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HEALTH SECTION NEWS“For Professional Recognition of the Health Actuary”

NUMBER 39 DECEMBER 2000

Page

Chairperson’s Cornerby Bernard Rabinowitz .....................1

The Art & Science of Pricing SmallGroup Medical Coverage

by William R. Lane............................1Letter from the Editor

by Jeffrey D. Miller ...........................2Health Section Meets at ChicagoAnnual Meeting .....................................9Medicare Supplement Insurance ClaimCost Trends

by Michael S. Abroe........................10Using the Internet as a Pricing Tool

by Joan C. Barrett ...........................11

Page

Will Your Unpaid Loss Reserve StandUp to IRS Scrutiny?

by Rowen B. Bell.............................14Combining an Actuarial and anUnderwriting Approach

by David L. Reichlinger..................16Health Care and the Role of the Actuaryin Ireland

by Aisling Kennedy .........................17Part One: A Short History of A NewProduct

by Johan L. Lotter...........................19

The Retirement Needs Framework:Issues for Health Actuaries

by Anna M. Rappaport....................23

Page

The Managed Care Market − CurrentStatus, Future Direction

by Kevin M. Dolsky.........................26What No One Ever Told Me About theRate Filing Process

by Karl G. Volkmar .........................28Industry PerspectiveConsumer Protection -Continuation ofBenefits in Event of HMO Solvency

by Harry L. Sutton, Jr. ....................30

Why Everyone Hates HMOsby Gerry Smedinghoff .....................32

The time has come to sayfarewell. My term is upand this is my last col-umn as the Health

Section chairperson. I would like totouch on three subjects. These arevolunteering, expanding the profes-sional role of the healthcare actuary,and communications. In fact all threeare interrelated.

VolunteeringI want to thank the many volunteersfor the great effort and numerous

Chairperson’s Cornerby Bernie Rabinowitz

The Art & Science of PricingSmall Group Medical CoverageInitial Pricing Schemes

by William R. Lane

In This Issue

(continued on page 3)

The Process Of Setting RatesSetting rates for small employer medical coverage usually involves three specific tasks,as follows:

First, one needs to determine what the average cost will be for the products to besold. This includes setting age/gender factors, determining the relative worth of variousplan designs, determining the relative cost in various geographic areas, setting trendfactors, determining the worth of differing networks, and determining the impact ofindustry on the relative cost. Most important it includes setting a base rate.

Setting base rates has been greatly complicated by the use of provider networks. Theexperience of other companies cannot be assumed to match your own. Purchased ratemanuals need to be adjusted to reflect your network and your utilization management.As always, the best indicator of the needed base rate is your own experience adjusted


Welcome to the thirdedition of the HealthSection News underour new re-energized

format. We can all thank BernieRabinowitz for making this happen.His knowledge, wisdom, and energyhave been a great gift to the HealthSection over the past year.

I heartily recommend that you setaside some time to read the articlesin this edition. Several critical areasof health actuarial practice areaddressed in a very thoughtful way.Another big THANK YOU goes tothe brilliant authors who continue tocontribute to our literature on avolunteer basis.

Based on my personal experience,we are now right in the middle of the“hardest” part of our famous cyclesin health insurance. Trends haveaccelerated dramatically, significantlosses (which were predictable) havenow emerged from the “soft market”pricing of 1997 and 1998, and veryfew risk takers are active in themarket. It would be nice if actuariescould “flatten out” these cycles, butwe don’t seem to have such aninfluence. We all live in the market,rather than make it.

We can, however, keep our clientsand employers aware of the basics ofhealth insurance. These never seemto change. For example, 80% of theclaims in a comprehensive majormedical plan will come from 20% ofthe people. These are the “sickpeople.” For every dollar of premiumthey pay, they will receive, on

average, $2.50in claims(assuming aglobal lossratio of 70%).The remaining20% of claimscome from80% of thepeople. Let’scall them the“healthy people.” For every dollar ofpremium they pay, they will receive,on average, $0.17 in claims. If thecondition of “sick” or “healthy,” asdefined herein, were a random event,then we wouldn’t have a problem.Unfortunately, such a condition is notcompletely random, and the insuredsknow more about their likely statethan the health plans. People whothink they are likely to be in the“sick” group are quite interested inbuying health coverage. People whothink they are likely to be in the“healthy" group try to avoid buyinghealth coverage. The reasons areobvious.

In order to make a health planwork, we must find ways to excludethe “sick” people or include the“healthy” people. If we don’t do oneof the two, our health plans arecertain to crash and burn.

Good luck in your health actuarialwork!

Jeffrey D. Miller, FSA, MAAA, is aconsulting actuary in Overland Park,KS. He can be reached at [email protected].

HEALTH SECTION NEWSPAGE 2 DECEMBER 2000

Letter from the Editorby Jeffrey D. Miller

HEALTH SECTION NEWSIssue Number 39, December 2000

Published quarterly by the Health Sectionof the Society of Actuaries

475 N. Martingale Road, Suite 800Schaumburg, IL 60173Phone: 847-706-3500

Fax: 847-706-3599

World Wide Web: http://www.soa.org

This newsletter is free to Section members.A subscription is $10.00 for nonmembers.

Jeffrey D. Miller, FSAHealth Section News Editor6806 West 132nd Terrace Overland Park, KS 66209913-685-8191913-685-8199 (Fax)E-mail: [email protected]

Health Section CouncilLeigh M. Wachenheim, ChairpersonAnthony J. Wittmann, Vice-ChairpersonDaniel L. Wolak, Secretary/TreasurerKevin M. Dolsky, Council MemberCharles S. Fuhrer, Council MemberRobert R. McGee, Council MemberMary P. Ratelle, Council MemberGeoffrey C. Sandler, Council MemberDaniel D. Skwire, Council Member

Health Section News Editorial BoardBernard RabinowitzLeigh M. WachenheimAnthony J. Wittmann

SOA StaffJoe Adduci, DTP Coordinator([email protected]) - E-mail(847) 706-3548 - PhoneLois Chinnock, Section Coordinator([email protected]) - E-mail(847) 706-3524 - Phone

Facts and opinions contained in these pages are the responsibility of the persons who expressthem and should not be attributed to the Societyof Actuaries, its Committees, the Health Section,or the employers of the authors. Errors in fact, if brought to our attention, will be promptly corrected.

Copyright © 2000 Society of Actuar ies .

Al l r ights reserved.

Pr inted in the Uni ted States of America .

Jeff Miller, Editor

DECEMBER 2000 HEALTH SECTION NEWS

hours they contributed in creatingtop quality health sessions at thepast SOA meetings and also increating a first-class newsletter. Inparticular, I want to thank themoderators, the panelists, thenewsletter authors, the Councilmembers, the program coordinatorsand our newsletter editor. Also,thanks to the SOA staff for theirwonderful support — always therewhenever we needed help.

Many of us got to where we are asactuaries through the voluntary helpof others. I strongly feel that we inturn have an obligation to put some-thing back into the profession. In fact,panelists and authors who were reluc-tant and skeptical at first have told methat volunteering was both a reward-ing and worthwhile experience.

So when a volunteer who is work-ing very hard for your benefit asksyou to serve as a moderator orpanelist at a SOA meeting or asksyou to write an article for thenewsletter, please do the right thingand say YES.

Expanding our RoleOur actuarial risk models and how weuse these risk models to arrive at busi-ness decisions is what distinguishes usfrom other business disciplines. If weimprove our modeling capabilities(e.g. by making use of complexityscience, and behaviorism.) and if welearn to incorporate the work of otherhealthcare business professionals,(e.g. healthcare economists) into ourmodels, we will be on our way to

becoming the recognized experts inmodeling the healthcare business andenvironment. So I’m calling forvolunteers to take the initiative onthis.

CommunicationsI believe that to advance our profes-sion in the health practice area, weneed to promote interactive forumsfor the discussion of ideas, the shar-ing of knowledge, the disseminationof information, and the solicitation ofopinions. Some of this is alreadyhappening at SOA meetings andseminars. But I don’t think we arethere yet. For instance, our discus-sion forum (on the SOA Web site) isat present, underutilized and needs tobe jumpstarted.

The Section’s Web page has beengreatly enhanced. It now contains auseful list of both internal and exter-nal resources, a list-serve sign upbutton with guidelines for use,minutes of the last three Councilconference calls, and a volunteerbutton that we urge you to CLICK.

(To visit our Web page, go to theSOA home page at www.soa.org, thenclick on “Sections / Special Interest”and then click on “Health”).

The major challenge is how tocreate the facility for developing theknowledge base and skills to thrive asactuaries in the ever-evolving healthinsurance industry.

* * *

With thepublication ofthis issue, wenot only metour goal ofthree newslet-ters per year,but the contentis larger thanbefore. Andthanks again toour authorswho have put in so much effort toshare their ideas and knowledge withus. I appeal to those who haven’t writ-ten articles before to try it — and Iknow that you will surprise yourself.As I have said before, we alsowelcome short articles of 300 to 500words that express maybe one thoughtor observation.

I would now like to welcome thenew Council members: Chuck Fuhrer,Dan Wolak, Mary Ratelle, and KevinDolsky. Also, congratulations to thenew officers for 2000-2001: LeighWachenheim, chairperson; TonyWittmann, vice-chair; and Dan Wolak,secretary / treasurer. And farewell toour departing members: RobertGrignon, John Heins, and myself.

Bernie Rabinowitz, FSA, FIA, MAAA,is executive vice-president and chiefactuary of Radix Health ConnectionLLC in Chicago. He can be reachedat [email protected].

Chairperson’s Cornercontinued from page 1

Bernie Rabinowitz


for any changes in how you are managingyour business. The actual experienceneeds to be analyzed using incurredclaims and earned premium adjusted to acommon basis such as a standard age/gender factor, a standard plan factor, astandard area factor, a common timeperiod, and a standard industry factor.Adjusting out these factors and the im-pact of large claims, usually, a block assmall as $10 to $20 million in annualclaims is sufficiently stable enough toprovide a reasonably good base rate.

Second, for both quotes and renewals,a company needs a process which willdetermine whether a specific case isbetter, worse, or about average in risk.Given that a company will usually havemore data for renewals, the process forsetting the relative risk of a renewal isusually different from the process used ininitially quoting a case. For initial quotes,

the best information available is oftensome form of individual medical ques-tionnaire answered by each employee.For renewals, the best information avail-able is often the actual claims experienceof the case, both in total (i.e. the case’sloss ratio) and in terms of specific largeclaims or serious medical conditions.

Companies have become increasinglysophisticated in their ability to set relativerisk levels. Maintaining these skills is criti-cal to long-term success in this market.

Third, unless the laws of a state onlyallow strict community rating, once youhave set the allowable factors and thebase rates, and you have a process fordetermining the relative risk of a givencase, you still need a process whichdecreases or increases the rate for thespecific case based on its perceived risk.This article focuses on how companiescan set these factors for quotes.

For the purpose of comparing threeapproaches to setting risk adjustmentfactors, we need to know the distributionof cases within a market according totheir relative risk level. The overall distri-bution of cases by risk class in a marketdepends on a number of variables includ-ing the size of the cases, the extent ofmanaged care in the market, and thegeneral medical practices in the area(such as the relative availability of highintensity, high cost procedures). For thepurposes of this article, we will use thefollowing distribution. It bases the defini-tion of “low risk” or “high risk” on themost recent twelve months of claimsexperience within the case as comparedto the “average” after taking into consid-eration such factors as age/gender, plandesign, industry and geography.

The Art & Science of Pricing Small Group Medical Coveragecontinued from page 1

Relative Number Expected Claim LevelCurrent Claim Level of Cases Following Year

Under 50% 30.0% 44.8%50 to 70% 15.0% 69.6%70% to 100% 21.7% 89.6%100% to 140% 18.3% 112.7%140% to 200% 6.0% 145.3%Over 200% 9.0% 303.7%

Initial Pricing SchemesThere are three basic pricing schemes forsmall group business with infinite grada-tions in between. The most prevalent issimply setting the mid-point of a pricingrange at the average rate, pricing thelowest risk business at the lowest possi-ble rate, pricing the highest risk businessat the highest possible rate and then grad-ing the rates in between as the perceivedrisk changes. This is such a self-evidentapproach that many actuaries are unawarethat other schemes exist, much less havepractical value. I will refer to this schemeas “Following The Curve.”

The other two basic schemes are simi-lar in appearance, but produce strikinglydifferent results. One scheme is to setone rate level for all business that isabove average in risk. As we will seebelow, this allows the pricing for thelowest risk class to be set at the lowestpossible rate. I will refer to this schemeas “Lowest Best Rate.” This is anapproach that is sometimes favored bymarketing-oriented organizations simplybecause it is most competitive for the“best risks.” The assumption is that ifyou can attract mostly very low-riskgroups, your experience will be excellent

overall. This approach often occurs, notas a deliberate strategy, but as the by-product of setting “new business rates”according to competition rather than risk.These rates are intended only for the“lowest risk” cases and everything else isloaded up to the maximum allowed bylaw. Frequently, little attention is paid towhether or not the overall scheme will beprofitable.

Even though this scheme is generallyquite unprofitable, the scheme is some-times hard to change simply because forthe lowest risk cases, the low rates areadequate and the financial problems are


blamed on the “bad cases” causing the“shock” losses.

The third scheme is to set one ratelevel for all business which is belowaverage in risk. As we will also seebelow, this allows the pricing for thehighest risk class to be set at the highestpossible rate. I will refer to this schemeas “Highest Worst Rate.”

This not a particularly popular schemebecause for the lowest risk class you areuncompetitive, and there are many casesthat fall into the category of lowest risk.Financially, however, it can be the mostproductive approach of the three.

All of these schemes are dependent onthe rating flexibility allowed by state law.The most common restriction is ±25%

from index (“average”) rates. Anothercommon restriction is ±35% from indexrates, and other ranges are also in place.The table below shows these schemesmight be initially implemented for the±35% rating variations, but the results aresimilar using other ranges.

Current Claim Level Lowest Best Rate Following The Curve Highest Worst Rate

Under 50% 0.50 0.65 1.00

50 to 70% 0.70 0.80 1.00

70% to 100% 0.90 0.95 1.20

100% to 140% 1.00 1.15 1.50

140% to 200% 1.00 1.35 2.07

Over 200% 1.00 1.35 2.07

Allowable Rating Variation ±35% - Initial Rate Levels

The above factors are somewhat mean-ingless as is, since you also need to knowthe base rate which will be multiplied bythese factors. If the base rates were “areaaverage” and the above factors were usedas shown, the “Lowest Best Rate” scheme

as shown would produce rates which, onaverage, were well below the needed leveland vice versa for the “Highest WorstRate” scheme. In other words, the valuesas shown above need to be adjusted sothat they produce an average rate equal to

the average claims. Using our assumeddistribution of claim levels for smallgroups, the rating schemes produce thefollowing values.


Current Claim Level Lowest Best Rate Following The Curve Highest Worst Rate

Under 50% 0.638 0.696 0.772

50 to 70% 0.894 0.856 0.772

70% to 100% 1.149 1.017 0.926

100% to 140% 1.277 1.231 1.158

140% to 200% 1.277 1.445 1.598

Over 200% 1.277 1.445 1.598

Allowable Rating Variation ±35% - Normalized Rate Levels

The “Lowest Best Rates” had to beincreased by 27.7% to produce an averagerate that matched the average claim level.The “Highest Worst Rates” could belowered by 22.8% to achieve this result.What may surprise some actuaries whoare not familiar with this type of businessis that the “Following The Curve” schemealso had to be increased to make therating structure produce sufficient pre-mium to meet average claim levels. Thereason is simple. The worst risk cases are

fewer in number, but have very highclaims levels. The best risk cases are farmore frequent.

Thus raising rates on higher riskcases and lowering rates on better riskcases doesn’t average out. You arelowering rates for many more cases thanyou are raising rates. Hence, the entireset of rates must be adjusted upward oryou will automatically lose money onthe block.

In this case, the “Following The

Curve” factors had to be raised by 7.1%to make them sufficient.

Even after normalizing the rate levels,we see that the three schemes producedistinctly different patterns. The patternsare less distinct when the allowed ratingvariations are very narrow or very wide.The patterns are much more distinctwhen the allowed rating variations are inthe ±20% to ±35% range, which are typi-cal legal restrictions. Viewed in terms ofcompetitiveness, the “Lowest Best Rates”


are the lowest (and therefore mostcompetitive) for the best risk cases andfor the worst risk cases. The “HighestWorst Rates” are the most competitivefor cases in between the two extremes.The “Following The Curve” rates are not“most competitive” for any of the ex-pected claim levels. While theoreticallythis is an issue, the vast majority of themarket prices in this manner, and there-fore it is significantly less of an issuethan it might otherwise be.

Even so, the factor of competitivenessis very important. Obviously, a companymust have sales to exist. Just as importantis understanding that a company can becompetitive for one type of risk, anduncompetitive for others. This changesthe mix of the resulting business andtherefore, has a strong impact on thefinancial results.

As a whole, the market tends to usethe “Following The Curve” pricingscheme. The scheme is so inherentlyobvious that few actuaries have spentmuch time considering alternatives. To acertain extent it almost seems like therearen’t any other logical alternatives.

Hence we will consider the market tobe only using the “Following The Curve”approach, even though we recognize it tobe an oversimplification.

At first, it would seem that if twocompanies were using the same ratingscheme and had normalized their rates tothe same average, then there would be nodifference between the two rates, andtherefore, everyone would get an equiva-lent mix of business. In the real world,things can be more complicated.

On the one hand, companies havelegitimate reasons for pricing higher orlower than their competition. Some com-panies have better networks, some haveworse. Some companies have lowerexpenses, some have higher. Some com-panies get conservative in rating, someget aggressive. While the price level ofother companies will certainly impact theability of your company to sell, if theother companies are uniformly higher orlower in price, then your companyshould still sell a uniform distribution ofbusiness.

On the other hand, this is not truewith regard to the pricing of your owncompany. Very few actuaries have work-ing crystal balls. Hence, sometimes rateswill be lower than appropriate and some-times higher. While it might seem thatthis would average out, the net result isthat your company will sell more busi-ness when its rates are lower than theyshould be and vice versa. The net result

is an overall cost which must also befactored into the equation. Essentially,the better a company can assess risk, thelower the rate it can generally charge (orthe higher its profit margin will be). Forexample, using the assumptions in thispaper, if a company underprices itsquotes by 5% on three out of ten quotesand overprices its quotes by 5% on threeout of ten quotes, its loss ratio on soldbusiness will rise by 1½% overall.Having the data to analyze and properlyset the rate levels on a case-by-case basisis valuable, even if you can accuratelyset the “average” claim cost, and evenmore so when you can’t.

What is more striking, however, is theresult of using one of the two other ratingschemes in a market that predominatelyprices by “Following The Curve.”

Chart One illustrates a company usingthe “Following The Curve” approach andprovides a comparison to the other twocharts. These rates match the rates in themarket place. This company sells busi-ness by risk class in proportion to theavailability of such business. The result isbeak-even financially and a closing ratioof 8% which has been set as the “normal”closing ratio.


Current Claim Percent of Price Market Closing Percent ofLevel Quotes Quoted Price Ratio Sales

Under 50% 30.0% 69.6% 69.6% 8.0% 30.0%

50 to 70% 15.0% 85.6% 85.6% 8.0% 15.0%

70% to 100% 21.7% 101.7% 101.7% 8.0% 21.7%

100% to 140% 18.3% 123.1% 123.1% 8.0% 18.3%

140% to 200% 6.0% 144.5% 144.5% 8.0% 6.0%

Over 200% 9.0% 144.5% 144.5% 8.0% 9.0%

Chart One: "Following The Curve"

Average Premium: 100.0%, Average Claim Level: 100.0%, Underwriting Gain: 0.0%


A couple of points should be noted.“Break-even” actually means that thiscompany is achieving a gain or losswhich is consistent with the market andthe company’s relative expenses andnetwork prices. Overall, if the market islosing money, then this company isdoing likewise and vice versa. Similarly,the 8% closing ratio simply means thatthe company is selling an “average”amount of business. We need thesevalues to compare the results of theother approaches, but they shouldn’t betaken as absolutes. They merely allowus to know what the model produces for“average” business.

As shown in Chart Two, when a

company uses “Lowest Best Rate,” itmostly attracts cases at the two extremesof risk. It has the lowest rate for thelowest risk groups and most of the casesit writes are in this category.

However, the rating restrictions forceit to have the lowest rate on the highestrisk groups as well. While there are rela-tively fewer of these cases, this ratingscheme will be competitive for thesecases as well. The net result is excellentsales and a financial disaster. The calcu-lated closing ratio grows from 8% to11.1%. Cases written in the lowest riskcategory goes from 30% to 54%. On theother hand, the underwriting loss goesfrom break-even to -21.9% of claims.

The reason is simple: too many high riskcases. The percentage of cases sold in thehighest risk category has gone from 9%to 20.2%.

Generally speaking, raising rates doesnot provide the relief the company mightexpect, because the low risk cases willbecome uncompetitive before the highrisk cases do so.

It should be noted I am using a table(not shown) which grades the closingratio up or down based on the companies’prices relative to the market price for thatcategory of risk.


Under 50% 30.0% 63.8% 69.6% 20.0% 54.0%

50 to 70% 15.0% 89.4% 85.6% 3.0% 4.0%

70% to 100% 21.7% 114.9% 101.7% 0.0% 0.0%

100% to 140% 18.3% 127.7% 123.1% 5.0% 8.2%

140% to 200% 6.0% 127.7% 144.5% 25.0% 13.5%

Over 200% 9.0% 127.7% 144.5% 25.0% 20.2%

Chart Two: "Lowest Best Rate"

Average Premium: 92.7%, Average Claim Level: 117.4%, Underwriting Gain: -21.9%

As shown in Chart Three on page 8,using a “Highest Worst Rate” schemeproduces a different picture. The ratesfor the lowest risk category are nowessentially uncompetitive. This meansvery few of these cases will be written.The good news, however, is that a maxi-

mum loaded case in the highest risk cate-gories is also uncompetitive and veryfew of these cases will be written aswell. In essence, a company using thisapproach has abandoned both the lowestrisk cases and the highest risk cases. Onthe other hand, it should be very compet-

itive in essentially all other cases. Theclosing ratio stays the same or rises (bythese calculations to 10.1% from 8%).The underwriting gain goes from break-even to +4.9%. The reason again issimple essentially no high risk caseswere written.



The results shown above set salesbased on relative price alone. While priceis a very strong indicator of sales, manyother factors influence the final result.Hence, actual results from the use of oneof these schemes will probably not be asextreme as shown above.

The formula-driven results shownabove generally illustrate the impact ofusing the three basic pricing schemes.Other factors are also very important. Theability to properly establish the risk classfor a specific case is critical.

A company which can underwritebetter than its competition will generallythrive, and vice versa. Expense levels are,of course, very important. It should alsobe noted that no pricing scheme in and ofitself will cure the problem of inadequateprovider discounts or below averageutilization management.

RenewalsThis article isn’t long enough to thor-oughly discuss the impact of ratingstructures on renewals, but a few simplepoints are worth considering.

The expected loss ratio for a smallemployer group increases by trend everyyear, but it also has a tendency to movetoward “average” over time. This regres-sion toward the mean shows that a groupof cases which are all low risk today willbe relatively low risk next year, but not aslow risk as they were this year. In otherwords, their trend will be higher than

average. The trend on very low risk busi-ness can be quite high. Many actuariesrefer to this phenomenon as the “wearingoff of underwriting.” The reverse is alsotrue. A group of cases which are all highrisk today, will still be relatively high risknext year, but not as bad as they were thisyear. Their trend will be lower than aver-age. This phenomenon, however, issometimes masked by the ability of thecase to select against the carrier. Whenone insured in a small employer has beenvery ill, the employer will typically knowlong before the carrier if that individual isleaving the group. Hence, a significantproportion of those groups which arehigh risk today, but will be lower risknext year, are aware that this is the caseand will seek lower rates as soon as theycan “pass underwriting” elsewhere. Thus,the high risk cases that remain with theircurrent carrier might not exhibit themoderation in trend. This is more promi-nent in the smallest cases and, in theextreme, is referred to as an “assessmentspiral,” where no amount of rate actionseems able to reduce the loss ratio of ablock of business.

Thus, the distribution of business byrisk class will have an impact on theexpected trend for the whole block. Itmight not be much, perhaps 1% or 2% atmost, but those percentages are significantin comparison to most profit margins.

The distribution of business by riskclass will also have a strong impact on

the ability of a carrier to renew the busi-ness at adequate rates. Blocks of businesswith a disproportionate number of highrisk cases face serious challenges in rais-ing rates to an adequate level withoutdriving off large numbers of low riskcases. Blocks of business with a dispro-portionate number of very low risk casesface serious challenges, since the trendneeded to overcome the “wearing off ofunderwriting” is difficult to anticipateand equally difficult to sell to cases withgood loss ratios. Hence, renewing a blockwhich was sold on the basis of “LowestBest Rate,” can be quite difficult.

One of the side benefits of using a“Highest Worst Rate” scheme is that ittends to attract cases whose claims willtend to increase in a more moderatefashion, and is, therefore, easier tomanage at renewal.

Rating small employer medical cover-age has never been easy, but with theadvent of rating laws, the challenge hascertainly increased, and actuaries needmore information than ever before toadequately set prices.

William R. Lane, FSA, MAAA, is aconsulting actuary at Heartland ActuarialConsulting LLC in Omaha, NE. He can bereached at [email protected].



Under 50% 30.0% 77.2% 69.6% 0.0% 0.0%

50 to 70% 15.0% 77.2% 85.6% 20.0% 29.7%

70% to 100% 21.7% 92.6% 101.7% 20.0% 43.0%

100% to 140% 18.3% 115.8% 123.1% 15.0% 27.2%

140% to 200% 6.0% 159.8% 144.5% 0.0% 0.0%

Over 200% 9.0% 159.8% 144.5% 0.0% 0.0%

Chart Three: "Highest Worst Rate"

Average Premium: 94.3%, Average Claim Level: 89.9%, Underwriting Gain: 4.9%


Health Section Meets at Chicago Annual Meeting

Jim Murphy of the AAA Health Practice Council looks on as retiring SOA HealthSection chairperson Bernie Rabinowitz reports on Section activities during the jointSOA Health Section/AAA Health Practice Council breakfast at the annual meeting inChicago.


The American Academy ofActuaries was asked by theNational Association ofInsurance Commissioners to

examine issues that may be affecting thecost of Medicare supplement insurancepolicies. The Academy formed aWorking Group that collected and ana-lyzed claims data from 11 insurance car-riers providing Medicare supplementcoverage.

The final report was released June 8,2000 and was presented at the springand fall NAIC national meetings. Thereport is being used by the NAIC as asource document for revisiting the bene-fit composition of Medicare supplementstandardized plans as well as for otherpurposes.

The following few paragraphs outlineseveral interesting results contained inthe report.

The aggregate nationwide annualclaim trend from 1996 through 1998 was11.2% for all plans A through Gcombined. This was twice the 5.6%

expected trend over the same timeperiod (1996-1998). The following tableprovides some details by Medicaresupplement plan.

The analyses presented in the reportreveal that hospital outpatient costs had amajor impact on claim cost trend. Formost outpatient services, the Medicarebeneficiary was liable for the annual PartB deductible plus 20% of the hospital’soutpatient billed charges. It is importantto note that no limits were placed on theabsolute level or amount of annual in-crease of hospital outpatient charges, sobeneficiaries were subject to full medicalinflation on their coinsurance liability, anannual 18.2% claims trend based on theexperience of one large carrier.

Medicare’s new prospective paymentmethodology for hospital outpatientservices is expected to initially decreaseoutpatient hospital claims costs on anationwide basis by about 11% and slowannual trend thereafter. The reportshows that results are expected to varyby state, with some states not reaping

any initial reductions in claims costs.States such as: Alaska, Idaho, Montana,New York, and Vermont will see initialincreases in claims costs in excess of10%. On the other hand, Alabama,Florida, California, Texas, and others areexpected to benefit from initialdecreases in costs of 25% or more.

The Academy’s report addresses otherissues related to Med Supp claims costs,including, state-mandated rating meth-ods, prescription drug coverage, guar-anteed issue, and fraud. The study isavailable online at the AmericanAcademy of Actuaries Web site, http://www.actuary.org/whatnew.htm#medbrief.

Michael S. Abroe, FSA, MAAA, is aconsulting actuary at Milliman &Robertson, Inc. in Chicago. He can bereached at [email protected]

Medicare Supplement Insurance Claim Cost Trendsby Mike Abroe


Not too long ago, pricing anew product or benefitoften meant spending longhours in a library or mak-

ing phone calls to providers and associa-tions in hopes of finding enough clinicalinformation and general population datato make a reasonable cost estimate.Today, using the Internet can greatlyreduce the time and energy needed tocollect this type of information. TheInternet also provides a means to keep upto date on current events and to discusspricing issues with other actuaries.

Clinical BackgroundInformationA basic understanding of what happens inreal-life clinical situations is necessary toprice a new benefit or product or to deter-mine the impact of new technology ontrend. For example, to price an acupunc-ture benefit, one has to understand:

• What kinds of conditions are treatedwith acupuncture?

• Is there any consensus of opinion in the medical community regarding the effectiveness of acupuncture?

• What mix of services are performed in conjunction with the acupuncture?

• How long is a typical course of treatment?

• What are the licensing requirements for providers?

• Will the new covered service replace existing covered services, or will it be in addition to existing services?

• Are there new diagnostic or therapeutic techniques in the offing that will in-crease or decrease the utilization and cost per procedure?

High level answers to thesetypes of questions can befound on consumer-orientedhealth sites, such ashttp://www.intelihealth. com,http://www.webmd. com, orhttp://www.mayohealth.org.

Other sources of informa-tion are non-profit disease-advocacyorganizations such as the AmericanCancer Society (http://www.cancer org)and professional associations such as theAmerican Academy of Ophthalmology(http://www.eyenet.org). The MedlinePlus site (http://www.nlm.nih.gov/medlineplus) provides a table of links tomany such organizations.

If you need more formal or detailedinformation, then you may find what youneed in a federally-sponsored treatmentguideline or consensus statement.

Guidelines and consensus statementsare prepared by a panel of professionalspracticing in the field. They normallyinclude a review of the applicableresearch, prevalence data and evidence-based treatment recommendations. TheNational Guideline Clearinghouse site(http://www.guideline.gov) provides a listof guidelines. Other sources of federally-sponsored clinical information includethe National Institutes of Health(http://www.nih.gov) and the Food andDrug Administration (http://www.fda.gov).

Finally, if you need to look at paperspublished in professional journals, you

can use Medline (http://www.ncbi.nlm.nih.gov/pubmed) to find a list of articlesthat have been written on the subject.

Medline search results usually returnonly a site for ordering a reprint of thearticle. Occasionally, the article is online,however.

Defining the Change inCoverageTwo of the key questions asked duringthe pricing process are “Who is payingwhat now?” and “Who will be payingwhat after the change goes into effect?”

If there is only one primary payor,then the answer lies in the applicablecontractual language and claims-payingpractices. This information is proprietary,so it won’t be found on the Internet. Non-profit disease-advocacy organizations,however, often contain information oncurrent industry practices and how apatient can maximize his or her benefits.This information may be helpful in fram-ing the thought process. Also, your com-pany Intranet may contain the specificinformation you need.

If the change in plan is in response toa legislative mandate, then you probablywant a copy of the bill and related

Using the Internet as a Pricing Toolby Joan C. Barrett



committee and research reports. For fed-eral legislation, this information may beobtained through http://thomas.loc.govor the Congressional Budget Office site(http://www.cbo.gov).

Information for state legislation cangenerally be accessed through the stateWeb page. State Web sites use the URLformat http://www.state.ss.us where “ss”is the 2-digit state abbreviation. Forexample, the address for Connecticutstate site is http://www.state.ct.us.

You can often find a more focuseddiscussion of a bill on the AmericanAcademy of Actuaries site (http://www.actuary.org) or on an industry trade asso-ciation site, such as the AmericanAssociation of Health Plans (http://www.aahp.org).

If the plan you are pricing is not theonly payor, then you also need to con-sider changes in the payments by theother payor. For Medicare, this informa-tion can usually be obtained through theMedicare site (http://www.medicare.gov).For Social Security, the site is http://www.ssa.gov.

Most cost analyses prepared by out-side organizations are based on the mostcommon industry practices. If your com-pany practices vary from the norm, thenobviously you should reflect that in yourfinal pricing estimates.

Collecting DataCredible data based on the experience ofthe pricing population is always thesource of choice for utilization and costdata. This data is also proprietary, so itwill not be found on the Internet.

If that data is not available, then expe-rience of a similar population is usuallythe second choice. Information on bothMedicare and Medicaid populations canbe found on the Health Care Financing

Administration site. (http://www.hcfa.gov).

For other populations covered under amedical plan, one alternative is to pur-chase an intercompany study sponsoredby the Society of Actuaries or by a con-sulting firm. The Internet can be used forresearching availability and contactingthe sponsoring organization.

If data from a similar population canbe found or if it is impractical to purchasethe data, then you may find general popu-lation that meets your needs. The federalgovernment provides quite a bit of bothhigh-level and detailed general popula-tion data online at no charge. In additionto the clinical sources mentioned above,the Center for Disease Control (http://www.cdc.gov), which includes theNational Center for Health Statistics,provides several data sets, including:

• Incidence and prevalence rates for several diseases, including Lyme disease,cancer, and AIDS.

• Surveys such as the LongitudinalStudy of Aging and the National Survey of Ambulatory Surgery

• Downloadable chart books for easy reference including Health, United States, 2000 and the InternationalHealth Data Reference Guide, 1999

Both prevalence and cost data may befound on consumer, individual provider,provider organizations and disease advo-cacy organizations,and occasionally, onconsulting firm sites.

Regardless of the source of the data, itmust be adjusted for trend, age-sex distri-butions, benefit richness, geographic, etc.In addition, if the data is not based on the

pricing population, then it must beadjusted for expected differences inutilization between the two populations.

Pricing MethodologySince the focus of this article is on usingthe Internet, many important aspects ofthe pricing process have not beendiscussed. Both the Society of Actuariesand American Academy of Actuarieshave many methodology aids availableonline including professional specialtyguides, and Transaction articles. Also,some consulting firms have case studiesonline for review.

Data QualityData quality is always a key concern toactuaries regardless of the type of data orthe source of the data. Some of the keyquestions used to determine data qualityinclude:

• How objective is the author and/or sponsoring organization?

Using the Internet as a Pricing Toolcontinued from page 11

“If data from a similar population can be found or it is impractical to purchase the data, then you may findgeneral population that meets your needs. The federalgovernment provides quite a bit of both high-level anddetailed general population data online at no charge.”


• How recent is the data?

• Are the underlying methods and assumptions sound?

• Is there sufficient documentation to verify the author’s conclusions?

• Does the data reflect the circum-stances and population for which it will be used?

• Is there enough detail available to make any necessary adjustments?

The Internet poses some additionalproblems, however, because of itsdynamic, consumer-oriented nature.

First, if you cite a traditional printsource in your documentation, thenanyone who wants to, can go to thatsource for more information. With theInternet, your source may be deleted orchanged after your work is complete. Asa work-around, it is a good idea to printout or download any information you usein your work, especially work requiringan actuarial statement of opinion.

Second, the quality of information in general and medical information inparticular varies considerably on theInternet. So how do you determine thequality of the medical information?

The Healthfinder site (http://www.healthfinder.gov) has a white paper onmedical information quality that mayhelp you gauge the quality of the infor-mation you are using. Also, some sitesdisplay an HONcode icon indicating thatthey adhere to the principles of the Healthon the Net Foundation (http://www.hon.ch), a Swiss non-profit organization.Althoughorganiza-tionsparticipatingin theHONcodeprogram are

self-regulated, there is a complaint andreview process in place. Some of theprinciples stated by both Healthfinderand HONcode include:

• Does the site clearly separate advertis-ing and sales from health information?

• Clearly state its purpose and sponsors?

• Tell you how it gets it information?

Using the Internet EffectivelyAt times, the seemingly infinite amountof information can be daunting, espe-cially if you have to find an answer in ashort time period. Most people use asearch engine to find data, but even withvery specific search strings, they almostalways return literally thousands ofresults. One work-around for this is touse a more focused approach to thesearch using such sites as:

• The Society of Actuaries (http://www. soa.org) table of links for sites of interest to actuaries

• The National Association of HealthData Organizations (http://www. nahdo.org) for health data

• The Society of Actuaries Ambassador Program for international data

• Fedgate for a complete list of federal government sites (http://fedgate.org. Note: the www reference is not needed in this address).

Although the amount of informationon the Internet may seem infinite, in real-ity it is not. If you have questions about aspecific site, then you can use the e-maillink to contact the sponsoring organiza-tion. If you have a more general question,you can throw it out to the actuarial com-munity using the Society of Actuarieslist-serves or discussion forums.

Finally, the Internet does not alwaysprovide instant, free access to informa-tion. Many sites require you to sign upfor an ID before you can access all thedata available on the site. Sometimes,you can immediately use the data afteryou fill out the on-line form. In othercases, the ID requires a subscription feeor proof that your employer is a partici-pating member in the sponsoringorganization.

Joan C. Barrett, FSA, MAAA, is directorof pricing, United Health Group,Hartford, CT. She can be reached [email protected].


Most writers of healthinsurance in the U.S. aretaxed as “nonlife insur-ers” and thus fall under

Section 832 of the U.S. Tax Code, whichallows the insurer to deduct lossesincurred on health policies in determin-ing taxable income. According toTreasury regulations, the reserve forunpaid losses used in the calculation oflosses incurred must “represent a fair andreasonable estimate of the amount thecompany will be required to pay.”

While Section 832 specifies that theinsurer’s statutoryfiling with theNAIC shall form thebasis for determin-ing losses incurredfor tax purposes, theHanover Insurance(1976) case reaf-firmed that the IRScan challenge theinsurer’s lossesincurred deductionon the grounds thatthe statutory unpaidloss reserve doesnot meet the “fairand reasonable” test.

Two recent legal cases from the casu-alty insurance world shed significantlight on the meaning of “fair and reason-able” and have interesting repercussionson actuarial practice regarding unpaidloss reserves.

Utah Medical (1998)Utah Medical Insurance Association is asmall carrier whose only line of businessis medical malpractice liability insuranceand who outsources all of its actuarialservices to consulting firms. At eachyear-end, a consulting actuary was

employed to determine a range, usingstandard actuarial methods, for thecompany’s unpaid loss reserves; the actu-ary did not make a point estimate of thereserve. Utah Medical’s CFO then set thestatutory reserve, and in both 1991 and1992 he chose a figure that was within,but near the high end, of the consultingactuary’s range. This statutory reservewas not adjusted by the Utah Departmentof Insurance during its triennial examina-tion of Utah Medical.

The reserves established in 1991 and1992 turned out to be overly sufficient by

several million dollars. The IRSargued that this development im-plied that the reserves had not metthe “fair and reasonable” test, andhence that Utah Medical had over-stated its losses incurred deductionduring those two years. Utah Medicaldisagreed and the ensuing case washeard by the U.S. Tax Court.

The Court ruled in favor of UtahMedical. After weighing expertactuarial testimony from both sides,the Court concluded that the rangeof reserve estimates established byUtah Medical’s consulting actuarywas reasonable. However, the IRS

had argued that even if that range werefound to be reasonable, the only “fair andreasonable” estimate for tax purposes wasthe midpoint of that range. The Courtrefuted this reasoning, asserting that anypoint within an actuarially reasonablerange meets the “fair and reasonable”test. Finally, the Court stated plainly that“reserves for unpaid losses must be fairand reasonable, but are not required to beaccurate based on hindsight.”

Minnesota Lawyers (2000)Many pundits suspected that the favor-able Utah Medical ruling might seriously

impede the ability of the IRS to challengean insurer’s losses incurred deductionunder the “fair and reasonable” standard.When the superficially similar MinnesotaLawyers case came before the U.S. TaxCourt, it was widely thought that a simi-larly favorable ruling would result.However, as we shall see there are mater-ial differences in reserving practicebetween the two situations.

Like Utah Medical, MinnesotaLawyers Mutual Insurance Company is asmall casualty insurer engaged in only asingle line of business, namely profes-sional liability insurance for lawyers, andhaving no qualified actuary on staff.

The unpaid loss reserves of MinnesotaLawyers were determined in two compo-nents: the “case reserves,” and the“adverse development reserve.” Casereserves were set on a claim-by-claimbasis by the company’s claims depart-ment; the adverse development reservewas set in aggregate by senior manage-ment and typically amounted to anadditional 35-50% on top of the casereserves.

After the reserves were set, a consult-ing actuary was brought in to review thereserves and issue the statutory certifica-tion. The Minnesota Department ofCommerce did not adjust the statutoryreserves during the examination process.

In 1993, the consulting actuary deter-mined only a point estimate for thereserve, which was less than the com-pany’s case reserves. A new consultingactuary was hired for 1994, and the newactuary determined both a point estimateand a (very wide) range for the reserve. Ineach of 1994 and 1995, the point estimateswere higher than the company’s casereserves, but lower than the total statutoryreserves, which in turn were lower thanthe high endpoint of the actuary’s range.

Will Your Unpaid Loss Reserve Stand Up to IRS Scrutiny?

by Rowen B. Bell


The actual runout for each of 1993,1994, and 1995 showed that the casereserves by themselves were overly suffi-cient, and hence that the company’s totalstatutory reserves had been highly redun-dant. The IRS argued that the reservesdid not meet the “fair and reasonable”standard and furthermore, that the actualrunout should be used to determine whatthe tax reserves for those years shouldhave been.

The U.S. Tax Court ruled thatMinnesota Lawyers’ reserves did not meetthe “fair and reasonable” test. Factorscited by the Court in arriving at a differentdecision in Minnesota Lawyers than inUtah Medical include the following:

• There was no evidence that MinnesotaLawyers’ case reserving methodology was prone to insufficiencies, and hence there was no demonstrable need for the company to hold an adverse development reserve on top of the case reserves;

·• There were no workpapers indicating

what facts were considered or anal-yzed by management in determining the level of the adverse development reserve;

• Minnesota Lawyers’ reserves could not be said to have been determined via “consistent actuarial methods and standard actuarial loss development techniques,” since the reserves were first established by non-actuaries and then only reviewed by an actuary, whereas in Utah Medical the statutory reserve was not set until after the con-sulting actuary’s calculations had been performed;

• The Court could not establish whether or not the ranges recommended by the consulting actuary were reasonable, due primarily to the extreme width of those ranges (in 1995 the upper end-point was more than twice the lower);

• The company provided no explanation of why, for the three years in question,

its statutory reserves were 49%, 15%, and 37% higher respectively than the best point estimate made by its con-sulting actuary.

In addition, the Court refuted twoother arguments raised by MinnesotaLawyers in defense of its statutoryreserves:

• The Court held that an actuarial opinion that the statutory reserves“made reasonable provision” for the company’s unpaid claims was not clearly intended to be equivalent to the regulatory “fair and reasonable” standard;

• The Court held that the regulator’s acceptance of the company’s statutory filings, without requiring an adjust-ment to the reserves, was a positive but not conclusive factor in assessing whether the reserves met the “fair and reasonable” test, as it was not clear that a regulator would be concerned with excessive reserves.

However, the Court did not accept theIRS stance that actual experience shouldbe used in retrospect to establish the taxreserves for the years in question.

Instead, for 1994 and 1995, the Courtfound that the point estimates made atthat time by the consulting actuary were“fair and reasonable,” even though subse-quent experience proved that thoseestimates were generous, and ruled thatthose estimates be used as the taxreserves. A similar ruling was made for1993, but here the Court ruled that the taxreserve would be a point estimate maderecently (but using only data available atthe time) by an actuary testifying onbehalf of the IRS, even though this esti-mate was actually higher than the oneoriginally made by the company’sconsulting actuary.

ConclusionsWhat lessons can we as health actuariesdraw from these rulings in terms of

assuring that the unpaid loss reserves thatwe set will stand up to scrutiny under the“fair and reasonable” standard for taxreserves?

• Decisions as to explicit levels of margin or conservatism added in aggregate to the reserves (akin to Minnesota Lawyers’ adverse develop-ment reserve) cannot be made arbitrarily, but must instead be supportable by studies of past experience

• Neither issuance of a statutory opinion on the reserves nor acceptance of those reserves by the regulator is suffi-cient to ensure that the reserves are acceptable for tax purposes;

• If the actuary computes ranges of reserve estimates rather than point estimates alone, wider ranges (as in Minnesota Lawyers) may be more susceptible to attack than narrow ranges (as in Utah Mutual);

• The reserves may be vulnerable to attack if it cannot be demonstrated that the computations by which the re-serves were established conform with appropriate Actuarial Standards of Practice, even in cases (as in MinnesotaLawyers) where a qualified actuary subsequently reviewed the reserves and performed parallel calculations using accepted actuarial methodology.

Rowen B. Bell, FSA, MAAA, is an associ-ate actuary at Blue Cross/Blue ShieldAssociation in Chicago. He can bereached at [email protected].


The essence of our professionis to reach a conclusionthrough an objective analysisof available data. For much

of my career I felt this was the onlyviable approach. After assuming respon-sibility for an underwriting unit, I real-ized that it is possible to successfullycombine the objective actuarial approachwith the subjective underwritingapproach. This is not to suggest that weexchange our computers for crystal ballsand tarot cards. Instead, I am suggestingthat we use the knowledge and experi-ence we have gained in a different way.

Developing underwriting instincts islike learning to swim. It’s best to start atthe shallow end of the pool. Begin bymaking small decisions or focus on areas

in which you are very knowledgeable.Try taking something you have alreadycompleted and see if you could arrive at asimilar result intuitively. Talk to under-writers who have a strong underwritinginstinct. With continual practice, you willbe able use an underwriting approachmore and more often.

One of the biggest challenges we faceis insufficient data. You can use the fol-lowing simple formula to estimate thecredibility of your data:

(A/B)^.5 where:

A = Amount of data available(however measured)

B = Amount of data needed for 100%credibility. This is obviously subjective.

You can determine this by estimatingthe amount of data needed to be totallyconfident in the results.

If the credibility is 75% or higher,there should be no concern. In most situa-tions, credibility of 50% or higher issufficient. If the credibility is below 50%,additional data will often be necessary.

Another problem we often face isusing data that isn’t totally applicable.For example, it may be necessary to usegeneral population data. To make theadjustment, use the following steps:

1. Determine what factors are needed to make the adjustment

2. Decide whether each factor will have a positive or negative impact

3. Estimate the total adjustment

4. Estimate the impact of each factor, and calculate the total

5. Resolve any discrepancies between the two approaches

6. If necessary, discuss with someone else.

Continuing with the example, youmay assume that underwriting actively atwork employees and policy restrictionswould reduce morbidity, while anti-selec-tion would increase morbidity. Aftergoing through the remaining steps, youassume an X% decrease is in order.

Finally, let’s consider dealing with anunusual quote. There are many factors toconsider.

However, if you look at the fol-lowing“R” factors and balance them off eachother, you will usually reach a conclusion.While each factor should be reviewed, thefirst three are most important.

Revenue −− How much premium will begenerated?

Risk −− What is the potential loss?

Reward −− What is the expected profit,and how likely is it to be achieved?

Resources −− Will the case be difficult toadminister?

Relationship −− Is an important client oragent involved?

Renewability −− Will it be possible torenew the case?

There isn’t room in this article todescribe every possible situation that youmay encounter. However, if you continueto develop your underwriting skills, theprocess will become more automatic andapplicable in a variety of situations. I havefound that using an underwriting approachhas made me a better actuary. I hope thatyou will reach the same conclusion.

David L. Reichlinger, FSA, MAAA, is theowner of Reichlinger Consulting Servicesin Fort Wayne, IN. He can be reached [email protected].

Combining an Actuarial and an Underwriting Approachby David L. Reichlinger

“Developing underwriting instincts is like learning to swim. It’s best to start at the shallow end of the pool. Begin by making small decisions or focus on areas in which you are very knowledgeable. Try something you have already completed and see

if you could arrive at a similar result intuitively.”


We inIreland are fond of say-ing that our health caresystem is unique. In

some respects, this is perhaps true ofevery country’s health system, but oursdoes have some unusual features thatmay be of interest from a U.S. perspec-tive. In addition, U.S. health care actuar-ies may be interested to hear a littleabout the progress the profession inIreland has made in developing the roleof the actuary in the health care arena.

Health care provision in IrelandHealth care in Ireland starts with thegeneral practitioner (GP) or family physi-cian. GPs are self-employed and themajority of GP practices are staffed by asingle physician, serving an averagepatient population of around 1,600. TheState pays for GP care, including pres-cription drugs, for the percentage of thepopulation considered “low-income”(approximately 30%). The rest of thepopulation pay for GP visits entirely onan “out-of-pocket” basis and must alsopay “out-of-pocket” for prescriptiondrugs up to IR£42 (approximately $54U.S.) per family per month. The State

pays for pharmacy costs above thisthreshold.

The average Irish person visits his GParound four times per year. About fourpercent of visits to a GP result in thepatient being referred to a specialistphysician. A significant proportion ofthese patients will go on to receive carein a hospital setting.

The entire population is entitled tospecialist and hospitaltreatment almost freeof charge within theState’s public healthsystem. The portion ofthe population that isnot considered “low-income” pay a modeststatutory charge of

IR£25 (approximately $32U.S.) per day, subject to an annual maxi-mum of IR£250 (approximately $320U.S.). However, a public patient maywait months for an appointment with aspecialist physician, may then have towait again for diagnostics, and then waitfurther months, or in some cases years,for surgery.

Private health insuranceAs a result of the possibility of lengthywaits, over 40% of the population chooseto buy private health insurance. Thisinsurance covers the cost of being treatedin a private hospital or as a private patientin a public hospital, and therefore, helpsbeat the long queues for treatment in thepublic system. The freedom to chooseone’s health care provider and a higherstandard of facility accommodations areadditional factors in the decision topurchase private insurance.

Private insurance mainly covers onlythe cost of inpatient treatment and “daycare” (within ambulatory care, a distinc-tion is made between “day care,” wherethe patient is “admitted” to a hospitalbed for the purposes of a therapeutic or

diagnostic procedure, and “outpatient”services). Fees for GP consultations andfor outpatient specialist consultationsand diagnostics are paid by the patienton an out-of-pocket basis and onlypartly reimbursed by the insurer, if totalannual expenses in this category exceeda substantial deductible.

The government actively encouragesthe purchase of private health insurance,as it is seen as reducing the cost of thepublic health system, which is financed bygen-eral taxation. Private health insurancepremiums are therefore, tax deductible.

Most people pay their own healthinsurance premiums. Increasingly,however, health insurance benefits areprovided by employers (multi-nationalemployers in particular). By Americanstandards, premiums are low. The annualpremium for a typical plan amounts toaround $1,000 for a family of two adultsand two children!

Managed competitionUntil 1994, a statutory body (theVoluntary Health Insurance Board orVHI) had a monopoly on private healthinsurance in Ireland. Following EuropeanUnion legislation that required all insur-ance markets be opened to competition,the Irish government introduced a formof “managed competition” for privatehealth insurance. The principal featuresof the regulatory structure include:

“community rating” -A health insurer must charge the samepremium to every insured person regard-less of age, sex or health status. Thoseinsured under group contracts can begiven a maximum discount of 10% on thebasic premium rate, regardless of the sizeof the group or whether premiums arepaid by individuals or by their employers.

Premium rates for children under 18may be charged at about one-third of theadult rate.

Health Care and the Role of the Actuary in Irelandby Aisling Kennedy



“open enrollment” -A health insurer must accept all applica-tions for coverage, regardless of the age,sex, or health status of the applicant.

“lifetime coverage” -Once a person is covered by health insur-ance, he is entitled to renew his coverageannually throughout his lifetime, regard-less of his state of health.

“minimum benefit” -There is a statutory minimum level ofbenefit which must be provided underevery health insurance contract.

Risk adjustmentIn addition, there is a provision in theregulatory structure for a risk adjustmentmechanism. This mechanism is intendedto ensure that, under a community-ratedsystem with open enrollment, no insurerwill incur disproportionately heavyclaims because of preferred risk selectionby other insurers in the market. Under therisk adjustment mechanism, health insur-ers with a better-than-average member-ship risk profile (that is, with memberswho are younger and healthier than themarket average) will contribute to acentral fund. The fund would be used tocompensate health insurers with a poorer-than-average membership risk profile.

White paper on private healthinsuranceTo date, only one insurer has entered themarket to compete with VHI and thegovernment remains keen to encouragefurther competition.

There has been significant controversyin relation to the risk adjustment mecha-nism. While the necessity for such asystem has been endorsed by the Societyof Actuaries in Ireland, it is perceived bysome insurers as a significant barrier tocompetition.

The original risk adjustment mecha-nism was withdrawn a year ago. Thegovernment has recently published aWhite Paper on Private Health Insurancethat sets out details of a new methodology

based on diagnosis-related groups (DRGs)as well as age and sex. The White Paperalso indicates that new insurers will not berequired to participate in the risk adjust-ment process until they have been inoperation in the Irish market for an initialperiod of perhaps two to three years.

The White Paper sets out a number ofother changes that will be made to theregulatory framework. These include:• an amendment to the community

rating rules to allow insurers to apply a “late entry” premium loading to any person who is over age 35 when they purchase private health insurance for the first time.

• an amendment to the effect that insur-ance for non-hospital based services will not have to be community-rated. This amendment is expected to en-courage the development of new prod-ucts to cover GP, outpatient, and dental services.

• a provision for privatization of VHI.

More wide-reaching reforms apossibility?The present government is committed tomaintaining the current public/private mixof health care financing. The benefit ofthis system is that it reduces the taxburden related to public spending onhealth care. On the other hand, thesystem’s major flaw is the two-tier struc-ture, with those who cannot afford privatehealth insurance often having to wait fartoo long for treatment.

Historically, there has been relativelylittle public debate in relation to potentialalternative approaches to paying for healthcare. Recently, however, health care hasbegun to receive some political attention,particularly in the context of the extraordi-nary economic boom Ireland is currentlyenjoying. The Labour Party (which is notpart of the current government) publisheda policy document in April 2000 whichcalls for the introduction of universalhealth insurance and has launched anational series of debates on this proposal.

The results of the next general electioncould therefore give rise to significanthealth care reforms.

Role of the health care actuaryJust ten years ago, there were no actuar-ies working in the health care field inIreland. Actuarial involvement beganfrom an employee benefits perspectiveand increased when the governmentappointed an actuarial firm to advise onthe development of a regulatory frame-work for managed competition.

Subsequently, an actuary wasemployed by VHI for the first time in itsexistence. There are now eight actuariesinvolved in Irish health care on a part-time or full-time basis (this amounts totwo health care actuaries per millionpopulation).

The Society of Actuaries in Irelandfounded its Health Care Committee in1994 and has subsequently developed anactive public profile on health issues. TheSociety has hosted national conferences onthe future of health care financing inIreland (December 1997) and health caremetrics (April 2000). The Society has alsomade a number of policy proposal submis-sions to the Minister for Health and hascalled for a fundamental review of thesystem of health care funding.

Like other actuarial associationsaround the world, the Society’s aim is tocontinue to expand the role of the healthcare actuary through the application ofactuarial skills to enhance the manage-ment of the provision and the funding ofhealth care in both the public and privatesectors.

Aisling Kennedy , FIA, ASA, is a healthcare actuary with William M. Mercer inIreland and is Chairman of the HealthCare Committee of the Society ofActuaries in Ireland. She can be con-tacted by e-mail at [email protected].

Health Care and the Role of the Actuary in Irelandcontinued from page 17


Critical Illness insurance isstill in its infancy in theUnited States, but it is gain-ing ground. While local in-

formation is scarce, foreign develop-ments are being closely followed by U.S.specialists.

History.A physician, Marius Barnard, inventedCritical Illness Insurance in South Africa,circa 1985.

Barnard first verbalized the obvious:for almost all his patients, a catastrophichealth event such as diagnosis of cancer,heart attack or stroke was a life trans-forming event, leading, in the vastmajority of cases, to personal financialruin due to massive non-reimbursableexpenses, truncation of productive work-ing lifetimes and uncompleted assetaccumulation.

Barnard felt strongly that insurancecompanies should address this problem,offering suitable protections.

South African insurance companiesquickly saw the potential market associ-ated with Barnard’s idea.

In devising products to fill Barnard’s“void,” insurers realized that every poli-cyholder’s financial needs after diagnosiswould be unique: one policyholder wouldhave an unpaid mortgage, another wouldhave children to send to college, a thirdwould have insufficient savings to sup-port dependents when earning powers arereduced.

Thus there could be no basis forprojecting and adjudicating utilization.Instead, it made sense to have everyapplicant estimate his/her future financialexposure just as one would for life insur-ance, and then apply for an appropriateface amount.

Product Properties.Barnard was concerned with the mostcommon Critical Illness incidences suchas cancer, heart attack, and stroke, butalso realized that protection against finan-cial devastation by kidney failure andcost of organ transplant should be

insured. Over time, Critical Illness cover-ages were extended to other calamitiessuch as: loss of sight, loss of hearing, lossof speech, paraplegia, quadriplegia, andmultiple sclerosis. Many Critical Illnesspolicies today provide for partialpayment of the Face Amount for coro-nary bypass surgery and angioplasty.Some modern Critical Illness policiesprovide for as many as 30 differentcalamities.

Paradoxically, while Critical IllnessInsurance pays out on diagnosis of veryserious maladies, it has almost none ofthe features of health insurance and mostof the features of life insurance.

A working knowledge of CriticalIllness Insurance is best attained by look-ing at the product through a life insurance“microscope” and not through a healthinsurance “prism.”

Basic Actuarial IssuesCritical Illness Insurance is a straightfor-ward incidence product free of anyutilization concepts. This simplifies theCritical Illness Insurance product actuary’swork, reducing it to the determination ofage-specific critical illness incidence ratesthat “look and smell” just like mortalityrates.

Since there is a known policy FaceAmount to be paid on diagnosis, onlyincidence rates matter; utilization ratesare of no consequence.

Sticky issues such as inflation ofhealth-related expenses can safely beignored. All you need are appropriatetables of age-specific incidence rates.Like mortality rates, these incidence ratesare binomial, and subject to the samelaws of large numbers as mortality rates.

This is not to say that the actuarialissues in managing Critical IllnessInsurance are trivial. Ratemaking forCritical Illness Insurance adds layers ofcomplexity to the processes employed inmodern actuarial pricing models.

Basic Underwriting Issues. The major Critical Illness claim diagnosisevents (cancer, heart attack, stroke) are

also the major “killers” of human beings.Overall, nearly 75% of all deaths arecaused by these three diseases. Hence, itshouldn’t surprise you that scientificCritical Illness underwriting closely“tracks” life underwriting.

If you are underwriting individuallives for life insurance, you need to knowwhether the applicant is in normal goodhealth and whether the amount of theinsurance is justified. In Critical Illnessunderwriting, you also need to classifyrisks in appropriate health categories, andto eliminate financial anti-selection.

The concerns of Critical Illness under-writers and life insurance underwritersshould be, and very often are, the same.

While Critical Illness Insurance under-writing practice generally is very muchlike life insurance underwriting practice,there are some differences. CriticalIllness Insurance is purchased for theinsured’s own sake, while life insuranceis purchased for beneficiaries. Oneshould expect self-interest stronger thanthe usual concern for loved ones and atendency towards stronger anti-selectionamong Critical Illness Insurance appli-cants. On the other hand, suicide risks inlife insurance have no counterpart inCritical Illness.

You can underwrite Critical IllnessInsurance as an individual product or as agroup product.

Whatever your Critical IllnessInsurance marketing opportunity, you canmake a good practical start by modelingyour underwriting on your company’s lifeinsurance product most closely resem-bling your proposed Critical IllnessInsurance product.

Finding Suitable IncidenceRatesFinding suitable Critical Illness incidencerates applicable to insured lives was nosimple matter in 1985, when the productwas invented: there were no criticalillness insured portfolios that could bestudied by actuaries. In 1985, Critical

Part One: A Short History of A New Productby Johan L. Lotter



Illness Insurance incidence rates were inthe same “dark ages” as life insurancemortality rates were 150 years ago.

Fortunately, actuaries working forinternational reinsurance companiesfound clever ways to calculate CriticalIllness incidence rates for members of thegeneral population on the basis of avail-able population statistics and also in-vented powerful calibration techniques toadjust these population incidence rates toCritical Illness incidence rates that wouldbe applicable to insured portfolios.

Even today, these foreign actuarialtechniques are not well-known or widelyunderstood in the U.S.A. They are notpart of the SOA’s syllabus for students.As far as we know, no scholarly papersdealing with Critical Illness have beenpublished by any U.S. actuarial body.

Incidence Rates for TwoDistinct ProductsThe first sets of rates actuaries developedthrough calibration techniques were usedto price two distinct types of products:

Product One: Standalone Critical Illness Policies. The contract is simple. The policyholder pays premiums. The Face Amount is paid on diagnosis and the policy is canceled.

Product Two: Critical Illness Acceleration Policies. The basic policy is a life insurance. The Face Amount is paid on diagnosis of a Critical Illness or on death. Premiums cease after the Face Amount is paid and the policy terminates.

Given a known Critical Illness annualunit incidence rate ix at age x, the cashflow cost of a Critical Illness exposure ofEx for the year of age x to x+1 is simplyix Ex. This last expression is the net one-year term cost of a standalone CriticalIllness policy. It is suitable for pricingProduct One above.

Given a known critical annual unitincidence rate ix at age x, and the propor-tion of deaths due to Critical Illness at

age x, kx, the cash flow cost at age x of abenefit of Ex payable on diagnosis ofCritical Illness or on death during theyear of age x to x+1 is

Ex {ix+(1−kx)q x}. This last expres-sion is the approximate (slightly over-estimated) net one-year term cost of aone- year term life policy which ispayable on death or Critical Illness diag-nosis. It is suitable for pricing ProductTwo.

Export of Critical IllnessProduct IdeasAfter its birth in South Africa, the rein-surer Critical Illness midwives quicklyexported the Critical Illness concept tothe U.K., Canada, Europe, Australia, andthe Far East.

In Australia and in the U.K., CriticalIllness products became an instant success.

Available Australian information isanecdotal, but observers in the Pacificrim warn that it is almost impossible tosell a life insurance contract in Australiaif you are unable to offer a Critical IllnessAcceleration Rider, and that reinsurancecompanies that are unable to offerCritical Illness product developmentsupport in the far east are unable to getany traction with the major direct lifeinsurance companies.

Hard data covering annual CriticalIllness sales in the U.K. show that salesof individual Critical Illness policies in-creased seven-fold from 100,000 insur-ance policies in 1990 to 700,000 policiesin 1998. This can be compared to stag-nant, declining sales of pure individuallife insurance policies (without CriticalIllness rider), which declined over theperiod by roughly 20%.

In the U.K., fully 86% of CriticalIllness policy sales closed on life insur-ance policies with the CI Rider; only14% of policies sold were of the stand-alone type.

Slow Growthin the UnitedStates.Although Critical Illness Insurance hasbeen so successful elsewhere, it has notyet taken off in the U.S.A. Why has theU.S. been slow to develop Critical IllnessInsurance Products? Reasons for the slowtakeoff may be among the following:

Ill-considered criticism byindustry “pundits” and“experts.”A small number of “pundits/experts”have said things like: “If you are going toinsure your automobile, would you sepa-rately insure the fenders and the doorsand the trunk lid? So why purchaseCritical Illness Insurance, since it worksthis way?” This “sound bite” is plausible,but the analogy is flawed, since the pur-pose of all personal insurance is to amel-iorate financial loss, not to replace orrepair health conditions and human bodyparts. These “pundits” often appear to beunder the mistaken impression thatCritical Illness Insurance pays out ondeath due to CI, not diagnosis.

Lack of local rate-makingexpertise.To our knowledge, none of the U.S.professional actuarial or insurance bodiesoffer any training in Critical IllnessInsurance product design, ratemaking, orunderwriting. Until the SOA providestraining in the mathematics of CriticalIllness Insurance, many U.S.-trainedactuaries may, for the most part, beunable to provide their companies withappropriate technical support.

Over-specialization of the U.S.Actuarial Profession. In the United States, few actuaries prac-tice in life insurance and also in healthinsurance. Actuaries tend to specialize.

Most U.S. health insurance actuariesfocus on employer-provided group healthplans with underwriting and ratemakingprocesses completely unrelated to lifeinsurance practices. Critical IllnessInsurance, with its life-like features, is,therefore, a strange animal for manyhealth insurance actuaries.

Yet, when your CEO first recognizesCritical Illness Insurance as a majormarketing opportunity, he will most likelyrefer his request for evaluation of a CriticalIllness Insurance product idea to his healthinsurance actuaries. Since Critical IllnessInsurance does not fit anywhere in healthactuarial practice, this product’s chances ofa favorable evaluation by health actuariesare practically zero.

Most U.S. life insurance actuaries arecomfortable with mortality rates and not

Part One: A Short History of A New Productcontinued from page 19


familiar with current health insuranceissues. If a U.S. life actuary is asked toevaluate Critical Illness Insurance as aproduct opportunity, his/her first reactionmight be to route it to the health insur-ance actuaries who will very likely rejectthe product idea.

Thus any good Critical IllnessInsurance idea in your company may verywell circulate from your life insuranceactuaries to your health insurance actuariesand back, remaining in product develop-ment “limbo” until its original salesmanchampion moves on to another company,and it dies a natural death in a dusty file.

Inimical and Ponderous StateRegulatory Processes.In our work, we have found that CriticalIllness Insurance is poorly understood byregulators. Regulators are not certainwhether it should be “vetted” by depart-mental health actuaries or life actuaries.Some regulators appear to find the seri-ous consequences of CI diagnosis toofrightening to even think about and have,perhaps viscerally, placed the insuranceon their list of coverages that are never tobe approved.

Reasons given by regulators in privateconversations for their animosity toCritical Illness Insurance generally comearound to the conviction that the mereprospect of Critical Illness will “scare”consumers.

Ironically, in conversations withnumerous state legislators, we have seentremendous and vocal support for theCritical Illness Insurance idea, once thefeatures and benefits are explained.

Legal Overhead in ProductDevelopment. The sheer weight of work in getting 50-state approval for a revolutionary productlike Critical Illness Insurance will likelydiscourage very large, surplus-rich, andwidely licensed insurance companies fromdeveloping the product. This view appearsto be supported by the fact that mostCritical Illness Insurance products in theU.S. are currently marketed by regionalcompanies that are not household namesand are not strongly capitalized.

Finding Incidence Rates.Hampered by zero available insured livesexperience, actuaries have had to turn to

incidences experienced by the generalpopulation containing the members of theportfolio to be insured against criticalillness.

Since critical illness Insurance benefitsare paid on first Critical Illness diagnosis,population incidence rates have to be“scrubbed clean” of repeat incidencesbefore they can be used in ratemaking.Suitable mathematical techniques exist fordoing this. They were mostly invented bydemographers, not actuaries.

Once you have a set of “scrubbed”incidence rates, you need to employ cali-bration techniques to adapt yourpopulation critical illness incidence ratesto the insured portfolio. Miraculously,techniques for such adaptation have beeninvented. These techniques were firstpublished by Dash & Grimshaw in theirlandmark paper “Dread Disease Cover:An Actuarial Perspective.” (At the timethe Dash & Grimshaw paper was written,the term “dread disease” was commonlyused to refer to “critical illness.”)

Dash & Grimshaw were the firstresearchers to produce population criticalillness incidence rates for the UnitedKingdom. The Dash & Grimshaw inci-dence rates as published in 1990, remainan important standard of comparison forBritish actuaries. They are used exten-sively in this primer in a comparativecapacity.

The Rate Calibration Formula. Clearly, population critical illness inci-dence rates, no matter how accuratelyderived, cannot be directly used in insur-ance ratemaking. They have to becarefully calibrated from a populationlevel to a level appropriate to the risks tobe insured.

In their 1990 paper, Dash &Grimshaw published the Rate CalibrationFormula. Unfortunately this very impor-tant result was only one of manyinteresting mathematical resultspublished in the Dash & Grimshawpaper. Many actuaries may not haveaccorded it the importance it deserves.This may be the reason that it appears tobe less well understood than one mighthave hoped. It also seems as if its almostuniversal applicability has not yet beenappreciated by many technical workers.

The Rate Calibration Formulafurnishes a method for calibrating critical

illness incidence rates of a “seed” popula-tion P to critical illness incidence ratesfor a “target” population G. The formulais as follows:

Where

and

And where

is the proportion of deaths due tocritical cause occurring betweenage x and age x+1 in the targetpopulation,

is the proportion of deaths due tocritical cause occurring betweenage x and age x+1 in the seedpopulation.

is the number of lives exposed todeath due to critical cause at age xin the target population,

is the number of lives exposed todeath due to critical cause at age xin the seed population.

is the mortality rate at age x in thetarget population,

is the mortality rate at age x in theseed population.

PxqP

xkPxw

GxqG

xkGxwP

xi=Gxi

)Gxl

S.Gxl-(1

)GxqG

xk

D2.Gxq

Gxl

S.Gxl-(1

D1.Gxq

1=G

xw


)Pxl

S.Pxl-(1

)PxqP

xk

D2.Pxq

Pxl

S.Pxl-(1

D1.Pxq

1=P

xw

Gxk

Pxk

Gxl

Pxl

Gxq

Pxq


is the number of lives that are suffering from a critical illness at age x in the target population,

is the number of lives that are suffering from a critical illness at age x in the seed population.

is the critical illness incidence rate in the target population,

is the critical illness incidence rate in the seed population.

is the death rate at age x applicable to healthy lives contracting a critical illness after age x

in the target population, is the death rate at age x applicable to healthy lives contracting a critical illness after age x in theseed population.

is the death rate at age x applicable to lives critically ill at age x in the target population,

is the death rate at age x applicable to lives critically ill at age x in the seed population.

The Rate Calibration Formula is derived from a differential equation describing a general process of transition from critical illnessto death. The Rate Calibration Formula says that, if you know the critical illness incidence rate in a ‘seed’ population P, and you knowthe proportion of deaths due to critical cause for P as well as for the “target” population G, and you can make reasonably accurate esti-mates of the wx factors for both P and G, you can derive reliable critical illness incidence rates for target population G. Application ofthe Rate Calibration Formula is perfectly general. You can define your seed population in any way you wish. Proper implementation ofthe Rate Calibration Formula requires that critical illness definitions for your seed and target population correspond very closely. It alsorequires that cause of death certification in the target population and the seed population are consistent. This means that critical illnessdiagnosis protocols and cause of death registration systems of the Seed population and the Target population must be similar. unfortu-nately, these correspondence and consistency requirements void the application of the Rate Calibration Formula to derive critical illnessincidence rates for U.S. insurance underwriters from U.K. population critical illness incidence rates.

The Rate Calibration Formula is widely used by practitioners to derive insured portfolio Critical Illness incidence rates from popu-lation Critical Illness Incidence Rates. But its general applicability to other types of transitions is less well understood, even by foreignpractitioners.

A little reflection may convince you that the Rate Calibration Formula can be even more effectively applied when one wishes totransition from one group of risks in a portfolio to another group of risks in the same portfolio. The Rate Calibration Formula is apowerful tool that can enable actuaries to transition from ultimate critical illness incidence rates to select critical illness incidence ratesin the same insured portfolio. The Rate Calibration Formula is also directly applicable in deriving substandard underwriting extramortality ratings under the numerical rating system. These powerful intra-portfolio adjustments are possible because of the “almostassured” correspondence between critical illness diagnosis protocols and cause of death registration systems.

Johan Lotter wrote this article. It is the first part of our Primer on Critical Illness. Alistair Cammidge, FIA, ASA, of Lotter ActuarialPartners Inc. reviewed it. Johan Lotter will provide “Part Two: An Overview Of Foreign Critical Illness Claims Experience” in thenext edition of this newsletter.

Johan Lotter, FIA, ASA, MAAA, is a consulting actuary and President of Lotter Actuarial Partners Inc., 915 Broadway, New York, NY10010. For additional information about Critical Illness Insurance, see the Lotter Actuarial Partners Web site at www.lotteract.com.He can be reached at [email protected].

Part One: A Short History of A New Productcontinued from page 21

S.Gxl

S.Pxl

Gxi

Pxi

D1.Gxq

D1.Pxq

D2.Gxq

D2.Pxq


IntroductionHealth actuaries focus on benefits at allages — and often separately think of bene-fits for active employees as compared toretirees. They also focus on both publicand private programs. As populations areaging in many countries, providing fortheir economic and health needs is a chal-lenge to individuals, families, businesses,and the nations themselves.

An analysis of the post-retirement periodindicates retirees have changing needs,which often are not fully recognized orplanned for at the time of retirement.

In looking at issues related toretirement and the informationneeds of retirement professionals,the Society of Actuaries observed

that most of the focus has been on build-ing up adequate fundsfor retirement. Therehas been relatively littlefocus on the use offunds after retirementand on changing needsafter retirement. In1997, the Society ofActuaries started aresearch project focus-ing on the post-retire-ment period. The firsttwo phases of theRetirement NeedsFramework projectincluded a combination of researchpapers and a symposium for presentationand discussion of the papers. The 14papers and some key discussions havebeen published in a monograph“Retirement Needs Framework: SOAMonograph M-RS00-1” by the Societyof Actuaries. This article provides a pro-ject overview and discussion of some

issues which may be of substantial inter-est to health actuaries. It focuses on threeareas: models, data, and issues for thefrail elderly. There is a great deal moreof interest in the monograph.

Project Goals and OverviewThis project is focused on understandingpost-retirement events, understandingmodeling approaches for working withthe events, and searching out data. Thepost-retirement events include: inflation,death of a spouse, changes in health,changes in care needs, changes in theavailability of family members to providecare, changes in housing needs, andchanges in interests and avocations.

The project sets the stage for bettermodeling and development of retireeneeds. The project committee looked forareas where there are mismatches

between retiree needs andthe common forms ofutilization and distributionof retirement assets. Theproject participants weremulti-disciplinary andincluded actuaries, attor-neys, demographers, andeconomists. The participantsincluded academics andpractitioners, offering achance for the two groups towork together and exchangeideas. The issues are univer-sal across geography, but

most of the discussion relates to theUnited States and Canada, and policyconnections link to these two countries.

This project is extremely importantbecause of changing individual, govern-ment, and corporate retirement roles.Responsibility of the individual is beingstressed. At the same time, so much ofthe research around retirement focuses on

the period before retirement rather thanon the management of post-retirementevents.

The research has served to identify anumber of areas where current policyserves as a barrier to effectively meetingthe needs of the elderly. While the projectis not directly focused on policy, it isanticipated that this work will be helpfulin providing a more complete picture topolicymakers, and that it will informpolicymaking. It should also serve as aresource for those who are building toolsfor personal retirement planning andthose who are assisting plan sponsors inmaking decisions.

Issues with Regard to the FrailElderlyCare for the frail elderly is a major prob-lem for which no solution is in place formany families. Long-term care insuranceis the private sector insurance solution tofinancing part of the care, whereasMedicaid is a public sector solution forthe poor. Elderly women living alone aremost likely to need such care on a paidbasis. In Chapter XV, “Retirement andHealth: Estimates and Projections ofAcute and Long Term Care Needs of theU.S. Elderly Population,” Eric Stallardpresents key summary U.S. data onexpected costs of care over a lifetime.

He estimates that the discountedpresent value of future health care costsat retirement is $150,000 − $182,000,with Medicare paying about 50%-55%under current law. Chapter 15 contains awealth of information and includesprojections of the disabled population,plus cost projections for medical care andlong-term care. Health care costs aremuch less of a concern to the individualin Canada because of much more exten-sive public benefits, and much lower

The Retirement Needs Framework: Issues for HealthActuaries

by Anna M. Rappaport



residual needs over the public benefits.Health care is a long-term public policyissue in many countries including theU.S. and Canada.

Only 7% of long-term care is paid forby private insurance. The individual andMedicaid are the largest payers. This dataprovides a great deal of information onthe continuum with regard to individualhealth status and the status of the popula-tion. The data provides insights withregard to the frail population and thosewho could qualify for benefits under a

long-term care policy qualified underHIPAA and those who could not. In theU.S., long-term care insurance has beensold for a number of years, but it coversonly a small percentage of the populationand a small percentage of total care.Insured claims data is not mature, andbenefits are only provided for the mostseverely disabled individuals. TheNational Long-Term Care survey,presented in the study, is representative ofthe total population. Several waves of thestudy have been completed. One of thechallenges for actuaries is resolving howto use the national and insured datatogether.

Chapter XV provides information onmodeling of the frail population and theircosts. Chapter VIII, “Analysis ofFinancial Needs in Retirement, AMultistate Approach” by Bruce L. Jones,also provides information on modelingthe disabled elderly population. He

presents a model for looking at fourstages in retirement. Both presentationsuse a Markov chain model.

Modeling, Practical Issues and IntegrationModels are the tools that permit applica-tion of observed, or hypothetical,relationships. At an early stage of develop-ment, they offer some insights, but maynot be very practical. With further devel-opment and suitable data, they provide thedirect means of practical application. They

can also be dangerous if they are acceptedas reality without understanding of theunderlying assumptions, simplifications,and degree of validation.

Some of the ideas and models pre-sented in the Retirement Needs Frame-work project will need further develop-ment and consideration of practical issuesin application. Application requires bothadditional analysis and acquisition ofsuitable data.

Models identified and needs for moremodeling• The modeling and analytical

approaches applicable to different areas were discussed:

• (a) Markov chain models to model transitions between different states of health. Both Bruce Jones and Eric Stallard produced models for this purpose.

(b) Stochastic models of alternativewithdrawal and investment strate-gies to look at differences in the chance of ruin where assets were invested in different ways

(c) Models of the effectiveness of different annuity payout strategies

(d) Models linking expected health care costs to different states of health

(e) Models based on derivatives and investment strategies to analyze different payout strategies

It would be very interesting to seedialogue about these models, refinementsto them, and their application. TheHealth Section may wish to provide aforum for such dialogue. Some of theareas needing further developmentinclude the application of multi-statemodels to analyze the needs of the frailelderly, models of alternative investmentand payout strategies, analysis of issuesinvolving annuity vs. alternative formsof distribution, and application of thesemodels by various users.

Integration of different elements of thepost-retirement periodThis project provides a start at integratingthe ideas presented. The changes anddiscontinuities after retirement are insome cases mutually independent and inothers dependent. From the perspectiveof the insurer, it is possible to considerintegrated or separate products. Traditionand regulation probably lead to separateproducts, but integrated products may doa better job in the future.

However, from the perspective of theindividual, a total plan is what is needed.It is important that the events be consid-ered and analyzed on an integrated basis.There are many interconnected issues inindividual planning, employee benefit

The Retirement Needs Framework: Issues for Health Actuariescontinued from page 23

“Only 7% of long-term care is paid for by private insurance. The individual and Medicaid are the

largest payers. This data provides a great deal of information on the continuum with

regard to individual health status and the status of population.”


program design, financial product devel-opment, and in setting public policy. Inall of these areas, the solutions need to befocused on dealing with multiple needs.

DataThe papers presented focus more onmodeling and concepts than on data. Datawill be critical to applying these conceptsin the real world as they are developed.

Asset modelingFor modeling assets, there are well-estab-lished sources of average historical returnson different assets classes.Ibbotson Associates is afrequently used source, andis cited by Ray Murphy inhis paper “A Simple Modelof Investment Risk for anIndividual Investor AfterRetirement.”

It would be a greatadvance to be able to modela combination of assetclasses including traditionalinvestments, annuities andinsurance products. Data sources on annu-ities and insurance products will be achallenge. Piggott and Doyle, in theirpaper “Annuity Payout Streams: AnAnalytic Survey,” also point to the prob-lems of market risk on annuities, and ourdata will need to reflect that.

Frail elderly and long-term careBoth population data and information onlong-term care insurance help us focuson issues related to the frail elderly. EricStallard provides insights on theNational Long-Term Care Survey. Thisis an extremely valuable data source onfrailty within the U.S. population. Thisdata is very helpful in looking at transi-tions between different health states, orsteps in the continuum. This is a peri-odic study, and the next round is in theplanning stage.

There are questions about how to inte-grate this data with insured data andapply it to insurance. Additionally, itwould be quite interesting to havecomparative data between countries.

Another challenge is how to apply thisdata to different sub-populations. Forexample, a Continuing Care RetirementCommunity or insurer may wish to lookat data that is relevant to the particularparticipants in the group as selected bythe entry rules of the program and by thechoices of the individuals. Economicstatus eliminates participation by many.

Data is also being collected on long-term care insurance. This data is veryimmature, and covers only a small partof the population. One of the key chal-lenges is using this data together with the

population-wide data refer-enced above.

The SOA’s Long-TermCare Task Force is workingwith the data on the frailelderly. Further data will beneeded for applications inother models.

Development of regulardata resources is important ifthe models are to be updatedregularly. The project groupfor The Retirement Needs

Framework project is further exploringthe issue of data that can be published ona regular basis by the SOA for pensionand health actuaries.

Other DataThe October 1998 issue of the NorthAmerican Actuarial Journal provides astudy of mortality patterns in NAFTAcountries and illustrates that there arevery different, issues among them. TheU.S. and Canada have similar issues, asdo many European countries. Mexico isvery different and there may be othercountries with similar issues. WhileMexico is much younger, it will undergomuch faster and more dramatic popula-tion aging.

The Health and Retirement Survey is amajor U.S. longitudinal study of retire-ment in the population. It looks at agroup of people nearing retirement age,and then re-interviews them every twoyears. Four waves of this study havealready been completed. A recent book,Forecasting Retirement Needs and

Retirement Wealth, 2000, University ofPennsylvania Press, provides substantialinsights into the findings from this data.The book provides research developedunder the auspices of the PensionResearch Council and is edited by OliviaS. Mitchell, P. Brett Hammond, and AnnaM. Rappaport. This data is publicly avail-able and is a major resource for furtherresearch on the period before and afterretirement. One of the key issues at thetime of retirement is decision making bythe individual. This database providesinformation on how recent retirees havebeen making these decisions. The data-base also includes personal informationabout assets, health, and data on pensionplans and Social Security.

ConclusionThe Retirement Needs Frameworkproject raises many issues for society ingeneral and for professionals workingwith retirement programs. It presentschallenges for research, data collection,planning for individuals, and for policy.

It is hoped that this work will encour-age the various groups involved inbuilding better retirement systems toaddress some of these issues.

Anna M. Rappaport, FSA, MAAA, FCA,is a consulting actuary at William M.Mercer, Inc. in Chicago. She a past presi-dent of the Society of Actuaries. She canbe reached at [email protected].


Asnapshot of the rapidlyevolving managed care mar-ket is a difficult concept.However, several key fac-

tors that characterize its current statuscan be identified. This characterization,along with consideration of newly devel-oping influences, provides insight to themarkets’ likely future direction.

Consolidation Industry consolidationcontinues at a rapid pace. National playershave largely replaced local and regionalplans in the last five years. The factorsdriving this, weak balance sheets, a desirefor growth, pessimism about future indus-try prospects, and the belief that largetechnology investments are necessary,will continue to fuel consolidations.

One byproduct of the consolidationshas been a substantial reduction in thecyclicality of underwriting results. Theformer pattern of growth thru pricing andmarketplace operations has been replacedwith national companies, and BCBSconsolidators’ top line growth is theresult of acquisitions rather than samestore enrollment increases.

Capital MarketsThe investment community has moreinfluence on the managed care marketthan historically and is generally notenthusiastic in company valuations. Weakand inconsistent profit margins, consumerbacklash, Medicare exposure, and thetreat of litigation have provided negativepressure. The investment community ispoised to reward (and managements havetaken notice) companies with strongunderwriting discipline, low operatingcosts, innovative products, a strong mar-ket position, and low exposure on thenegative pressures.

Consumer BacklashThe managed care industry has lost thepublic relations battle, and its legitimacyas a concept is somewhere between

severely damaged and destroyed. Thegeneral population seems to believemedical management units are staffed andmanaged by accountants. The industry isnot willing or able to defend itself. Theresult has companies running away from asubstantial reason for their economic basisfor existence, namely, managing cost.Companies are rapidly trying to remakethemselves into customer friendly advo-cates for good health.

Who Will Manage The Cost ?A typical health plan mission five yearsago would sound something like this. Wefinance health care. How we providevalue and gain competitive advantage togrow and make money is to negotiate thebest deals with providers and eliminateunnecessary utilization of services. Wewill send patients to lower cost providersand not allow higher cost ones to partici-pate with us. Often statements are addedabout quality, access, and customer focus.

Contrast this with the typical healthplan mission today. We will be nice toconsumers. We will help them achievegood health. We will develop services tomake it easy for them to get health care.We love everyone and are not nasty.

Providers, after widespread movesinto risk and capitation, have in manycases decided they do not want responsi-bility for the cost and are insisting on feeor service-based reimbursement.

Employers for the most part are pay-ing the expense. However, they are notequipped or in business to be able to domuch to control it.

The change in emphasis away frommanaging medical expenses can be per-plexing to actuaries, whose contributionoften deals with financial aspects of com-petitiveness and maximizing ROI.

Rapidly Increasing CostsHealth plans’ lower standing on the foodchain is not lost on providers in many

negotiations over terms and fees. Thereduction in inpatient utilization, whichcovered increases in other categories ofmedical service, has leveled off for manyplans. Pharmacy costs are increasing at20% per annum or more for most plans.Government reimbursement for serviceshas been constrained as a result of theBalanced Budget Act of 1997.

Particularly affected are hospitals andto a greater degree in non-metropolitanareas. This reimbursement is generatingpressure to raise fees to private-paypatients. Additionally, inflation in theeconomy has gone from under 2% tonearly 4% in the last two years.

In addition to the increase in medicalcost is the desire for the industry toimprove profitability by lowering theirmedical loss ratio. The result is rateincreases averaging in excess of 10% forthe industry for CY2000. Many increasesfor individual customers or businesssegments are 20% or more.

Pharmacy CostsHealth plans are experiencing annualincreases in per member per month(pmpm) cost ranging from 15% to 30%.Evidence of pharmacoeconomic benefit isanecdotal at this time. An analysis of thedrug pipeline indicates increases in thehigh teens can be expected for the nextfour years, without adding additionalbreakthroughs that may occur. Despite thecost increase, there is great hope that

The Managed Care Market −−Current Status, Future Direction

by Kevin M. Dolsky


biotechnology will provide better health,better outcomes, and less invasive cures.Genetic therapy is on the horizon, but isnot affecting costs or treatments today orin the near term.

Regulatory and LegalGovermnent will be asked, through theelective process, to continue to incre-mentally increase their involvement inmanaged care and the health care system.Despite a budget surplus, the govern-ment has more attractive items to spendmoney on than adequate health carereimbursement rates.

There were 21 class action lawsuitsfiled against the industry in the fourmonths following the 9/30/99 announce-ment by the tobacco lawyers of theirintention to target the managed careindustry. The Carle case decided by theSupreme Court in June 2000 provided theindustry some relief from concern overliability. The consensus is that the legalchallenges will be mitigated when anational patient protection bill is passed.

Future Direction of theManaged Care Industry

ConsumerismConsumers are convinced they are enti-tled to medical care — presently througha system where someone else pays for it.The industry has learned THECONSUMER IS KING — PERIOD!Managed care companies learned this thehard way when their efforts to containcost interfered with consumer desires forfreedom and access. The industry isscrambling to be friendly to consumers.Plans are developing ways to be advo-cates for consumers. It remains to be seenwhether they will be successful at beingadvocates for health, access to qualityservices, and cost effectiveness all at thesame time.

TechnologyInformation about medical care, treat-ment options, quality, cost, and pro-viders can be gathered and provided toconsumers in fulfilling managed carecompanies’ advocate role. The Internet

will provide the medium for communi-cation of such information.

Technology and the Internet will alsoprovide the ability and medium for moreefficient claims and eligibility processing,and better communication with customerson claims, inquiry, and other serviceissues.

Defined ContributionThere is admittedly a debate over howfast employers may move to limitingtheir financial and legal obligationthrough moving away from promisinghealth benefits to providing a definedcontribution for employees use in payingfor health care selected by the employee.I believe the change will occur rapidlyand extensively, meaning in the next fiveyears, as much as half of the market willbe through a defined contribution.

Providers and managed care compa-nies have demonstrated they do not wantthe risk or are willing to pass it onthrough rate increases. Employers havebeen largely paying for this because ofemployment shortages and strong earn-ings. I expect large rate increases to con-tinue for the next several years becauseof pharmacy, government reimburse-ment, lack of ability to aggressivelymanage costs, consumerism, and medicalcost inflation.

Of the four parities involved in healthcare, individuals, employers, healthplans, and providers, the employers havethe least ability to manage cost or affectmedical decisions. It is not in employ-ers’ business interest to provide benefitguarantees, and they continue to do sobased only on tradition and tax benefits(the latter of which can be obtained inother ways).

It is for these reasons that I believeonce a certain momentum is achievedtoward defined contributions, it willaccelerate. This does not mean managedcare companies will be shut out, butrather will be consistent with their desireto be close to consumers.

Group underwriting (eligibility) andpricing will still be provided through theemployer grouping with more individualchoice and consequence for decisions.

New CompetitionIn a world where managed care compa-nies’ value is derived from their ability tobe advocates for health, access, and infor-mation concerning medical care, newcompetitors will spring up. Companiessuch as Vivius that sell over the Internethealth care coverage designed as person-alized health care systems can provide formuch of the advocate responsibility.Positive brand image and trust will bevaluable assets for health plans insucceeding against this competition.

Government ProgramsIt is unlikely that managed care companyinvolvement in at-risk programs forMedicare and Medicaid will be prof-itable in the near future. For this reason,plans will reduce their exposure to this inthe near term. Opportunities on the hori-zon may be in government-sponsoredprograms for prescription drugs and theuninsured.

ConclusionThe managed care market has changed

from one of aggressively managing coststo one reflecting consumerism. Theauthor’s view is the change is a perma-nent shift rather than a pendulum thatwill swing back in a few years.

Consumers have expressed theirdesires and exercised their authoritythrough backlash and through theirelected officials. It remains to be seen ifthe consumerism will also entail an adop-tion of responsibility by individuals. Ifconsumers become financially responsi-ble for their medical care, they will bemuch more incented and receptive tomanaging their health as a result. Thiswill provide an opportunity for a pendu-lum swing of a different type wherecompanies can provide value and thriveas health maintenance organizationsrather than the maligned managed carecompanies.

Kevin M. Dolsky, FSA, MAAA, is a con-sulting actuary at Actl & Health CareSolutions in Mequon, WI and a memberof the Health Section Council. He can bereached a [email protected].


In my experience, it is difficult (ifnot impossible) to make moneyin many health insurance productlines unless you have the ability

to:

1) Quickly and accurately tabulate and review emerging experience; and,

2) Quickly respond to adverse emerging experience by taking the corrective actions necessary to help ensure that projected future experience is (at least) more in line with pricing expectations.

A list of corrective actions could in-clude “rate increases,” many of whichwould be subject to state filing andapproval requirements.

As I mentioned in my last article, Ihave spent nearly all of my actuarialcareer in health insurance, and most ofthat time working with supplementalhealth products (e.g., LTC, Medicaresupplement, and specified disease).While I have some group experience incertain product lines, most of my experi-ence has been with individual products.This background has certainly impactedmy exposure to the rate filing process, aswell as my opinions regarding thatprocess.

Overview −− What I Wanted to BelieveWhen I first started working on rate filingprojects, I wanted to believe that the opti-mal approach to filing for rate increaseswas a standardized approach. I wanted tobelieve that any debates or discussionsarising during the recommendation devel-opment or filing processes would beactuary-to-actuary, and that they would

surround data issues, credibility, the pro-jection methodology, and assumptions. Iwanted to believe that the harder I workedon a specific rate filing, the better chanceI had of obtaining regulatory approval forthat filing.

Anyone who has worked on ratefilings will tell you that the above para-graph does NOT,in many cases,accurately charac-terize theseaspects of the ratefiling process. Inthe followingsections, I willattempt to outlinea few major differ-ences betweenreality and theabove. This list isnot meant to beexhaustive, nordoes it present issues in any particularorder. I have simply attempted to presenta few items for consideration and furtherdiscussion.

“Generic”As I mentioned, I wanted to believe thatthe optimal approach to filing for rateincreases was a standardized approach. Iwill focus my discussion here on theconcept of the “generic” (a.k.a., “nation-wide”) filing.

As actuaries working on rate filings,our primary method of presenting orcommunicating a proposed rate increase,along with the reasoning behind andjustification for that increase, is the actu-arial memorandum and its attachments. Ifthere were a “standardized” approach torate filing, my assumption would be that

there is a standard actuarial memorandumand attachments that would satisfy many-to-most scenarios. While this was closerto being true 10-15 years ago, the conceptof a “generic” filing today seems to begetting closer to “not applicable” everyyear.

As in any area of business, a cost-benefit trade-off exists — ifyou research all state-specificlaws and regulations, attemptto anticipate any state-specificfiling requirements and/orrespond in advance to the typi-cal DOI questions for eachstate, and modify each andevery memorandum based onthe above, is that in the bestinterest of the company? Willthe time and resource cost ofassembling and implementingthis information “pay off” inultimate approval and imple-

mentation time-savings? My experiencewith this has varied — I would be inter-ested in hearing other perspectives.

Simplicity Versus ComplexityAs an actuary without much practicalexperience, my inclination was to believethat the faster the filing and approvalprocess should be. My initial response, inretrospect, is that this is generally nottrue. The following outlines a couple ofreasons:

a) the more time I put into developing and creating a rate increase filing;

b) the more thorough and complete the actuarial memo and the underlying actuarial work; and,

What No One Ever Told Me About the Rate Filing Process

by Karl G. Volkmar


c) the more I research and try to antici-pate state-specific filing requirements,

a) In some cases, the more information you provide (even if it’s not material

to the filing), the more questions are generated; and,

b) The regulations for a given state can change or be applied differently year-to-year, company-to-company, depending on who reviews the filing and their interpretations of the regulations.

In my experience, the easier a filing isto walk through and explain, the easierthe approval process will be. Obviously,we need to be thorough; however, it isusually in the company’s best interest tobe thorough without being unnecessarilycomplicated or providing unnecessarydetail.

You Don't Get What You Ask ForWhen you file for a rate increase, youwill not get what you ask for on an aggre-gate, nationwide basis. In my experience,there are a few items that help create thisphenomenon:

a) The Negotiation Principle −−

In practice, what you ask for is perceived to be the high-end amount, regardless of what the actuarial memorandum and other supporting documentation indicate. Do you want

to test this principle? Concede a few points from the proposed rate increase request in a given state and observe the impact on the timing of regulatory approval.

b) Direct Consumer Accountability −−Many times, the DOI rate reviewers are directly or indirectly involved with consumer complaints. Obviously, this creates pressure for the regulators to limit increases as much as possible.

c) Visibility −−For example, election year and/or media issues are real and can be very influential in the rate filing approval process.

If a company needs an X% aggregateincrease, how should it account for thisphenomenon? This can be a tough issueto address — I would be interested tohear how other actuaries attempt tohandle it.

The Politics of Getting Things ApprovedAn important “reality” in the rate filingprocess is that who you know and thestatus of your relationship with thatperson(s) is at least as important as theactuarial work itself. The keys to all typesof relationships are also keys here —

consistency, trust, honesty, and humility.Building and maintaining these relation-ships is an important part of developingan effective rate filing process.

Given the above, you can see how“burning bridges” can be devastating to aprofessional relationship, and therefore toyour company. Always remember that therate filing process and its purpose arebigger than you. Don’t jeopardize yourprofessional standards, your reputationyour company’s/client’s reputation, andtheir financial standing by “cuttingcorners” in an attempt to expedite the ratefiling process.

Reality −− A SummaryAs I mentioned in my last article, thehealth business is a high risk/low rewardbusiness. It must be aggressively, compre-hensively, and constantly managed inorder to be profitable. As part of thismanagement, a company needs to developan efficient, effective rate filing process.

In order to develop an optimal ratefiling process, a company needs to realizethat this is a “people business,” and thatevery state and person involved is differ-ent. As an actuary working for thatcompany, you need to learn the details forevery significant state in which yourcompany does business — how its reviewprocess works, the people involved, itsrelevant laws/regulations, and its politicallandscape. While this may be a challenge,the rewards can be significant.

I would be interested in hearing anycomments/criticisms you have regardingthe issues presented in this article. Pleasecontact me with any questions/commentsvia phone at (317) 580-8661 or via e-mailat [email protected].

Karl G. Volkmar, FSA, MAAA, is aconsulting actuary at United ActuarialServices in Carmel, IN. He is a memberof the Health Section.

“Always remember that the rate filing process and its purpose are bigger than you. Don’t jeopardize your professional standards, your reputation, your company’s/client’s reputation and their financial standing by ‘cutting corners’ in an attempt to

expedite the rate filing process.”


Abasic requirement in theFederal HMO Act of 1973(and later by states) was arequirement of hold harm-

less agreements between the HMO andproviders. There were a number ofinsolvencies in the 1970s, but the planswere small, and usually there were suf-ficient funds to cover most of the liabili-ties. Because of the hold harmlessagreements, the providers were paid lastand some business liabilities did not getpaid. Nevertheless, protection was suc-cessful in that terminated subscriberswere not dunned for claims by hospitalsor doctors.

It was recognized, however, that amore formal protection of the subscribers

was necessary for the post-insolvencyperiod. There could be claims from non-con-tracted providers, includingemergency claims out of the plan servicearea. It would be difficult for one state toenforce a hold harmless against a providerin a different state. In addition, if premi-ums had been paid in advance, or the dateof cessation of operations of the HMOwas in the middle of a month, there wouldbe liabilities for some patients after thedate of insolvency, unless the provideragreements made clear that coveragewould continue up to the point for whichpremiums had been paid under terms ofthe original contract.

In the late 1970s, an arrangementwas developed by a large carrier, a large

non-profit HMO, and the FederalOHMO to come up with what theycalled “the insolvency provision” to beadded to reinsurance agreements.Essentially, this continuation of benefitsagreement included the following items:1) A reinsurer would continue plan bene-

fits for members confined in an acute care hospital on the date of insolvency until discharge from the hospital.

2) Coverage would be provided after the HMO ceased operating for continua-tion of plan benefits until the end of the period for which premiums hadbeen paid (excluding benefits which were the contractual liability of a hospital or physician).

Industry Perspective

Consumer Protection −−Continuation of Benefits in Event of HMO Insolvency

by Harry L. Sutton, Jr.

Author's Note: This article was written for the periodic magazine of NAMCR, the National Association of Managed CareRegulators, in late 1998. NAMCR was originally an operating subcommittee of the NAIC, but was eventually discontinued and maintained a separate existence. It was essentially ignored until recent rapprochement by the NAIC, particularly because of their emphasis on the rules of insolvency and how to deal with them at the state level — which because of an increasing number of insolvencies caught the attention of the NAIC.

Since the article was written, there has been an increasing reluctance in the HMO reinsurance market to provide any continuation of coverage in the agreement. Also, contract provisions regarding continuation of benefits have been tightened. Anumber of carriers will not consider writing it.

As indicated in the article, Medicare used to have its own requirement of two months of uncovered services. HCFA reduced that requirement to one month in 1999 and later removed the requirement of such an insurance provision subject to adequate holdharmless arrangements. A definition of these arrangements has not yet been published.

States continue to desire some type of continuation of benefits provisions in HMO reinsurance agreements. In occasional cases, the regulations require it, which will make some carriers refuse to offer reinsurance.

With the near insolvency of two major multi-billion dollar HMOs in Massachusetts, the Commonwealth passed new laws tightening up and expanding the liability of providers in the event of insolvency, thus minimizing the potential liability of a reinsureroffering continuation of benefits. At the present time, the NAIC HMO Model Act is being redrafted, including the insolvency provisions.As for Allianz, we have tremendously increased our emphasis on analysis of the financial status of the HMOs we reinsure. I can onlyassume that the other carriers in this business who continue to offer this extension of coverage in the event of cessation of HMO operations must be tightening up their scrutiny as well.

While a few states have recently added HMO guaranty funds to their statutes, there has been very little industry or carrierinterest in expanding these provisions. The well managed HMOs feel that an aggressive competitor coming in with rates below cost will take market share away, and if it does not survive, will be bailed out by the guaranty funds.


3) A conversion privilege was often pro-vided for members who did not have an employer group to return to.

Of particular interest is the fact thatbenefits must be continued for anyMedicare risk enrollee in the event ofinsolvency, as in (2). The problem withMedicare is more complex than foremployer based organizations, sinceHCFA typically pays premiums on the 27th

day of the prior month. In the event ofinsolvency at the end of a given month,the plan will have one full month ofadvance premiums for its Medicaremembers. There are estimates that the costof the continuation provision could runbetween $50 and $100 per commercialmember, and possibly $300 to $600 perMedicare member after plan closure.

Other permitted alternatives to rein-surance coverage included: RestrictedReserves, Letters of Credit, and ParentalGuarantees all hold harmless agreementsin provider contracts until the end ofcontinuing liability. In the 1970s, enroll-ments of more than 10,000 to 15,000were relatively rare, except for some ofthe older, larger, well-financed plans suchas Kaiser, Group Health Cooperative, andHIP. The majority of HMOs were not-for-profit and were quite small. With theconversion to for-profit and the tighten-ing of utilization controls on hospital useby HMOs, a low visible level of insol-vencies resulted. Often HMOs would buymembership of terminating plans. As aresult, reinsurers usually ignored theprobability of insolvency.

Today, HMOs have total revenue inthe range of $10 to $20 billion per year.In the event of a major insolvency, theliability for continuation of coveragecould run into several hundred milliondollars — even possibly as much as $1billion!

HMO reinsurers have typicallyprovided unlimited benefits for continua-tion of coverage in the event ofinsolvency, without really underwritingthe financial condition of HMOs. This

liability could bankrupt companies thatsell HMO reinsurance. While state andfederal regulators have demanded unlim-ited continuation of coverage provisions,it seems likely that significant changes inthe continuation of benefits arrangementswill occur during the next year:

• Already many carriers put aggregate limits of $3 to $5 million on the total liability for continuation of benefits.

• Reinsurers will tighten their definition of what would constitute eligible claims. For example, there are at least five insolvent HMOs in the jurisdic-tion of Florida. Reinsurers with loose provisions may find a substantial liability if enforced as written. Florida now also has the equivalent of a State Guaranty Association for HMOs. The continuing dissolution of HMOs may severely test the capacity of this Florida Guaranty Association to support the runoff claims through taxation of other HMOs.

• Historically, the HMO movement has fought strongly against the develop-ment of Guaranty Associations. The insolvency issue lacked urgency when HMOs were not-for-profit, small, and the provider hold harmless agreements were assumed to prevent large liabil-ity. With the size of current HMOs, the industry may need to rethink its anti-pathy to the solution of a state-by-state Guaranty Fund — including whether it should be added to the Health Insurance Guaranty Fund (excluding disability, long-term care and other non-medical benefits).

• On the other hand, HMOs that are at the 175% or 200% level of the Company Action Level under new Risk Based Capital rules are well enough capitalized to avoid specific excess reserves or reinsurance provisions, letters of credit, or other insolvency related requirements.

• HCFA is transferring effective control of the continuation of benefits for itsMedicare contracts to state regulators. The HCFA “uncovered expenditures” calculation will no longer be used for a Medicare+Choice HMO or PSO. PSOs regulated directly by HCFA will still have the old requirement.

• It is now clear that some of the provi-sions permitted by the states, or HCFA, are not adequate insolvency protection: for example, adequate lines of credit (LOC) can be terminated at will, leav-ing the plan without access to capital; parental guarantees cannot be enforced if one state will not permit the capital to be transferred to a second state; use of unregulated intermediaries may inter-fere with hold harmless provisions.

• Major inadequacies of claim liability estimates have shocked NAIC and the actuarial profession into improving methods of estimation and enforcing certification requirements.

Harry L. Sutton, Jr. FSA, MAAA, FCA, issenior actuary of health care at AllianzLife Insurance Company of NorthAmerica in Minneapolis, MN. He can bereached at [email protected].


Poor Richard Huber, the formerCEO of Aetna, had both thefortune and misfortune to runa company in the over-regu-

lated health care industry, where the cus-tomer feedback loop is measured indecades. In unregulated consumer prod-ucts, where the feedback loop is mea-sured in weeks or even days, things arevastly different.

In less than 90 days, U. S. consumersso overwhelmingly rejected New Cokethat the Coca Cola company was forcedto return to its original formula. ButHMOs, born in 1973 with the HMO Act,signed into law by President Nixon, keepgoing and going — like the EnergizerBunny — regardless of how intenselyconsumers hate them.

What’s truly amazing about HMOs isthat they’ve lasted this long. Althoughfew people are aware of it, twenty yearsago, two major U. S. corporationsrestructured their businesses on the HMOmodel. But since both were disastrousfailures, they didn’t last very long, andconsumers never got a chance to hatethem as much as HMOs. They failed forthe simple reason that no company cancover a category so well that it offers acomplete range of products and servicesto all people, at all times, in all places,with the highest quality, at the best price.

The most famous attempt by a regularbusiness to adopt the HMO model isUnited Airlines, or more accurately,Allegis. Allegis? Yes, back in the 1980s,that was the name for the new parentcompany that United thought wouldrevolutionize commercial travel. LikeHMOs, which pretend to be an associa-tion of networks covering every possiblehealth care need, in every possible way,at the highest level of quality, at thelowest price, Allegis was going to be asimilar association of travel networks —what could be described as a TravelMaintenance Organization, or TMO.

Allegis was going to cover the trav-eler’s every need from door-to-door,

including the flight, the cruise, thehotel, the rental car, etc. No onewould want to seek travel outsidethe Allegis TMO because it hadeverything and because itsdiscounts would assure that itwould offer the best price.Fortunately, because Allegis’sconcept wasn’t backed by coercivegovernment legislation — such asthe Internal Revenue Code (IRC)Section 105 tax-exemption for employer-sponsored health benefits and the HMOAct — travelers today can fly any airline,get a car from any rental agency, and stayat any hotel they choose. And, by theway, they don’t require any new federallegislation to sue their travel agent.

The other great corporate ventureusing the HMO model was the SearsFinancial Network model of a FinancialMaintenance Organization or FMO. Thiswas the world-beater combination ofAllstate Insurance, Dean Witter broker-age, the Discover credit card, and homemortgage lending by Coldwell Bankers— not to mention supplementing yourhome with Sears furniture, Kenmoreappliances, and Craftsman tools.

Without the coercion of federal legisla-tion, Sears attempted to leverage itsdominance (at the time) in the retail sectorby refusing to accept American Express,Master Card, and Visa. Instead, Searsoffered its customers the annoying time-wasting option of filling out an applicationfor their new Discover card. To someextent, this strategy worked. Sears wasable to gain limited acceptance of its FMOand get its Discover card off the ground.Unfortunately, it was even more successfulat driving away its customers to theplethora of other stores that readilyaccepted other major credit cards.

The only industry that still uses theHMO model is a weak, half-heartedattempt by new car dealers to convincetheir customers to get all their parts andservice though them. But since they don’thave coercive legislation to back them

up, and since they can’t be the best ateverything, most people get their oilchanged at Jiffy Lube, batteries fromSears, tires from Goodyear, and mufflersfrom Midas. And no one needs to get areferral from Mr. Goodwrench (theirprimary care mechanic) to go there.

The moral of the story: if you want topush mediocre overpriced products andservices onto the public, and deny themany choices and options, you’d better getCongress and the IRS to do the dirtywork for you. Because the free marketwill tolerate that kind of behavior only aslong as you’re willing to burn throughyour dwindling supply of cash. The freemarket didn’t create HMOs; Congressdid. And Congress didn’t have the fore-sight to kill the Allegis TMO and theSears FMO; angry and indifferentcustomers did.

Congress once had the sense to deregu-late the travel industry and the bankingindustry (although there’s still more workto be done here). It should have the col-lective intelligence to deregulate thehealth care industry by repealing theHMO Act and doing away with the IRC.Otherwise, the state of Minnesota willhave to change its motto to “the land of10,000 lakes … but only one health plan.”

Gerry Smedinghoff is a consulting actu-ary with UniversalCIO, an applicationservice provider (ASP) in Wheaton,Illinois, and is a frequent speaker onhealth care reform.

Why Everyone Hates HMOsby Gerry Smedinghoff

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