal, or a contractual cap on the maximum percentage the stop-loss premium can increase year-over-year. While these clauses may slightly increase the baseline administrative fees, they provide critical long-term stability for the employer.

The Role of the Third-Party Administrator (TPA)

The success or failure of a level-funded plan rests heavily on the capabilities of the entity administering it. In a fully insured plan, the carrier (e.g., UnitedHealthcare, BlueCross BlueShield) handles everything. In a level-funded plan, you are fundamentally buying a financial structure, and you must hire someone to run the operations.

Independent TPAs vs. ASO Arrangements

You have two primary avenues for administration:

1. ASO (Administrative Services Only): You contract with a major national carrier (a BUCA: BlueCross, United, Cigna, Aetna). They provide the network, adjudicate the claims using their proprietary systems, and bundle their own stop-loss insurance into the deal. This is convenient and provides employees with familiar ID cards, but it often lacks the aggressive cost-containment strategies needed to generate massive surplus refunds.
2. Independent TPAs: You hire an independent firm to adjudicate claims. The TPA then “rents” a network (like the Cigna OAP or Aetna Signature network) so your employees still have broad access to doctors. Independent TPAs are highly motivated to manage your claims efficiently, as they do not have a conflict of interest regarding fully insured profit margins. They often employ aggressive strategies like reference-based pricing (RBP), direct primary care (DPC) integration, and medical bill auditing to drive down the cost of claims before they drain your fund.

Pharmacy Benefit Managers (PBMs) and Prescription Carve-Outs

Prescription drugs frequently account for 25% to 35% of a group’s total medical spend, driven largely by the explosion of specialty biologics and GLP-1 weight-loss medications.

In a fully insured plan, the pharmacy benefit is locked into the carrier’s proprietary ecosystem. The carrier negotiates massive rebates with drug manufacturers, but they keep those rebates as profit.

In a well-designed level-funded plan, the employer has the flexibility to “carve out” the pharmacy benefit. This means the medical claims are handled by the TPA, but the employer contracts directly with a transparent, pass-through Pharmacy Benefit Manager (PBM) to handle the drug claims.

A transparent PBM charges a flat administrative fee per script but passes 100% of the manufacturer rebates directly back to the employer’s claims fund. For a mid-sized company, recapturing these pharmacy rebates can easily translate to tens of thousands of dollars in savings, drastically increasing the likelihood of a year-end surplus refund.

Compliance: ACA, PCORI, and Form 5500

Transitioning to a self-insured legal framework (even under the protective umbrella of level-funding) alters an employer’s compliance obligations under federal law.

The Employer Mandate (MEC and Minimum Value)

Under the Affordable Care Act (ACA), Applicable Large Employers (ALEs)—businesses with 50 or more full-time equivalent employees—must offer health insurance that provides Minimum Essential Coverage (MEC) and meets Minimum Value (MV) standards, or face severe tax penalties.

Level-funded plans easily satisfy both MEC and MV requirements, provided they are designed to cover standard major medical services and the employer subsidizes enough of the premium to make the coverage “affordable” under ACA safe harbor rules.

PCORI Fees

Because the plan is self-insured, the employer is responsible for calculating and paying the Patient-Centered Outcomes Research Institute (PCORI) fee annually. This is filed using IRS Form 720, typically due by July 31st of each year. While the fee itself is relatively small (a few dollars per covered life), failing to file it is a compliance violation that triggers IRS scrutiny.

Form 5500 Reporting

ERISA requires plan sponsors of self-insured plans with 100 or more participants to file an annual Form 5500, detailing the financial condition and operations of the plan. Your TPA or benefits broker will generally prepare this complex financial document, but the legal liability for its accuracy and timely filing rests solely on the employer.

Transition Strategy and Implementation Timeline

Moving a company from a fully insured environment to a level-funded model cannot be done overnight. It requires strategic planning and careful employee communication.

90 to 120 Days Prior to Renewal

Begin the GRx underwriting process. This requires providing an accurate census to your broker so they can pull prescription data and shop the group to multiple level-funded carriers and TPAs. Compare the specific and aggregate stop-loss terms, not just the monthly baseline cost.

60 Days Prior to Renewal

Select the carrier and finalize the plan design. Because you are exempt from state mandates, you must decide which benefits you wish to include or exclude. You must also formally review and sign the stop-loss contract, ensuring you understand the terminal liability provisions (e.g., ensuring you have a 12/15 or 12/18 run-out clause).

30 Days Prior to Renewal: Employee Education

This is the most critical step. From the perspective of the employee, a level-funded plan looks and acts exactly like a traditional health plan. They receive an ID card, they have a network of doctors, they pay a copay at the pharmacy, and they have a deductible to meet.

However, HR must proactively educate employees on the new network structure, any changes to the pharmacy formulary, and the importance of using in-network, high-quality facilities. Because every dollar saved on claims directly impacts the employer’s surplus refund, HR has a massive financial incentive to guide employees toward cost-effective care (e.g., using an urgent care clinic instead of the emergency room for minor issues, or using telehealth services).

Is Your Company the Right Fit?

A level-funded plan is a highly sophisticated financial tool, but it is not a panacea for rising healthcare costs. An organization should carefully consider this transition if they meet the following criteria:

1. You have 20 to 250 employees. This is the operational sweet spot where you have enough scale to generate predictable data, but aren’t so massive that unbundled self-funding is the obvious better choice.
2. Your workforce is generally healthy. If you consistently use less healthcare than the community-rated pool, level-funding allows you to capture the financial reward for that health.
3. You have stable cash flow. Even though the monthly payment is fixed, you must have the operational stability to handle the administrative transition and potential fluctuations in renewal pricing if claims spike.
4. You value data. If your executive team wants to understand the root causes of their healthcare spend rather than blindly accepting annual increases, the transparency of a level-funded plan is invaluable.

Conclusion

Level-funded health insurance fundamentally changes the relationship a Maryland employer has with their benefits package. It transitions healthcare from a passive, sunk operational cost into an actively managed financial asset. By fixing the monthly maximum liability through stop-loss insurance, bypassing costly state mandates via ERISA preemption, and securing the rights to unspent claims dollars through surplus refunds, employers regain control over their second-largest line-item expense.

The decision to adopt this model requires rigorous underwriting analysis, a deep understanding of contractual run-out provisions, and a willingness to step into a fiduciary role. However, for the mid-sized company tired of subsidizing the broader fully insured market, level-funding offers the clearest, most protected path to long-term financial control.

Frequently Asked Questions