Inside the Hidden Legal Risks Small Businesses Face with Self-Funded Health Plans

As rising healthcare costs push more small employers toward self-funded health plans, many are taking on significant fiduciary and compliance risks without realizing it. Roughly 16% of small businesses with fewer than 50 employees now self-insure at least one of their group health plans, up from 13% in 2010. That shift brings heightened exposure under federal laws such as ERISA and the Consolidated Appropriations Act (CAA), responsibilities many small employers are unprepared to manage.

Frank Pennachio is the Founder of Gaffney Hill Consulting, an insurance industry veteran and outspoken critic of how self-funded health plans are sold to small employers. The author of The Silent Danger, a book that examines the often-overlooked legal and financial liabilities of self-funded health plans, Pennachio has spent years warning that a convergence of industry failures has left many small business owners exposed. He argues that the core promise of self-funding is frequently built on a fundamental misunderstanding of risk, fiduciary duty, and responsibility under federal benefits law.

"This is a perfect storm of rising costs, miseducation, and contracts no one is reading. Small employers are adopting self-funded and level-funded plans without understanding that they are assuming fiduciary responsibility and putting personal assets at risk in a way that fully insured plans simply do not," says Pennachio. He argues that the promise of cost savings and flexibility often obscures the legal realities of self-insurance.

• The level-funded misconception: Employers frequently underestimate the full financial and fiduciary risk they assume, relying on stop-loss coverage as a perceived safety net in an already complex landscape. "The marketing term 'level-funding' is designed to sound like it's not self-insurance, but it is self-insurance," he notes. "While the cash flow might be structured differently, the fiduciary liabilities, risks, and personal asset exposure are the same."

• Give me some credit: In reality, he warns, stop-loss insurance is merely a reimbursement policy, leaving employers ultimately responsible for paying every benefit promised under the plan, whether or not reimbursement arrives. "It's not a check; it's a credit on a future invoice, so you have to stay with that same carrier for five years to see it. If you leave before then, you don't get the credit."

Adding to the challenge is a legal imbalance built into the system. Under ERISA, fiduciary breaches can expose employers to personal liability beyond the corporate entity. "What employers don’t understand is that their personal assets are at risk to a much greater degree than under a fully insured plan. It’s exponentially higher," says Pennachio. Yet many employers enter this environment without specialized legal guidance. Plan-related contracts are often not reviewed by ERISA counsel, even as other parties involved typically rely on dedicated legal support, an oversight that can leave employers more exposed than they realize.

• A tale of two silos: Pennachio explains that the insurance industry operates in a culture of two silos. "The property and casualty team rarely works closely with the employee benefits team. As more employers move toward self-funding, benefits teams often aren’t aware of fiduciary liability risks. Many have never even had a conversation about fiduciary liability insurance."

• Follow the money: "The only people promoting self-funding to small employers are those selling products. Actuaries or private equity risk managers aren’t recommending it. It’s carriers, managing general agencies, and third-party administrators doing the promotion. There’s just too much risk," he continues. Legal challenges, including the recent PBM lawsuit involving grocer Albertsons, show that even sophisticated companies can encounter significant risk as Congress ramps up oversight.

• On the hook: To highlight the one-sided nature of the risk, Pennachio suggests a basic test: ask all vendors to sign a "hold harmless" agreement for fiduciary breaches. Their likely refusal, he says, exposes the reality that "they are purposefully shifting the liability." And fiduciary risk isn’t limited to owners. "HR staff are fiduciaries too, and many don’t even realize it. Their personal assets are at risk, and they don’t even own the company."

Pennachio urges business owners to stop chasing uncertain savings and make deliberate, informed decisions grounded in a realistic view of risk. For many, safeguarding their assets outweighs the lure of potential, but unpredictable, cost reductions. The real challenge, he says, is human. "It’s much easier to fool someone than to convince them they’ve been fooled. Right now, many agents believe there isn’t more risk and that they have control, but in reality, all the control is being signed away," he concludes.