Lakewood Avenue Children’s School in Durham, NC, has eight full-time and three part-time employees and serves 33 children. In June, its director, Marcia Brooks, wrote in the Raleigh News & Observer that she wants to offer her staff a level-funded health plan, a type of health care coverage. However, she faces limits in this decision because North Carolina considers her business is too small. If the same school operated in Virginia or South Carolina, she would typically have the option.
Whether she should have that option is a fair question facing North Carolina lawmakers, and it echoes an argument playing out nationally. Simply put, the debates about why rules like this exist and why changes have been slow to take hold speak volumes to the national debate about who pays for health care coverage and how tax incentives can influence (or be influenced by) the outcomes.
How Does Level-Funded Plan Health Care Coverage Work?
For an employer, a level-funded health care coverage plan is like any other type of employer-provided insurance. Where it differs is that it is self-funded. Part of each payment the employer makes goes into a fund that pays employees’ health care coverage claims. Meanwhile, part of it buys stop-loss insurance that covers claims above a specified threshold.
These plans are used widely across the country (particularly in small businesses). KFF estimates that 37% of covered workers at firms with 10 to 199 employees were in a level-funded plan in 2025.
The main appeal is the cost structure for these plans. Level-funded plans are self-funded, which can allow them to be priced on a group’s own claims rather than rates based on community ratings imposed by the Affordable Care Act.
For instance, if a company has a younger set of employees that tend to have lower health care costs, the savings can be meaningful. This notion would be the case for many industries that often employ a younger set of employees, such as child care providers, restaurants, and startups.
Level-funded plans can also provide benefits to employers afterwards. If an employer’s claims come in lower than expected, it may get part of the unused claims fund back at the end of the year. This opportunity is something a fully insured plan generally does not offer except through Affordable Care Act rebates tied to an insurer’s overall spending.
What Do North Carolina’s Laws For Level-Funded Plan Health Care Coverage Say?
The North Carolina laws surrounding this issue concern stop-loss coverage and the number of employees the company must have to qualify. They say that stop-loss coverage sold to an employer with fewer than 12 eligible employees has to follow the same rating rules as the small-group market. This differs substantially from most of the country: according to supporters, employers with five or more workers can buy level-funded plans in 43 of the 46 states where they are sold.
In practice, this works as a ban on level-funded plans for the state’s smallest employers, which matters given the mounting health care costs these businesses face.
Meanwhile, in November 2024 the North Carolina Chamber and Blue Cross NC launched Carolina HealthWorks, a self-funded multiple employer arrangement that allows members of the NC Chamber and participating local chambers with 2 to 50 employees to get self-funded coverage. However, this relies on the company paying dues and raises the question of why companies need to go through this channel (rather than the conventional path of buying it directly for their employees, as is common in most other states).
How Does The Tax Code Treat Employer Health Care Coverage?
The federal tax rules provide employers with generous tax treatment for offering health care. Importantly, these rules do not vary based on how the plan was funded.
An employer can deduct what it spends on employee health coverage as an ordinary business expense. The tax rules are indifferent as to whether that money is spent on an insurer as a premium or into a level-funded claims account.
On the flip side, under Section 106, employer-paid coverage is excluded from employees’ taxable income and from Social Security and Medicare taxes. Employees avoid both income tax and their 7.65% payroll tax on it, and the employer avoids its matching 7.65%. This marks a large amount of tax savings. An employee’s own share of the premium often also comes out of pay before tax. The result is that nearly every dollar flowing into an employer plan, from either side, is contributed pre-tax.
Small firms face two issues. First, employers with fewer than 50 full-time equivalent employees can drop coverage entirely without owing a penalty under the ACA’s employer mandate. Second, owners can be treated differently, since sole proprietors, partners, and more-than-2% S corporation shareholders generally deduct their own premiums through the self-employed health insurance deduction (rather than the employee exclusion).
There is a small-business credit for a company’s health care plan coverage for employees. However, it is limited, and a level-funded plan does not qualify.
Two more items are of note. First, that year-end refund is generally taxable because the original contributions were deducted, and the portion tied to employee contributions may have to stay with the plan. Second, at the state level, North Carolina’s 1.9% tax on gross insurance premiums applies to the entire premium of a fully insured plan but generally only applies to the stop-loss portion of a level-funded one.
What Is The National Debate On Health Care Coverage?
When a small employer drops coverage, the federal subsidy for its workers does not vanish. Instead, it moves from the employer exclusion to the ACA premium tax credit, if the worker qualifies. This year, fewer do.
With ACA Tax Credits In The Balance, Republicans And Democrats Clash
The enhanced credits expired at the end of 2025, and KFF estimates that subsidized enrollees’ premium payments more than doubled, rising over $1,000 a year to keep the same plan. The House passed a three-year extension 230-196 in January 2026, and the Senate has not acted. The subsidy cliff at 400% of the poverty line is back, and starting with 2026 coverage, the One Big Beautiful Bill Act removed the caps on paying back excess advance credits. For example, a North Carolina child care teacher whose employer drops coverage in 2026 may now be less able to find an affordable option because the enhanced credits expired, leaving smaller subsidies or none at all.
Despite some attempts by Congress to address this concern, questions still remain, like whether the employer exclusion should be capped. And would small-firm workers be better off in the individual market? However, the question in front of the North Carolina Senate is much more straightforward: should a small employer here have the same options as one in a neighboring state?
Would It Benefit States To Reconsider Level-Funded Health Care Coverage?
Taking everything together, change may be warranted. Lowering the threshold to five puts North Carolina in line with its neighbors and most of the rest of the country. However, lowering the threshold could carry costs, which is what concerns some policymakers.
For instance, critics argue that if younger healthier small groups leave the community-rated market, premiums could rise for the remaining groups, such as those who are older or less healthy. Still, North Carolina has already accepted some of these effects by authorizing Carolina HealthWorks, which pulls small groups into a self-funded arrangement.
What might be enticing for a state like North Carolina is that it can examine the impacts in real time. A five-person business in Mecklenburg County (Charlotte, NC) cannot buy what a five-person business across the line in York County, South Carolina could purchase. Tracking offer rates and small-group premiums on both sides of that border before and after a change would tell policymakers whether the adverse selection critics worry about actually shows up, and how large it is.
In the end, the level-funded debate is as much a tax story as an insurance one. The federal tax code already subsidizes health care coverage the same way whether a small employer buys a fully insured plan or a level-funded one. Thus, a threshold like North Carolina’s 12-employee rule mainly decides which businesses can stretch those tax-free dollars further, and which might drop coverage altogether.
This article was originally published on Forbes.com
