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Syam Adusumilli
The Architecture of Level Funded · LFP-01.03

Executive Summary: The ERISA Foundation: Why Self-Funded Plans Exist Outside State Insurance Law

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

LFP-01.03 — The Architecture of Level Funded
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ERISA preemption is not a loophole. It is a deliberate federal policy choice, enacted by Congress in 1974, that allows employers to sponsor health benefit plans under a single federal regulatory framework rather than fifty separate state insurance regimes. Without it, level funded would not exist in its current form.

Three statutory provisions do the work. Section 514(a) preempts any state law that relates to an ERISA-covered employee benefit plan. Section 514(b)(2)(A), the savings clause, preserves state authority to regulate insurance. Section 514(b)(2)(B), the deemer clause, prevents states from closing the gap by classifying self-funded employer plans as insurance. Together: states regulate insurance products, self-funded employer plans are not insurance products, therefore self-funded employer plans are not subject to state insurance regulation.

Four practical consequences follow. State mandated benefit laws do not apply. The Council for Affordable Health Insurance identified 2,271 individual state mandates as of 2012, and none bind a self-funded ERISA plan. State premium taxes, generally 1.75 to 4 percent, do not apply to the claims fund and administrative fee. Multi-state employers operate one federal plan rather than managing different regulatory requirements in each state. State insurance department rate review and market conduct oversight do not apply; DOL oversight through EBSA applies instead, and has historically been lighter.

Three Supreme Court cases define the boundary. FMC Corp. v. Holliday, 498 U.S. 52 (1990), held ERISA preempted Pennsylvania’s anti-subrogation rule as applied to a self-funded plan. District of Columbia v. Greater Washington Board of Trade, 506 U.S. 125 (1992), extended preemption to laws that indirectly affect plan design. Pilot Life Insurance Co. v. Dedeaux, 481 U.S. 41 (1987), established ERISA as the exclusive remedy for benefits disputes, eliminating state bad faith and extracontractual damages for plan participants.

Preemption is not a permanent fixture. States have introduced legislation to reclassify level funded as fully insured. The NAIC has produced model legislation on level funded regulatory classification. Some circuit courts have found that arrangements with low enough attachment points function as fully insured in substance regardless of formal structure. The outcome determines the scope and geography of the level funded market.