Disrupting Employee Health Insurance

December 18, 2014

A recent New York Times rumination about running a small business, employee health insurance and the apparent inevitability of higher cost and compromised benefits wound around to this somewhat plaintive reflection:

Yet, I have a feeling that somewhere there has to be better thinking and insight about the health insurance mess.

That is where a lot of small business owners are on the subject of employee health insurance right about now. But that urge for better thinking and insight is the power that fuels business disruption. Enter Zenefits, as if on cue.

Zenefits has been described as 2014’s hottest new startup. The company gives away cloud-based human resources software and lets businesses purchase insurance through their platform. Zenefits charges the businesses nothing for the software and nothing for the purchase.

It makes money by charging a commission to the health insurance companies who sell the policies, and it appears to be quite successful, with year-end revenue projected to be 20 times what it was at the beginning of 2014. Zenefits focuses particularly on the small employer market. In California, it is the top broker for Anthem Blue Cross for companies with fewer than 50 employees.

This is the software-as-service business model that observers have seen many times before with Uber, Airbnb, or the less familiar Nestdrop, which delivers medical marijuana to patients’ homes in Los Angeles. Zenefits also, quite predictably, has found itself in hot water with industry regulators, like the Utah Insurance Department, which claims that the company is violating Utah’s rebates and inducement law by giving away its software for free.

Where does this go from here?  Will Zenefits’s software be the solution to the “insurance mess” that small and mid-sized businesses have searched for, or will Zenefits morph into the uncool, unregulated, ethically challenged industry bully that Uber seems to be becoming? Is Zenefit’s businesses model actually disruptive in the sense that, although initially targeted at less profitable customers, it will eventually take over and devour an entire industry? And what about the risk that it presents to the entrenched insurance industry. Is there a risk of backlash?

What Zenefits Offers

HR Software

Through its free software, Zenefits offers a very comprehensive menu of HR functions. These include:

  • Attendance Management,
  • Benefits Management,
  • Compensation Management,
  • Compliance Management,
  • Employee Database,
  • Employee Lifecycle Management,
  • Employee Self Service,
  • Notifications,
  • Onboarding,
  • Payroll Management and
  • Vacation/Leave Tracking.

It also offers a number of non-core HR functions, including:

  • 360 Degree Feedback,
  • Communication Management,
  • Performance Appraisal,
  • Recruiting Management,
  • Succession Planning and
  • Training Management.

The latter are not free, and 85 percent of customers ignore them. The great divide seems to be between services that are necessary for legal compliance and those that are not.

The early word on the software, at least the free portion, is that it works remarkably well. Zenefits’s major competitor in the HR software field is often seen as Workday, but Workday’s target market appears to be larger employers, and it does not act as an insurance broker.

Brokerage Services

Insurance brokers identified the Affordable Care Act as a business opportunity from the beginning, and that is the way Zenefits actually makes its money. It is licensed in 50 states and does business in 47 of them. Once it has been authorized by the employer as a broker, Zenefits can make the insured portion of the benefits package very easy to manage, as well as the rest of HR functions.

Traditional brokers can’t compete with the client base Zenefits can build with the free, easy, quality software and service. According to Paul Mifsud, founder and chief executive of Melita Group, an insurance and HR firm in Santa Clara,  “Every broker in the country is scared now of Zenefits.”

From the employer’s perspective, what Zenefits sells is convenience. The insurance, itself, is not necessarily cheaper, but the time and attention that managing employee health insurance requires of the small or medium-sized business is a big part of the stress factor.

What the Naysayers Say

Criticism of Zenefits’s practices, at least so far, seems to come from two sources: traditional brokers who are being squeezed out of the market and Utah’s Insurance Department, although other state insurance regulators may ultimately become involved as well.

Traditional brokers point to the lack of a personal relationship with employers and the relatively remote nature of employee service. Zenefits handles most contact through e-mail and a call center.

To be fair, although most of the core services seem relatively mechanical, it is difficult to see how some other non-core functions, like succession planning could be handled remotely. Even having an error in a relatively routine piece of information like a mis-entered address in a database can be difficult and frustrating when working with a call center.

The business responses have been varied. Some brokers have sought unsuccessfully to partner with Zenefits or are in the process of developing competing HR software of their own. Others have clearly taken up their cause with state insurance commissioners.

Utah’s claim is that the free software amounts to a rebate prohibited under Utah insurance law. The Insurance Department is demanding not only that Zenefits cease Utah operations and pay a fine of $97,000, but that it stop advertising that it offers free HR cloud management services and charge a “fair market value” for its services to ensure fair competition with other insurance licensees in the state. That, of course, would eliminate Zenefits’s incentive to be in Utah in the first place. It is not entirely clear, at this point whether Zenefits may legally operate in Utah.

The Future of Zenefits’s Business Model

In order to be disruptive, a new business model has to take over an industry, and in order to do that, it has to be cost effective and high quality.

There is nothing particularly revolutionary about the insurance brokerage business. What makes Zenefits such a fierce competitor at the moment is the free, high-quality HR software it can afford to give away. Building a client base with a wonderful freebie is also not necessarily a revolutionary idea. Magic Decoder Rings did wonders for breakfast cereal once upon a time.

Cloud technology, which brings the price down to a point where Zenefits can afford to give it away and also permits rapid change, is certainly a revolutionary and disruptive force. It is also something that Zenefits’s competitors will figure out how to use for their own benefit in short order.

The Quality Challenge

That would leave the quality of the software as Zenefits’s distinguishing competitive advantage. It may also be the company’s Achilles heel.

Fifty-state legal compliance, especially at a time when states are the drivers of change in employment law, is a very tall order. This is especially true for a company that only 12 months ago had fifteen employees. Hours for sick leave payment purposes in California, for example, are not necessarily counted in the same way as hours for determining exempt status in New York, and either could change when the legislature comes back into session. Multiply that for every state and consider the breadth of the legal issues that could be involved. Compliance is not impossible, but it may be labor intensive.

One high-profile employer suit against Zenefits for a software error that resulted in employer liability under state law could take the shine off the company’s current star power. Maintaining the luster could be exacting and expensive.

The Regulatory Challenge

The other great risk may come, as it has already begin to emerge, from state departments of insurance.  This aspect of Zenefits’s future development may be very much like what Uber and Airbnb have faced, with very mixed success.

Much of the coverage of Utah’s challenge to Zenefits seems to take for granted that protection of entrenched local interests is a major motivator. There is no particular reason to expect other state legislatures to be more open to innovation, absent lobbying efforts on the part of small employers interested in higher quality, if not cheaper, employee health insurance options.

Can Zenefits make the argument that its business model is so different that it should not be regulated in the way that other state-licensed insurance brokerages are regulated? That remains to be seen, and the challenge in each state. where one is raised, may be different. It has not necessarily worked well for other disruptive innovators who very often, after a protracted legal battle, simply decide that it is easier to comply with state regulations.

If Zenefits can maintain the quality of its free HR software to build the client base for its brokerage services it might truly change the face of the human resources consulting industry. Its business model could also change the face of the market for employer-based insurance under the Affordable Care Act, by adding the concept of “affordable” back in and banishing the perpetual specter of compromised benefits.

If better thinking, insight and a healthy dollop of disruptive technology can bring about that result for small and mid-size employers struggling to offer insurance to employees, it would be very welcome.

 

Anne Wallace, Esq.

By

Anne Wallace is a New York lawyer who writes extensively on legal and business issues. She also teaches law and business writing at the college and professional level. Anne graduated from Fordham Law School and Wellesley College.

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