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Syam Adusumilli
The Architecture of Level Funded · LFP-01.04

Executive Summary: How Level Funded Got Here: The ACA, the Small Group Market, and Regulatory Arbitrage

By Syam Adusumilli · 2 min read
Executive Summary Read the full article.

LFP-01.04 — The Architecture of Level Funded
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Level funded is not product innovation. It is regulatory arbitrage made operational. Innovation creates value that persists independent of the regulatory environment. Arbitrage creates value that depends on a gap between two regimes persisting. The level funded market exists because the ACA transformed small group fully insured economics while ERISA preserved a self-funded alternative where health-status underwriting remained legal.

ERISA’s 1974 preemption framework gave self-insurance consistent legal protection across all states. Large employers adopted self-funding steadily through the 1980s and 1990s. Small employers remained almost entirely in the fully insured market. The capital needed to absorb claims variance at small group sizes was the structural barrier.

The ACA changed the demand calculation. Community rating eliminated health status as a rating variable, restricting factors to age within a 3:1 ratio, geography, tobacco use, and family size. Healthy small groups that had previously received favorable rates were merged into a community-rated pool including higher-cost populations. Essential health benefit mandates in ten coverage categories raised the fully insured plan design floor. Healthy small employers had a financial incentive to exit, and the exit mechanism was self-funding under ERISA.

Stop loss carriers and TPAs built the product that made the exit possible. Bundling specific and aggregate stop loss with TPA administration into a single fixed monthly payment converted small-group claims unpredictability into a manageable structure. Broker and carrier sources cite savings of approximately 15 to 30 percent or more below equivalent fully insured community rates for healthy groups; UnitedHealthcare has cited 19 percent average savings for migrating groups. By 2024, KFF reported 36 percent of covered workers at small firms in level funded plans, up from 7 percent in 2019. The market-structure consequence is adverse selection: healthy groups exiting the community-rated pool leave a less healthy remaining population, driving up community rates, which drives more groups toward level funded.

The durability of the market depends on the regulatory gap. States that reclassify level funded as fully insured close it within their borders. Federal restriction of ERISA preemption would close it nationally. An employer selecting level funded accepts a structural dependency on that gap remaining open.