Level Funded Health Insurance: How It Really Works
Level funded health insurance splits one monthly payment into a claims fund, an admin fee and stop-loss premium. How the refund and risks really work.
The first time a broker walked me through a level funded quote, the monthly number sat below the fully insured renewal next to it and there was a refund attached to the bottom of the page. I said yes quickly. What I had not asked was what happens in the year the refund does not arrive.
Level funding is a genuine product with genuine advantages for a healthy small group. It is also a self funded plan wearing a fully insured costume, and the costume hides three things: you become the plan sponsor, your renewal price depends on your own claims rather than a community pool, and the surplus refund every quote leads with is neither guaranteed nor always complete.
This guide covers the employer side of that decision: what your payment buys, what can come back, and what you take on as the plan sponsor.
I build FirstHR for small businesses that have no dedicated HR person, and FirstHR is an onboarding and HR platform rather than an insurance broker or a benefits carrier. What follows is general information, not legal, tax, or insurance advice.
What Level Funding Actually Is
Level funding is a self funded health plan packaged so the employer pays the same amount every month. The plan pays its own claims out of employer money. The carrier fixes the monthly cost in advance and sells stop-loss insurance that caps what a bad year can cost you.
The distinction matters more than the marketing suggests. In a fully insured plan you buy a promise, and the insurer keeps whatever it does not spend.
In a level funded plan, you fund your own claims as the sponsor of a self funded plan under the Employee Retirement Income Security Act (ERISA). The carrier steps back to administering the plan and selling you protection against a catastrophe.
Adoption among smaller employers is now mainstream rather than exotic. The Kaiser Family Foundation Employer Health Benefits Survey (2025) reported that 37 percent of covered workers at firms with 10 to 199 workers were covered by a level funded plan, similar to the share the same survey reported the prior year.
If you are pricing health insurance for a young company, level funding will almost certainly appear in the quote set.
The Three Parts of Your Payment
Your level funded invoice is one number assembled from three, and only one of them can ever come back to you. The claims fund pays claims. The administration fee pays for the plumbing. The stop-loss premium buys the ceiling.
Refundability is where most disappointment starts. An employer whose group spends far less than expected assumes the whole gap returns. It does not, because two of the three components were never refundable and part of the third is held back for claims that have been incurred but not yet reported.
Some quotes present a single monthly figure and treat the split as proprietary. Push back. Without the breakdown you cannot check the surplus arithmetic a year later, and you cannot compare two level funded quotes on anything but headline price when the difference may be sitting entirely in the stop-loss attachment points.
The Three Funding Models Compared
Fully insured, level funded and self funded are three positions on one spectrum: how much claims risk you keep and how much you pay somebody else to take. Level funding sits in the middle by design.
| Feature | Fully insured | Level funded | Traditional self funded |
|---|---|---|---|
| Who pays claims | The insurer | Your plan, from your claims fund | Your plan, from your assets |
| Monthly cost | Fixed premium | Fixed funding payment | Varies with claims |
| Medical underwriting | Not permitted in the small group market | Yes, at application and renewal | Yes, through stop-loss underwriting |
| Surplus if claims run low | Insurer keeps it | Partly refundable to you | Stays with you |
| Stop-loss insurance | Not applicable | Bundled into the payment | Purchased separately |
| ERISA plan sponsor duties | Yes, lighter in practice | Yes, full self funded duties | Yes, full self funded duties |
| State benefit mandates | Apply | Generally preempted | Generally preempted |
| Claims data visibility | Limited | Usually reported to you | Full |
| Cash flow risk | None beyond the premium | Low, capped by attachment points | Real, needs reserves |
The row that decides most small employer cases is underwriting. It is the reason a healthy group can beat the community rated market, and the reason an unhealthy one cannot get a competitive level funded quote at all. Everything else is a consequence of that.
The claims data row is worth more than it looks. A fully insured small group often sees almost nothing about where the money went, which makes any attempt at controlling benefits spend a guess. Level funded reporting, even in summary form, tells you whether your cost driver is pharmacy, emergency room use, or one ongoing case.
Individual and Aggregate Stop Loss
Stop loss is what caps your risk in a level funded plan, and it comes in two forms, individual and aggregate, that protect against two different disasters. You need both, and the attachment points are where the real negotiation happens.
Two contract details decide whether the ceiling is as solid as it looks. The first is the contract basis, which sets which claims fall inside the policy year. A twelve by twelve contract covers only claims both incurred (the care was delivered) and paid (the bill was settled) inside the same twelve months.
The twelve by twelve basis leaves a claim incurred in month eleven and paid in month thirteen outside both contract years. A twelve by fifteen contract, which gives claims three more months to be paid, or a renewal written on a run-in basis, which also reimburses claims incurred during a stated period before the renewal date, closes that gap.
The second detail is lasering. A stop-loss carrier can assign a higher individual attachment point to one known high-cost member, which quietly moves the risk the policy was supposed to absorb back onto your plan. Ask directly whether the quote contains any lasers and whether the renewal terms permit new ones.
According to the National Association of Insurance Commissioners stop-loss model act, adopted in 1995, an insurer may not write an individual attachment point below $20,000. For groups of 50 or fewer the aggregate attachment point may not fall below the greater of $4,000 times the number of group members, 120 percent of expected claims, or $20,000.
Those floors bind only where a state has adopted the model act, and states vary on whether they took it, amended it, or went further. Check what your own state did with it rather than assuming a national default applies to the quote in front of you.
What the Surplus Refund Looks Like
A surplus refund is the unused portion of your claims fund returned after the plan year closes. It is real, it is the main reason employers choose level funding, and it is smaller and slower than the sales conversation implies.
Three mechanics explain the gap between expectation and outcome. Run-out is the first: claims incurred in the last months of the plan year keep arriving for months afterward, so the administrator holds money back until the picture settles. Surplus sharing is the second: many contracts return a defined percentage rather than the full unused balance.
Form of payment is the third. Some arrangements pay cash and some apply the surplus as a credit against next year's funding, which is worth considerably less if you were planning to change carriers. Contract language decides that, not market custom.
Employee contributions add a further question. Where employees paid part of the premium, some portion of a refund may need to be treated as belonging to the plan rather than to you, which is a conversation to have with counsel before the money arrives, not after.
Underwriting at Application and Renewal
Level funded plans are medically underwritten and fully insured small group plans are not. That single sentence explains almost everything about who level funding suits and who it damages.
Since the ACA market reforms took effect, issuers in the small group market must sell to any employer that applies and may vary premiums only by age, tobacco use, family size, and geography (45 CFR 147.102). Health status, claims history, industry, and gender are excluded from rating entirely.
Stop-loss insurance is not health insurance for those purposes in most states, so the level funded arrangement sits outside those rating limits. A quote therefore usually arrives with a health questionnaire, a participation census, or a request for prescription claims history. A healthy group prices below the community rated market, which is the whole appeal.
Plan ahead for that possibility when you set your eligibility and waiting period rules, because switching funding models mid-stream is disruptive for employees whether or not it is disruptive for your budget.
Which ACA Rules Still Apply
Moving to a self funded plan drops several ACA requirements and keeps several others. The ones it drops are why the arrangement can be cheaper. The ones it keeps are why it is not a compliance holiday.
| Requirement | Applies to a level funded plan? |
|---|---|
| Dependent coverage to age 26 | Yes |
| Preventive services with no cost sharing | Yes |
| No lifetime or annual dollar limits on essential health benefits | Yes |
| Annual out-of-pocket maximum | Yes |
| Limit on waiting periods before coverage starts | Yes |
| Summary of Benefits and Coverage | Yes |
| No pre-existing condition exclusions | Yes |
| Employer shared responsibility, if you are an applicable large employer | Yes |
| Coverage reporting to the IRS and to employees | Yes |
| The essential health benefits package itself | No |
| Small group community rating and single risk pool | No |
| Medical loss ratio rebates | No |
| Risk adjustment | No |
| State benefit mandates | Generally preempted by ERISA |
| Section 105(h) nondiscrimination testing | Yes, and fully insured plans effectively escape it |
The Section 105(h) row surprises employers. Self insured medical plans are subject to nondiscrimination rules under 26 U.S.C. 105, which test both who is eligible and whether benefits are uniform.
A plan that gives owners or the highest paid people a richer design than everybody else can lose the tax treatment on those reimbursements, which is a very different exposure from the testing rules on retirement plans.
Whether you count as a small group at all depends on a federal definition that states can override. Federal rules cap the small employer definition at 50 employees and allow a state to raise the ceiling to 100 (45 CFR 144.103). That definition governs the fully insured alternative you are comparing against, and it also decides which state stop-loss restrictions reach you.
Dwight SchruteSales3 people
Darryl PhilbinWarehouse1 person
Kelly KapoorCustomer Service1 personYour Duties as the Plan Sponsor
A level funded plan makes you the sponsor and administrator of a self funded ERISA welfare plan. The carrier does the claims work; the legal responsibility stays with you, and it is heavier than the fully insured version.
Two of these carry hard filings. The annual return sits with the Department of Labor and is filed electronically (Form 5500 Series), and the research fee is reported to the IRS on the quarterly excise tax return (PCORI fee questions and answers). Both are easy to miss in year one because a small fully insured plan required neither from you.
The research fee has a published rate and a hard date. According to the Internal Revenue Service, it runs $3.84 per covered life for a plan year ending on or after October 1, 2025 and before October 1, 2026, reported on the second quarter Form 720 and paid by July 31.
The document duties are the ones that quietly go undone. If you are not already producing a summary plan description, moving to level funding is the moment that gap becomes a real exposure rather than a theoretical one. The same is true of the broader ERISA obligations that come with sponsoring the plan.
The failure mode here is not disagreement about who does what. It is that nobody ever asked. Fill the record below in during implementation, while the administrator is still selling to you and answers arrive quickly, and treat every line with no name against it as yours by default.
State Limits on Small Group Stop Loss
Some states restrict or prohibit stop-loss insurance for smaller employers, which can make level funding unavailable to you regardless of what a national quote says. Stop loss is insurance, so states regulate it even though ERISA preempts (overrides) state regulation of the underlying self funded plan (DOL Technical Release 2014-01).
New York bars an insurer from providing stop-loss, catastrophic, or reinsurance coverage to a small group that would be community rated if it bought insurance (New York Insurance Law 3231(h)), and since 2016 the small group definition there reaches 100 employees. That closes level funding to most small employers in the state.
Delaware sets a floor instead of a ban. A small employer carrier there may issue or renew a stop-loss policy only to an employer with more than five eligible employees, the majority of them working in the state (18 Del. C. 7218). The smallest groups sit outside the market.
Other states take the softer route of setting minimum attachment points, so a policy may be sold but only with a deductible high enough that the employer is genuinely retaining risk. For a very small group the effect can be the same as a ban, because nobody wants that deductible.
Check your own state before you spend time on a quote, and check it again if you have employees in more than one state, because the location that matters is usually where the policy is issued rather than where each employee sits. This is a question for your broker with your state named in it, not a question a national explainer can answer.
The Real Risks
Level funding suits a specific kind of employer and hurts another kind. The honest split looks like this.
The renewal risk is the one employers underestimate. Level funding is not a permanent position but a bet that your group stays healthy, and the bet is re-run every twelve months with your own claims as the evidence.
How to Decide
Run the comparison on the terms that actually differ rather than on the headline monthly figure, because the headline is engineered to win.
Those seven questions only work side by side. Two quotes read a week apart in two separate PDFs always come down to the monthly number, which is the one comparison the pricing was engineered to win. Put them in one grid instead, leave the cells you were not given blank, and the blanks become the questions to send back to the broker.
| A | B | C | D | E | |
|---|---|---|---|---|---|
| 1 | What to compare | Fully insured quote | Level funded quote A | Level funded quote B | Notes |
| 2 | Carrier or administrator | Name the entity that carries the risk and the one that administers | |||
| 3 | Monthly payment, total | The headline number, and usually the only one on the front page | |||
| 4 | Claims fund portion, per month | The only part that can ever come back to you | |||
| 5 | Administration fee portion, per month | Earned month by month, never refundable | |||
| 6 | Stop-loss premium portion, per month | Earned while coverage is in force, never refundable | |||
| 7 | Was the three-way split given in writing? | If no, you cannot audit the surplus a year later | |||
| 8 | Individual attachment point | The per-person deductible on the stop-loss policy | |||
| 9 | Aggregate attachment point | Usually expressed as a percentage of expected claims | |||
| 10 | Contract basis | Decides who owns a claim incurred late in the year and paid after it | |||
| 11 | Lasers applied, and on whom | Ask directly. A laser moves risk back onto your plan | |||
| 12 | New lasers permitted at renewal? | Get the renewal terms, not just this year’s terms | |||
| 13 | Share of the surplus returned to us | Often a percentage rather than the whole unused balance |
If the answer comes out against level funding, the fully insured route is not your only alternative. An individual coverage health reimbursement arrangement or a qualified small employer arrangement shifts the model entirely by giving employees an allowance instead of a group plan, and either one is worth pricing before you sign anything.
Nick Anisimov, FirstHR founder
Frequently Asked Questions
What is level funded health insurance?
Level funded health insurance is a self funded plan that your company pays for with the same amount each month. That payment is divided into three parts: a claims fund that pays your members’ medical and pharmacy claims, a fee for the carrier or third party administrator who runs the plan, and a stop-loss premium that limits how much one bad year can cost. In legal terms the plan pays claims from employer assets, so you act as the plan sponsor of a self funded plan and carry the duties that come with it. In practice it feels like a fully insured product because the monthly bill is known in advance. If claims finish below the funding target, part of the unused claims fund can return to you as a surplus refund.
Is level funded health insurance the same as self funded?
Yes, in law it is a self funded plan, and no, it is not what most people picture when they hear the term. A traditional self funded arrangement means variable monthly costs tied directly to claims as they arrive, plus a separately purchased stop-loss policy and a separately contracted administrator. Level funding takes the same legal structure and smooths the cash flow: the carrier calculates a maximum funding rate up front, bundles administration and stop loss into it, and bills one steady number. You carry the claims risk on paper but the stop-loss attachment points are set so your monthly payment is the practical ceiling rather than the floor.
Do you actually get money back from a level funded plan?
Sometimes, not always in full, and never quickly. Only the claims fund portion of your payment can come back, so even a year with no claims cannot return the administration fee or the stop-loss premium. Settlement takes months after the plan year ends, because claims incurred late in the year keep arriving and the administrator holds money back against them until the picture settles. After that, the contract sets how much of the remainder you receive. According to SHRM (2021), contract language can let the administrator keep a quarter or more of any excess funds, and some arrangements pay a credit against next year’s funding rather than cash. Before you count the refund in a quote as real money, find the surplus clause and read it closely.
What is the difference between individual and aggregate stop loss?
Individual stop loss, also called specific stop loss, covers the plan against one very expensive member. When one person’s claims pass the individual attachment point within the contract period, the stop-loss carrier pays the plan back for the amount above it. Aggregate stop loss covers the plan against a costly year overall: it pays once everyone’s combined claims pass an aggregate attachment point, usually set as a percentage of expected claims. Level funded arrangements normally carry both. With individual coverage only, a year of many mid-sized claims can still hurt, and with aggregate coverage only, one very large claim early in the year falls on the plan until the total threshold is reached.
Do ACA rules apply to a level funded plan?
Many do and several important ones do not, which is the whole reason the pricing can be different. Requirements that follow you into a self funded plan include dependent coverage to age 26, preventive services with no cost sharing, no lifetime or annual dollar limits on essential health benefits, the out-of-pocket maximum, the limit on waiting periods, the Summary of Benefits and Coverage, the employer shared responsibility rules if you are an applicable large employer, and coverage reporting. Requirements that generally do not reach a self funded plan include the essential health benefits package itself, small group community rating, medical loss ratio rebates, risk adjustment, and most state benefit mandates. Section 105(h) nondiscrimination testing, which fully insured plans effectively escape, does apply.
Does a level funded plan have to file Form 5500?
It depends on how many participants the plan has and how it is funded. An ERISA welfare plan is generally exempt from filing Form 5500 when it covered fewer than 100 participants at the start of the plan year and is unfunded, fully insured, or a mix of the two. Here unfunded means benefits are paid from the employer’s general assets rather than from a trust. Once the plan reaches 100 participants at the start of a plan year, the filing applies, and a plan funded through a trust files whatever its size. Because level funded arrangements differ in how the claims account is set up, confirm your own structure instead of assuming the small plan exemption covers you.
Can a level funded plan be medically underwritten?
Yes, and that is the structural difference that decides whether level funding saves you money. Fully insured small group coverage is guaranteed issue and can be rated only on age, tobacco use, family size, and geography, so health status and claims history stay out of the price. Level funded plans sit outside those limits in most states, because stop-loss insurance is not treated as health insurance for rating purposes. A quote typically starts with a health questionnaire, a participation census, or a request for prescription claims history. Healthy groups can price below the community rated market, while a group with one serious ongoing condition frequently cannot. The same underwriting repeats at every renewal.
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