Exploring Hybrid Funding Approaches for Diverse Employee Groups

For employers considering self-funding, the decision is often presented as an all-or-nothing proposition: either the company self-funds its health plan or it purchases fully insured coverage.

In practice, the answer can be more nuanced.

An employer with employees in multiple locations, job classifications, bargaining units, or other distinct employment groups may be able to use a combination of funding approaches. Properly structured, this type of risk segmentation can allow an employer to retain the advantages of self-funding where they make sense while using traditional insurance where the economics, provider market, population size, or risk profile suggest a different approach.

The key is understanding what may, and may not, be segmented.

What Is Risk Segmentation?

“Risk segmentation” is not a defined term under ERISA or HIPAA. In the context of an employer-sponsored health plan, however, it can be used to describe a strategy in which an employer evaluates distinct portions of its workforce separately rather than assuming that one funding arrangement must work equally well for every employee population.

For example, an employer might have several hundred employees concentrated in its primary market but a much smaller group working in another state. The larger population may have sufficient size, predictable claims experience, favorable provider contracts, and appropriate stop-loss terms to make self-funding attractive. The smaller population may have very different characteristics.

Instead of abandoning self-funding for the entire organization, the employer can evaluate whether the smaller population should be handled differently.

That could mean offering a different benefit option, using a different network, or in an appropriately structured arrangement, combining self-funded and fully-insured components.

This concept is not merely theoretical. The Department of Labor’s 2026 Annual Report on Self-Insured Group Health Plans specifically recognizes “mixed-insured” arrangements in which a plan sponsor pays some benefits itself while transferring the risk for other benefits to an insurance company. The DOL reported approximately 4,800 mixed-insured group health plans covering nearly 33 million participants in the 2023 Form 5500 filing data.

Federal Rules Permit Legitimate Employee Groups to Be Treated Differently

One of the most important regulatory concepts for risk segmentation is the HIPAA rule concerning “similarly situated individuals.”

The Department of Labor explains that a group health plan may distinguish between different groups of employees when the distinction is based on a bona fide employment-based classification consistent with the employer’s usual business practices.

Examples identified by DOL include:

• employees in different geographic locations;
• full-time versus part-time employees;
• employees in different occupations;
• employees covered or not covered by a collective bargaining agreement;
• employees with different dates of hire or lengths of service; and
• current versus former employees.

Importantly, DOL states that properly established groups can have “different eligibility provisions, different benefit restrictions, or different costs.”

The Treasury Department’s parallel HIPAA regulations contain essentially the same rule. The regulations provide that participants can be treated as two or more distinct groups of similarly situated individuals when the distinction is based on a bona fide employment classification consistent with the employer’s usual business practice. Geographic location is specifically listed as an example.

That regulatory framework creates an opportunity for employers with naturally distinct employee populations to look beyond a one-size-fits-all funding model.

The Critical Limitation: You Cannot Segment People Because They Are Sick

This is where the terminology matters. Risk segmentation does not mean identifying an employee with a large claim and moving that employee into a different plan.

HIPAA prohibits group health plans from discriminating against individuals based on health factors. Those factors include health status, medical condition, claims experience, receipt of health care, medical history, genetic information, evidence of insurability, and disability.

The DOL is equally clear that an individual with a history of high claims cannot be required to pay more than other similarly situated individuals because of those claims. Nor can an employer simply invent an employment classification for the purpose of isolating a high-cost claimant. The DOL states that a classification cannot be created or modified to target individual participants or beneficiaries based on a health factor.

That distinction is fundamental.

A longstanding Northeast sales office, for example, may constitute a bona fide geographic classification because the company already operates and manages that location as a distinct employment group. Creating a new “special projects division” consisting primarily of an employee with a large medical claim would present an entirely different, and highly problematic, set of facts.

How Risk Segmentation Can Work in Practice

The process should begin with the employer’s organizational structure rather than its medical claims.

First, identify legitimate employment classifications that already exist for independent business reasons. Geography is one of the most obvious examples for companies operating in multiple states or markets, but occupation, bargaining status, employment status, and other classifications may also be relevant.

Next, evaluate each population from a funding perspective.

That analysis can include population size, historical claims volatility, provider-network availability, stop-loss pricing and terms, fully-insured alternatives, administrative expenses, pharmacy costs, employee contribution strategy, and the employer’s tolerance for claim volatility.

A larger, more predictable population might remain self-funded while another bona fide employee group is offered an insured arrangement. Alternatively, different groups might receive different benefit packages or contribution structures where permitted.

The objective is not to remove sick employees from the plan. It is to determine whether the employer’s legitimate employee populations require identical funding solutions in the first place.

Employers Can Use Aggregate Claims Information for Plan-Design Decisions

Self-funding often provides employers with significantly greater visibility into plan performance. That information can be valuable when considering segmentation, but privacy rules are important.

HHS guidance expressly contemplates plan sponsors receiving “summary health information” for purposes such as obtaining insurance premium bids or modifying, amending, or terminating a group health plan. Summary health information can include summarized claims history, claims expenses, and types of claims experience, subject to HIPAA’s requirements regarding identifiers and use of the information.

That provides an important framework for evaluating plan economics.

An employer can analyze the financial performance of its plan and evaluate alternatives without turning medical information into an employment decision. Individually identifiable protected health information must continue to be handled in accordance with HIPAA, and it cannot be used for employment-related decisions.

In other words, good risk segmentation is an actuarial and plan-design exercise, not an exercise in identifying individual employees whom the employer would prefer not to cover.

Self-Funded Plans Have Additional Nondiscrimination Requirements

HIPAA is not the only consideration. Self-funded medical plans are also subject to the nondiscrimination requirements of Internal Revenue Code §105(h). In general, a self-insured medical reimbursement plan cannot discriminate in favor of highly compensated individuals with respect to eligibility or benefits.

This becomes particularly important when different employee groups receive different benefits or when a plan is divided into multiple components.

A risk-segmentation strategy should therefore be tested not only under HIPAA’s “similarly situated individuals” rules, but also under §105(h) and any other applicable nondiscrimination requirements.

Applicable Large Employers Must Also Consider the ACA

For employers subject to the Affordable Care Act’s employer shared responsibility provisions, segmentation does not eliminate the employer’s ACA obligations.

An Applicable Large Employer generally must offer minimum essential coverage to at least 95% of its full-time employees and their dependents to avoid potential liability under §4980H(a). Coverage offered to individual full-time employees must also be evaluated for affordability and minimum value for purposes of potential §4980H(b) liability.

Accordingly, an employer can use different funding arrangements for different legitimate populations while still ensuring that its overall coverage strategy satisfies the ACA.

When Does Risk Segmentation Make Sense?

Risk segmentation is most worth evaluating when an employer has meaningful differences within its workforce that already exist for legitimate business reasons.

A multi-state employer is a good example. One location may have a large concentration of employees and excellent access to the employer’s preferred provider network, while a smaller location hundreds of miles away has different providers, different carrier options, and a much smaller claims pool.

Forcing both populations into exactly the same funding arrangement may not produce the best result.

Likewise, an acquisition may leave an employer with geographically distinct populations, or an organization may have legitimately different union and non-union populations or occupational groups.

In those situations, the better question may not be, “Should we self-fund?”

It may be, “Which portions of our workforce are best suited for self-funding, and what is the most appropriate strategy for the others?”

The Potential Advantages

When properly designed, risk segmentation can provide several advantages.

It may allow an employer to preserve favorable self-funded economics for a substantial portion of its workforce rather than abandoning self-funding because one segment of the organization creates different financial or operational challenges.

It can also provide greater flexibility in selecting provider networks, stop-loss arrangements, carriers, and benefit designs appropriate to different markets.

Most importantly, it allows an employer to evaluate health-plan risk with greater precision. A company with several distinct employee populations does not necessarily have one homogeneous risk pool from an operational or financial perspective. Recognizing those distinctions can lead to better funding decisions.

Putting Risk Segmentation Into Practice

Self-funding does not always have to be an all-or-nothing decision.

Federal guidance recognizes that bona fide employment groups, including employees working in different geographic locations, can constitute separate groups of similarly situated individuals. It also recognizes that such groups can, within the applicable rules, have different health-plan provisions and costs. And current Department of Labor reporting confirms that combinations of insured and self-insured funding are an established part of the employer health-plan landscape.

The compliance line, however, is critical: employers should segment based on legitimate employment classifications, not individual health status or claims experience.

For employers with multiple locations or other naturally distinct employee populations, that distinction can create opportunities to manage health-plan risk more intelligently while maintaining the protections required by federal law.

Before implementing a segmented funding strategy, employers should coordinate with experienced benefits counsel, their third-party administrator, insurance broker, and other appropriate professionals to ensure the arrangement is structured properly and aligns with applicable ERISA, HIPAA, DOL, IRS, and ACA requirements.

This article is provided for general informational purposes and is not intended as legal or tax advice.