AOL

Why AOL ended up spending millions on 'distressed babies'

February 12, 2014: 11:10 AM ET

Tim Armstrong's latest blunder seems to go far beyond foolish pronouncements. Distressedbabygate is yet another sign that corporate America is taking on too much risk.

140211165848-tim-armstrong-620xa

AOL CEO Tim Armstrong

FORTUNE -- Tim Armstrong may not be the only one with an infirm infant problem.

The AOL CEO whined last week that two "distressed babies" had cost his company a million dollars each. That pronouncement was widely criticized, especially because it seemed Armstrong was trying to shift the baby care costs onto the Internet company's employees. Armstrong cited it as a reason AOL (AOL) had decided to change, but later reinstated, its 401(k) match.

But among corporate health care consultants and insurance experts Armstrong's pronouncement has raised another question: How did AOL leave itself exposed to million-dollar baby bills? It has also unearthed a potentially growing problem in corporate America. Amid rising medical costs, more and more companies may be taking on too much health care risk.

MORE: What does your employer know about your health?

According to its employee benefits page, the bulk of AOL-ers back in 2012, when the babies in question appear to have been born, had two main health insurance choices: Empire Blue Cross PPO or a plan offered by United Healthcare (UNH). Californian employees and those in some mid-Atlantic states had the option of going with another plan from Kaiser Permanente.

Companies have to give basic information to the government about the insurance they offer their employees. However, neither the Empire nor the United plans show up in the documents AOL filed for 2012. AOL did submit paperwork for a number of plans, including vision and disability insurance. According to the forms, AOL bought limited health insurance from CIGNA for 4,820 employees, nearly all of AOL's roughly 5,000 employees. But it only paid $38,500 for that insurance in total, or $0.67 per employee per month. So whatever health coverage it got for that it wasn't much, likely a plan that provided emergency health coverage to employees traveling overseas.

There are also the Kaiser plans, for which AOL paid $944,802. But that only covered 243 employees, or about 5% of AOL's workforce.

MORE: Add Tim Armstrong's 'distressed babies' to the pile of gaffes

What that means is that AOL didn't actually purchase any insurance to cover the health costs of 95% of its employees.

As odd as that sounds, AOL has plenty of company. These days, health insurance consultants regularly tell companies with over 500 employees not to buy health insurance. It's a waste of money. Instead, collect the payments that your employees would have paid an insurer. Then hire a big health insurance company to handle the paperwork. Voila, it looks like you are providing your employees health insurance, but you haven't purchased any coverage.

chart-self-insured_614xaAnd the percentage of companies that are going this route is way up. Of workers with health insurance, 61% are covered by so-called self-insured corporate plans, according to a recent study from The Kaiser Family Foundation. That's up from 44% in 1999. Of companies with 5,000 or more employees, it's 94%, up from 62% in 1999.

The problem with self-insurance, as the name implies, is that the company is now on the hook for all its employees' medical bills, which it has to pay, like everything else, out of whatever it generates in sales. So, what a majority of self-insured companies do is buy something called stop-loss insurance, which caps how much they would have to pay in medical expenses per employee, per year. It works like a typical insurance deductible. Anything above the cap, the stop-loss insurance provider has to pick up.

It appears, though, that AOL either didn't purchase stop-loss insurance or at least not very good coverage. The government has a place on its forms where companies can detail their stop-loss insurance, but companies aren't required to fill that section out, and AOL didn't. An AOL spokesman declined to comment.

Nonetheless, Armstrong's comments imply that AOL did have stop-loss insurance and that it was capped at $1 million per employee. Even if that is correct, Cori Cook, who runs a health care consulting firm, says that's crazy for a firm of AOL's size. Cook left a job at a large administrator of self-funded insurance plans in November, mostly working for companies with a few hundred employees to just over 10,000. She says the largest stop-loss insurance cap she saw in her decade at the company was $450,000.

"It would be risky to not have some sort of stop-loss insurance," says Cook. "Health care costs are accelerating exponentially."

MORE: 8 young B-school professors on the rise

Other consultants say the need to buy stop-loss insurance varies by the firm, its workers, and the amount of risk a company and its executives are willing to take. Armstrong apparently was willing to take on much more health care risk than most other companies of AOL's size; that certainly says something about his management style. According to Kaiser, 85% of companies with 1,000 to 4,999 employees had stop-loss insurance. The average cap for that group was $245,000. Even for companies with more than 5,000 employees, where stop-loss insurance drops to 40%, the average cap is still only $479,000.

Taking on that risk doesn't make a lot of sense for AOL. The company has nearly $165 million in cash. But, presumably, AOL's shareholders would prefer the company to be using its cash to expand the business, not covering medical bills. What's more, it appears AOL lost its insurance bet. Armstrong's decision to change the 401(k) plan, citing the health care costs, suggests that. The other possibility is that AOL banked its winnings from the years when its health care bet paid off, but then sought to get employees to foot the bill the one year it did not. Neither speaks well of Armstrong.

Anecdotally, consultants say, despite rising health care costs, more and more companies like AOL are opting to go without stop-loss insurance. This seems not too different from the subprime mortgage bonds that banks constructed in the run-up to the financial crisis. Bankers thought they had diversified their risk by packaging together thousands of home loans. But when housing prices fell, many of those borrowers defaulted all at once. In the same way, AOL has a relatively young workforce. That may be why it decided to take its ill-advised insurance bet.

But overall, the workforce is aging, and women are having babies later than they used to, leading to an increase in maternity costs. Cook, the consultant, said that million-dollar claims are becoming increasingly common. The financial crisis forced banks to deal with their long-tail risks, or at least it got regulators and others to wake up to them. The rest of corporate America may still be asleep.

  • Michael Arrington is raising another CrunchFund

    CrunchFund II already has held a first close.

    FORTUNE -- Last spring we wondered about the future of CrunchFund, the early-stage venture capital firm led by TechCrunch founder Michael Arrington:

    Some in Silicon Valley have whispered that Arrington is sitting at home in Seattle with his feet up, resigned to the notion that CrunchFund was a blogger's failed investment experiment. Yesterday those rumors got even louder, with news that one of CrunchFund's MORE

    - Jan 30, 2014 4:50 PM ET
  • Why did AOL buy Adap.tv now?

    Some thoughts about AOL's $405 million push into the online video ad space.

    FORTUNE -- AOL Inc. (AOL) today announced that it will pay $405 million to acquire Adap.tv, a San Mateo, Calif.-based online video advertising platform. It's the largest acquisition of the Tim Armstrong era, and represents a sizable return for many of the venture capitalists who plugged just under $50 million into the business between 2007 and 2011.

    Some notes and MORE

    - Aug 7, 2013 12:59 PM ET
  • CrunchFund's future

    With nearly 100 portfolio companies and just two remaining partners, what is the future of Michael Arrington's venture capital effort?

    FORTUNE -- It has been 20 months since TechCrunch founder Michael Arrington launched CrunchFund, a venture capital firm that had the blessing of AOL, the company that had purchased TechCrunch one year earlier. Until AOL changed its mind, and Arrington was fired. Until it changed its mind again, and he rejoined MORE

    - May 7, 2013 3:23 PM ET
  • Is Time Inc. better on its own?

    Will Time Inc. shareholders be as pleased as those of Time Warner Cable and AOL?

    FORTUNE -- Time Warner announced Wednesday that it plans to cut its Time Inc. magazine unit loose, spinning it off into an independent public company. There are all sorts of details yet to be worked out, but the largest question is whether this deal will actually work. And, by that, I mean create additional value.

    Time Inc. MORE

    - Mar 7, 2013 12:58 PM ET
  • Michael Arrington is (still) out at AOL

    Last Wednesday, Fortune reported that AOL and TechCrunch founder Michael Arrington had decided to part ways -- following a messy dispute revolving around a VC fund that Arrington had launched with AOL's consent and investment. Today, AOL (AOL) made it official.

    In a brief statement, the company said:

    "The TechCrunch acquisition has been a success for AOL and for our shareholders, and we are very excited about its future. Michael Arrington, the MORE

    - Sep 12, 2011 12:13 PM ET
  • Arrington out at AOL (for real this time)

    Not TechCrunch editor. Not AOL Ventures employee. Michael Arrington is on his own.

    It has been a very long week for AOL. And it's about to get even longer.

    Last Thursday, word leaked that one of its employees, TechCrunch founder Michael Arrington, was launching a venture capital fund that would include an $8 million commitment from AOL (AOL). Then came a more official version via the NY Times, which included positive quotes MORE

    - Sep 7, 2011 9:10 PM ET
  • The biggest CrunchFund loser is...

    Tech blogger Michael Arrington might be in limbo, but someone else has lost more in the CrunchFund debacle.

    It's now been five full days since CrunchFund was unveiled, and no one is coming out of this mess looking worse than Arianna Huffington.

    Various reports suggest that she's furious with the implicit breaching of AOL's editorial ethics, and wants Michael Arrington not just banished from AOL editorial, but from AOL (AOL) as a MORE

    - Sep 6, 2011 9:22 PM ET
  • CrunchFund confusion

    If Michael Arrington is leaving TechCrunch, what does that mean for the investors in CrunchFund?

    Yesterday we were first to report that tech blogger Michael Arrington has launched a $20 million venture capital fund, which is being backed by AOL (AOL) and a group of Silicon Valley's top VC firms.

    I'm still working through my thoughts on all this, and AOL apparently is working through what this means for TechCrunch, the Arrington-founded MORE

    - Sep 2, 2011 10:18 AM ET
  • AOL enters the import/export business

    AOL Inc. (AOL) today is firing hundreds of people, after closing its $315 million acquisition of HuffingtonPost. Many of these are journalists. For example, AOL exec Jonathan Dube tweeted:

    I have just laid off dozens of the most talented journalists & product folks I know. Need talent? Let me know!

    In a memo detailing the moves, AOL CEO Tim Armstrong tried to soften the blow:

    With the acquisition of The Huffington Post and this MORE

    - Mar 10, 2011 1:08 PM ET
    Posted in:
Current Issue
  • Give the gift of Fortune
  • Get the Fortune app
  • Subscribe
Powered by WordPress.com VIP.