Workers With Chronic Conditions: The Tension Between Risk Selection and Adequate Coverage

LFP-06.05 | Sharp Analysis | Series 06: The Populations

A level funded plan cannot exclude individuals based on health status. A stop loss carrier can. The gap between these two rules produces a structural tension that no current product resolves, and the employer who discovers it mid-plan-year is the one who absorbs the consequences.

The plan-level rule is clear. HIPAA’s nondiscrimination provisions, codified at Section 2705 of the Public Health Service Act and extended by the ACA, prohibit group health plans from denying eligibility to any individual, charging higher premiums based on health status, or excluding coverage for pre-existing conditions. A level funded plan administered under ERISA must enroll and cover every eligible employee regardless of their health history. The ACA eliminated even the limited pre-existing condition exclusion periods HIPAA had permitted. The prohibition is absolute.

The stop loss carrier operates under no such constraint. The plan-level nondiscrimination requirements do not apply to stop loss underwriting. The carrier can identify a specific member with a high-cost condition and either exclude that member entirely from specific stop loss protection or assign an individual attachment point set above any realistic claim level. The carrier has transferred the risk for that member back to the employer. The plan covers the member in name. The employer absorbs the catastrophic exposure the stop loss was supposed to prevent.

The Nondiscrimination Requirements

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The legal architecture of nondiscrimination has three interlocking layers, each building on the last.

HIPAA, enacted in 1996, established the foundational prohibition. Group health plans may not establish eligibility rules based on health status factors, including health condition, claims experience, receipt of health care, medical history, genetic information, evidence of insurability, or disability. Plans may not charge higher premium contributions to individuals based on these factors. The regulations implementing these requirements for ERISA plans appear at 29 C.F.R. § 2590.702.

The ACA extended HIPAA’s protections for plan years beginning in 2014 and eliminated the pre-existing condition exclusion period HIPAA had permitted for group plans. A group health plan may not impose any pre-existing condition exclusion. The prohibition applies to all group health plans, including self-funded plans operating under ERISA. Section 1201 of the ACA amended Section 2705 of the Public Health Service Act to reflect this absolute bar.

Enforcement mechanisms include excise taxes of $100 per day per affected individual under 26 U.S.C. § 4980D, civil penalties under ERISA, and participant civil actions. A level funded plan that refuses to enroll an employee based on her diabetes diagnosis, charges her a higher premium contribution, or excludes diabetes-related claims from coverage violates federal law.

The Stop Loss Exception

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Stop loss insurance is not a group health plan. It is a contract between the stop loss carrier and the employer, not an instrument that provides benefits directly to plan participants. The carrier reimburses the employer after the employer has paid claims exceeding the attachment point. Participants never interact with the stop loss carrier and may not know the arrangement exists.

Because stop loss is not a group health plan, HIPAA’s and the ACA’s nondiscrimination requirements do not govern stop loss underwriting. State insurance regulation applies, and most states permit health-status-based underwriting for stop loss policies. The NAIC’s Model Stop Loss Insurance Act, adopted in 1995 and revised in 1999, provides a framework states may adopt but does not prohibit individual health-status underwriting for stop loss.

Milliman’s 2024 Employer Stop Loss Market Survey, covering 32 stop loss market participants including eight of the ten largest carriers by written premium, documents current underwriting practices across the industry. Carriers review health questionnaires during enrollment and renewal. Members with high-cost conditions are identified. Claims data from prior plan years, when available, flags members who have triggered stop loss reimbursement or are trending toward the attachment point.

A laser is the mechanism. The carrier may exclude a member’s claims entirely from specific stop loss coverage, meaning the employer retains 100% of that member’s claims regardless of amount. Alternatively, the carrier assigns a member-specific attachment point substantially higher than the group’s standard specific attachment point. A group with a $50,000 standard specific attachment point may receive a $250,000 individual attachment point for a member with a transplant history. The employer absorbs everything below $250,000 for that member.

Common conditions that trigger lasers or pricing adjustments include hemophilia, solid organ and bone marrow transplants, neonatal intensive care unit exposure, cancer diagnoses, and gene and cell therapies. A 2022 Brown & Brown market report prepared by Conning documented that stop loss underwriters were reporting increasing frequency and severity of high-cost claims and increasing their use of lasers and exclusions accordingly. The pharmaceutical pipeline described in LFP-09 intensifies this dynamic: gene therapies priced at $2 million or more per administration, GLP-1 drugs with significant annual per-member costs, and Alzheimer’s therapies for conditions concentrated in older workforces all produce the kind of identifiable, predictable high-cost individual risk that stop loss carriers are structured to exclude.

The Structural Tension

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The combined effect of plan-level nondiscrimination and stop loss-level risk selection creates a specific financial exposure for small employers with high-cost members.

Consider a 15-person employer with one member who has hemophilia. Factor replacement therapy generates annual claims approaching $250,000. The employer’s total expected claims for the group might be $350,000. The employer establishes a level funded plan. The stop loss carrier identifies the hemophilia patient during underwriting and offers stop loss with a $50,000 standard specific attachment point but excludes the hemophilia patient entirely from specific coverage.

The employer now has a plan that must cover the hemophilia patient under federal law and a stop loss policy that provides no protection against that patient’s claims. The monthly claims fund, sized for expected claims of $350,000 annually, is depleted by the third quarter as the hemophilia patient generates $250,000 in claims. The aggregate attachment point, set at 120% to 125% of expected claims, has not been triggered because the claims came from one member rather than dispersed across the group. The employer owes amounts between the depleted fund and the aggregate threshold. The stop loss policy that was supposed to prevent catastrophic exposure has transferred that exposure back through the laser.

The Peterson-KFF Health System Tracker analysis of 2023 MEPS data found that 5% of the population accounted for nearly half of all health spending nationally, with the top 1% averaging $150,467 in annual expenditures. The concentration is more severe at small group scale. A single high-cost member in a 15-person group may represent 30% to 50% of the entire group’s expected claims. The actuarial logic of lasering is direct: the carrier cannot price specific stop loss for a small group where one member’s expected claims approach or exceed the entire group’s expected claims. The laser is the carrier’s rational response to that actuarial reality.

At renewal, the employer faces options that are not attractive by any path. Continuing the plan absorbs the uncapped exposure for another year. Transitioning to fully insured means community rating will price in the group’s known risk profile, which may be worse than the level funded pricing before the high-cost member was identified. Finding a different stop loss carrier willing to underwrite without the laser may not be possible for a group with this claims profile. The member with the chronic condition is covered throughout because the plan must cover them. The employer bears the financial consequence the product was supposed to prevent.

Why No Current Product Resolves It

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The tension is architectural. Resolving it requires changing one of the two rules that create it.

Extending nondiscrimination requirements to stop loss carriers would prohibit health-status-based underwriting. This requires federal legislation or state regulation that withstands ERISA preemption. State efforts to regulate stop loss more stringently have encountered preemption challenges when courts determine the regulation effectively governs the underlying self-funded plan rather than the stop loss product. No federal legislative proposal with momentum addresses this directly.

Pooling lasered members across multiple employers could spread high-cost individual risk across a larger base. Captive insurance structures and multi-employer welfare arrangements are the theoretical vehicles. Both face adoption barriers. Captives require minimum premium volume that small employers individually cannot provide. MEWAs face state regulatory complexity that has limited their growth outside specific industries and geographies.

Stop loss carriers could price for known high-cost conditions rather than excluding them, but the pricing logic undermines the product’s value. A carrier willing to cover a member with $250,000 in expected annual claims would price specific stop loss for that member at a premium approaching the expected claims. The employer would be paying near-full-cost insurance for one member instead of high-deductible catastrophic coverage.

The honest assessment is that level funded works well for groups whose members do not have conditions that trigger lasers, and its economics deteriorate with each step toward the profile that stop loss carriers are built to exclude. The tiered product architecture examined in LFP-15.01 must account for this structural limitation. A small-employer product offering needs to be explicit about the populations for whom the standard level funded structure exposes the employer rather than protects it.