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

ERISA preemption is not a loophole. It is not a technicality discovered by clever lawyers and exploited by employers seeking to avoid regulation. 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 complying with fifty separate state insurance regulatory regimes. The preemption applies to self-funded employer health plans, including level funded plans structured as self-funded. Without ERISA preemption, level funded would not exist in its current form, because the regulatory asymmetry between self-funded and fully insured plans that makes level funded economically attractive would disappear.

What ERISA Preemption Actually Says

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Three statutory provisions create the preemption architecture. They work together, and understanding one without the others produces an incomplete picture.

Section 514(a) of ERISA establishes the preemption principle. ERISA “shall supersede any and all State laws insofar as they may now or hereafter relate to any employee benefit plan” covered by the statute (29 U.S.C. § 1144(a)). The “relate to” language is broad. The Supreme Court has interpreted it to cover state laws that have “a connection with or reference to” ERISA plans, and the scope of that interpretation has been litigated for five decades.

Section 514(b)(2)(A), the savings clause, preserves state authority to regulate insurance. It saves from preemption state laws that “regulate insurance, banking, or securities” (29 U.S.C. § 1144(b)(2)(A)). This means states retain the power to regulate insurance companies and insurance products. A state can mandate that all health insurance policies sold within its borders cover certain treatments. A state can levy premium taxes on health insurance. A state can require carriers to file rates and justify increases.

Section 514(b)(2)(B), the deemer clause, closes the circle. It provides that an employee benefit plan “shall not be deemed to be an insurance company or other insurer … or to be engaged in the business of insurance … for purposes of any law of any State purporting to regulate insurance companies” (29 U.S.C. § 1144(b)(2)(B)). This provision prevents states from indirectly regulating self-funded plans by classifying them as insurance. Even though the savings clause allows states to regulate insurance, the deemer clause ensures that self-funded ERISA plans cannot be treated as insurance for the purpose of that regulation.

The three provisions together establish the regulatory architecture that governs level funded plans: states regulate insurance products. Self-funded employer plans are not insurance products. Therefore, self-funded employer plans are not subject to state insurance regulation. The logic is statutory, not judicial. Congress built this structure intentionally to create a uniform federal framework for multi-state employer benefit plans.

What ERISA Preemption Means in Practice

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The practical consequences for employers sponsoring self-funded plans, including level funded, are substantial across four dimensions.

State mandated benefits do not apply. States mandate coverage of specific conditions, treatments, providers, and services in fully insured plans. These mandates vary by state. Some states mandate coverage of applied behavior analysis for autism spectrum disorder. Some mandate coverage of in vitro fertilization. Some mandate coverage of chiropractic services, acupuncture, or naturopathy. The Council for Affordable Health Insurance identified 2,271 individual state benefit mandates across all states as of 2012, and the total has continued to grow since. A self-funded ERISA plan is not subject to any of them. The employer designs the benefit through the plan document, covering what it chooses to cover within the constraints of federal law, including the Mental Health Parity and Addiction Equity Act (MHPAEA), ACA preventive care requirements, and other federal mandates that apply to all group health plans regardless of funding mechanism.

State premium taxes do not apply. States levy premium taxes on fully insured health insurance at rates that vary by state, with the most common rate at 2.5 percent and rates generally ranging from approximately 1.75 to 4 percent. For an employer paying $500,000 annually in fully insured premium, the embedded premium tax could range from roughly $8,750 to $20,000 depending on the state. Self-funded plans, including level funded, are exempt from state premium taxes on the claims fund and administrative fee components. The stop loss premium component may or may not be subject to state premium tax depending on how the state treats stop loss insurance. In most states, stop loss premium is subject to premium tax because it is an insurance product. The claims fund and administrative fee are not insurance products and therefore fall outside the state premium tax framework.

State insurance department oversight does not apply. Fully insured plans are subject to state rate review, market conduct examinations, and carrier solvency requirements administered by state insurance departments. Self-funded plans are subject to Department of Labor oversight under ERISA, which historically has been lighter-touch than state insurance department regulation. The DOL’s Employee Benefits Security Administration (EBSA) oversees ERISA plan compliance, but its enforcement resources have been limited relative to the number of self-funded plans in the market. State insurance departments, by contrast, have established regulatory infrastructure, dedicated examination staff, and consumer complaint processes that have no federal equivalent for self-funded plans.

Multi-state operation is simplified. An employer with employees in multiple states operates one ERISA plan governed by federal law. The employer does not need to comply with different state mandated benefit requirements in each state, does not need to file with multiple state insurance departments, and does not need to manage different regulatory obligations across jurisdictions. For employers with remote workers spread across five or ten or twenty states, this simplification is operationally meaningful and frequently cited by brokers as a primary advantage of level funded over fully insured.

The Key Cases

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The boundaries of ERISA preemption for self-funded plans have been shaped by Supreme Court decisions that interpreted the statutory provisions in specific factual contexts.

In FMC Corp. v. Holliday, 498 U.S. 52 (1990), the Court addressed a Pennsylvania law that prohibited subrogation against the proceeds of motor vehicle accident settlements. FMC Corporation’s self-funded employee benefit plan sought to recover from an employee’s settlement the amounts the plan had paid for the employee’s medical care. Pennsylvania law prohibited this recovery. The Court held that ERISA preempted the state law as applied to the self-funded plan, reasoning that the deemer clause prevented Pennsylvania from regulating the plan as if it were an insurance company subject to state anti-subrogation rules. The decision reinforced that self-funded ERISA plans are insulated from state laws that affect how they administer claims and recover costs.

In District of Columbia v. Greater Washington Board of Trade, 506 U.S. 125 (1992), the Court addressed a D.C. law requiring employers providing health insurance to provide equivalent coverage to employees receiving workers’ compensation benefits. The Board of Trade challenged the law on ERISA preemption grounds. The Court held that the D.C. law “relate[d] to” ERISA plans because it required employers to structure their health benefits in a particular way based on employees’ workers’ compensation status. The decision extended the preemption principle beyond direct regulation of plan terms to laws that indirectly affected plan design by imposing external requirements.

In Pilot Life Insurance Co. v. Dedeaux, 481 U.S. 41 (1987), the Court addressed whether an employee could bring state common law tort claims for bad faith denial of benefits under an ERISA plan. The Court held that ERISA preempted the state law claims, establishing that ERISA provides the exclusive federal remedy for benefits disputes. This decision has a specific consequence for plan participants: in a self-funded plan, including level funded, a member whose claim is denied cannot sue under state bad faith or breach of contract theories. The member’s remedy is limited to the ERISA claims procedure and, if necessary, federal litigation under ERISA Section 502. The available remedies under ERISA are narrower than what many state laws would provide: ERISA generally limits recovery to the denied benefit plus reasonable attorney’s fees, without the punitive damages or extracontractual damages available under state bad faith theories.

More recent circuit court activity has addressed whether level funded plans qualify as self-funded for ERISA preemption purposes. The question arises because some level funded products include stop loss arrangements so comprehensive that the employer’s actual financial risk is nominal. If the stop loss carrier bears substantially all of the claims risk through low attachment points and broad aggregate coverage, the argument is that the plan functions as fully insured regardless of its formal structure. The outcomes in circuit courts have turned on the specific facts of each arrangement: whether the employer bears genuine financial risk below the stop loss attachment points, or whether the employer’s risk exposure is so small that the self-funded classification is a legal fiction. The case law is evolving, and the answer depends on the particular product’s structure. States have used this analytical framework to argue for regulatory authority over level funded plans, and LFP-03.03 examines the state-level regulatory challenges in detail.

Why ERISA Makes Level Funded Possible

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ERISA preemption is not a benefit that level funded happens to enjoy. It is the enabling condition without which the market would not exist.

Without ERISA preemption, level funded plans would be subject to state mandated benefits, eliminating the plan design flexibility that allows employers to customize coverage. Without preemption, level funded plans would be subject to state premium taxes, adding approximately 1.75 to 4 percent to the cost depending on the state. Without preemption, level funded plans would be subject to state rate review and market conduct oversight, constraining the underwriting flexibility that allows stop loss carriers like Sun Life, Voya, and Tokio Marine HCC to price level funded groups based on their own health status rather than community rating. Without preemption, multi-state employers would face compliance with different regulatory requirements in each state where they have employees, eliminating the operational simplification that makes level funded attractive to small groups with distributed workforces.

The entire level funded market depends on the employer’s plan being classified as a self-funded ERISA plan. When states attempt to reclassify level funded plans as fully insured, through legislation or regulatory interpretation, they are attempting to close the regulatory gap that created the market. Those efforts are the subject of LFP-03.01 through LFP-03.07, which cover the full regulatory environment in depth. The structural dependency creates a vulnerability: legislative or judicial changes to ERISA preemption scope, or federal legislation that subjects self-funded plans to state-level regulatory requirements, would reshape the level funded market. This is not a hypothetical concern. It is an active policy conversation at both the state and federal level. The Self-Insurance Institute of America (SIIA) has lobbied to preserve ERISA preemption for level funded plans. The National Association of Insurance Commissioners (NAIC) has produced model legislation and white papers on level funded regulatory classification. Various state legislatures have introduced bills to reclassify level funded as fully insured within their borders. The outcome of this debate will determine the market’s future scope and structure.