Tag Archives: ibnr

Hide and Seek With Healthcare Profits

Little did I know that the children’s game of Hide and Seek would provide valuable lessons for a life in business. But success requires trying new strategies, moving in different directions and venturing away from the illusion of comfort that home base appears to provide.

To win at Hide and Seek, you had to be flexible in your thinking to find great hiding spots, had to make a decision while the countdown was ticking and had to move fast if you wanted to win. Managing healthcare profits in a post-ACA world works the same way.

Hide and Seek is a business strategy used in healthcare like no other industry. The key players resist transformational change and use the power of political lobbying, fear, confusion and an almost unbelievable – you can’t make this stuff up – kind of limited transparency.

By lack of transparency, I mean like playing Hide and Seek with no moon in the sky and wearing all black. There’s no way you were going to find my hiding place!

Fully insured health insurance companies and HMOs are exceptional at playing Hide and Seek, with profit margins hidden in the premiums.

Besides the Affordable Care Act and its new extra charges and taxes, you have to look really hard to find out where the contingency margins are hiding in the premium calculations – especially when you consider that there is very limited transparency in the actual healthcare renewal calculations. Ask yourself – did your employees’ good health and low healthcare utilization inure to your corporate bottom line or to the insurance companies?

So, where are the good profit margin hiding places in the fully insured premiums? Let’s take a peek at the ones hiding inside the employer-paid healthcare premiums? For starters, try looking at the pooling charges, medical claims trend factors, demographic load factors, pharmacy claims trend factors or the capitation trend factors.

Of course, there are more profit margin hiding places in the retention factors, IBNR reserve, claim stabilization reserve, pending claim reserve and the earned interest rate assumptions built into reserves.

Don’t limit yourself playing Hide and Seek with your local fully insured health insurance company or HMO, because the game is rigged against you as long as there’s no financial transparency, profits can be hidden, your company’s good claims subsidize bad risks and you have no way of being rewarded for good claims.

The situation reminds me of the poor kid who always lost at “Bubble gum bubble gum in a dish” or “Engine, engine #9 going down Chicago line” to pick who was going to be “it” first. He didn’t know he was playing a rigged numbers game.

The answer was hiding in plain sight… and no one told him.

And, now you know!

Head for the Hills! Google and Amazon Are Coming! (Or Not)

Really ?

We have all seen the articles that breathlessly announce that Google, Amazon and others are going to become insurers. And somewhere in the next sentence or within the same paragraph, the writers exclaim that insurers must change their ways because doom is nigh.

Really?

More detail, please

I’d like to see more appreciation, more introspection and more detail concerning what insurers do (and have done since what I think is the start of the “modern insurance era,” when Edward Lloyd opened his coffeehouse in the late 1600s).

I’m not saying that insurers don’t have to innovate: They do. I’m not saying that insurers don’t need to better understand how to meet, if not exceed, the needs and expectations of customers already on the books and of their target prospects: They do. And I’m not saying that insurers don’t have to reduce and bring up-to-date the far too many core administration systems keeping the company running: They do.

I am saying, let’s take a breath or two and identify where the competition is and could come from for an industry that is heavily regulated, requires continual licensing and training of its sales people, requires specific types of investments (different for life or P&C insurers, if my memory serves) and is capital-intensive.

Further, let’s not forget what an insurance policy is: a legal contract with a financial wrap (i.e. the promise to pay a claim according to the terms, conditions and restrictions of the contract).

What does an insurance company really do?

I welcome others to add to this list of major activities of an insurance company:

  • Carries the risk
  • Creates the product
  • Prices the product
  • Files the product forms (different for each state)
  • Markets the product
  • Sells the product (keep in mind that each sales person, whether an agent or a faceless person at the other end of the phone or screen, MUST be trained and licensed for each insurance product for each jurisdiction – and the training must be continued throughout their career)
  • Underwrites the product (whether life or P&C, underwriters must minimize adverse risk as well as strive to put profitable business on the books)
  • Services the customer who bought the product (handling administrative “change of address” service as well as claim adjudication, which includes simultaneously providing responsive and empathetic service while setting reserves, estimating incurred but not reported (IBNR) claims and identifying and avoiding/managing fraudulent loss events)
  • Complies with all regulations at the federal and state levels
  • Makes investments as required by regulations and industry standards

Are Amazon and Google really going to become insurers?

Will Amazon or Google, or others, really become insurers? Are they going to want to do everything on that list?

Or, will they decide to become rate-comparison sites? Marketing sites? (And which insurer will carry the paper – carry the risk? I’m not saying that no insurer would carry the paper, but an insurer must do so.) Will Amazon or Google provide customer service? If you love FAQ pages now or waiting on hold for 25 to 30 minutes now when you have a question. . . .

Insurance service is not a FAQ, self-service situation when someone has a claim.

However, ….

Insurers do have to understand where non-traditional competitors could and will participate in the value chain … and ask themselves what will happen to their business (customer retention, profits) if they don’t respond accordingly.

But let’s take a breath. I think it is highly unlikely the digital technology firms are really going to become insurers.

Splitting California Into 6 States? Crazy

If a million people say a foolish thing, it is still a foolish thing.

Anatole France

Maybe that quote should be, “If 1.3 million people. . . . “ That’s because Tim Draper, having spent $5 million, secured 1.3 million signatures and put a measure on the 2016 California ballot that would split the Golden State into six states.

Calling himself the “risk master,” the 56-year-old, billionaire tech investor expresses his quirky desire to “reboot and refresh our state government” by creating separate areas that would be more governable – think “Hunger Games.”

California is the largest state by population, with 38 million people (12% of the U.S.’s total of 316 million), and third largest by area behind Alaska and Texas. It is the world’s 8th-largest economy. If Draper’s measure were approved, the new state of Silicon Valley would be the wealthiest in the country. Central California would be the poorest.

No state has been created from an existing one since West Virginia split from Virginia in 1863. But California has had at least 30 serious proposals to divide it into multiple states since its statehood in 1850, including a proposal passed by the state senate in 1965 to divide California into two states with the boundary at the Tehachapi Mountains, near Bakersfield. In 1992, the state assembly passed a bill to allow a referendum to partition California into three states: North, Central and South. Pundits referred to these proposed states as Log Land, Fog Land and Smog Land.

It is said that the area of the state adjacent to Oregon, long known by the fiercely independent locals as Jefferson State, produces 60% of the U.S. marijuana crop. Three years ago, ex-Google engineer-turned-political-economist Patri Friedman came up with a goofy proposal to build his own floating libertarian nation 12 miles off the coast of California – Googleland?

Assuming the current state legislature and Congress both approve of Draper’s nonsensical measure, the area we currently call California would have 12 senators in Congress, not two. As much as Texans like their beer, I’m not sure they’d like to see California get a six-pack of senators.

Among the serious repercussions that Draper fails to address are vital state infrastructure issues. These include water distribution, transportation systems, state prisons, the University of California system of 10 campuses and two national laboratories – and the largest and most progressive workers’ compensation system in the country.

Workers’ compensation laws in the U.S. are promulgated on a state-by-state basis. Besides a myriad of workers’ compensation laws, each state’s bureaucracy must produce and enforce a plethora of complex regulations, licensing procedures, collateralization requirements and other rules. States have choices to make about self-insurance, including about workers’ comp pools of smaller employers.

Perhaps one or more of the new six California states would be monopolistic – where workers’ compensation coverage is purchased through the state (as in North Dakota, Ohio, Washington and Ohio). Another possibility is an “opt-out” program (as in Texas, Oklahoma and Tennessee) that allows employers to litigate injuries in the civil system, as an alternative to the “exclusive remedy” system.

As if this weren’t enough to be concerned about, the legacy of the current active California workers’ compensation claims would be an issue.

Three key institutions were created by the state legislature and are operated like private companies: the State Compensation Insurance Fund (SCIF); the California Insurance Guaranty Fund (CIGA); and the Self-Insurers’ Security Fund (SISF). SCIF is the state’s largest workers’ comp insurer and provides an insurance alternative to those companies doing business in California that are unable or unwilling to: (1) purchase workers’ compensation coverage from private competitive insurance carriers, or (2) self-insure. CIGA provides insolvency insurance for property casualty insurers admitted to doing business in the state. SISF provides protection to the state and taxpayers for non-public, self-insured entities by taking over workers’ compensation obligations from entities that have defaulted (79 since its formation in 1984).

These three entities combined cover billions of dollars of known and incurred but not reported (IBNR) workers’ compensation with open claims going back as far as World War II. Their combined assets total in the billions.

How would those three entities be broken up into six pieces and reestablished?

Financial Reporting Of Medical Malpractice Self-Insured Losses

Healthcare entities, or groups of physicians (through a captive), may self-insure losses to better control the costs of medical malpractice insurance, particularly when insurance premiums rise. Self-insured losses are typically estimated by an actuary, who will provide an unbiased estimate of the loss reserves and can also forecast losses for the next policy period for purposes of budgeting and assessing the feasibility of self-insuring, while an auditor will ensure full compliance with accounting and financial reporting standards. The following will provide background information and points to be discussed with the actuary and auditor.

Common Coverages

In a self-insured program, losses are retained by the program up to the self-insured retention amount, while losses greater than the retention amount are the responsibility of the excess or reinsurance policy. A claims-made policy provides coverage for claims that are reported within the policy period; claims reported after the policy expiration date are not covered. Most programs continually purchase claims-made policies for reportings in subsequent years. Occasionally, when a program changes excess carriers, it may purchase a tail policy for prior acts that have yet to be asserted. Physicians that purchase commercial claims-made coverage may also purchase a tail policy when leaving an organization or ceasing to practice.

When following guidance in the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC), most of these same entities record the self-insured liability in their financial statements on an occurrence basis. An occurrence basis is determined by when the incident happens, or occurs, regardless of when it is reported. An occurrence year can also be viewed as the combination of claims-made losses and tail reportings for claims occurring during a year that are unreported. It is important to note that if the physicians are covered on an occurrence basis by an entity (hospital or captive), but the entity purchases claims-made coverage from a commercial carrier for its physicians, then the entity is liable for the tail reportings.

Unpaid Claim Liability And IBNR

The self-insured liability recorded in financial statements has two main components: 1) case reserves on known claims and 2) an incurred but not reported (IBNR) provision for unknown losses. The case reserves are determined based on the most current available information about the known claims while IBNR losses are usually estimated by an actuary. The IBNR losses account for case reserve development on known cases, pure late reportings, reopened cases, and pipeline claims (reported but not yet recorded in the system as a claim). Liability is simply losses that have occurred but are unpaid.

Actuarial Theory

Actuaries utilize models, centered on the theory of consistency and the assumption that the past is predictive of the future, in order to project losses of a program. This includes similarities in reserving strategy, payment philosophy, homogeneous risk management exposures (same types of procedures, same mix of specialties and maturities of physicians), and other program design characteristics. Any intentional change in a program by management should be reported to the actuary to avoid redundant or inadequate estimations.

Financial Reporting Discussion Points

Five key financial reporting items to discuss with both the actuary and the auditor are listed below.

  • Discounting
    Currently, guidance in the American Institute of Certified Public Accountants (AICPA) Audit and Accounting Guide Health Care Entities permits, but does not require, medical malpractice reserves to be recorded in the financial statements on a discounted basis. In order to discount a malpractice liability: 1) the amount of the liability must be fixed or reliably determinable; 2) the amount and timing of cash payments for the liability, based on the healthcare entity’s specific experience, must be fixed or reliably determinable; and 3) the expected insurance recoveries, if any, must also be discounted. If discounted reserves are presented, management must disclose the discount and be able to support the discount rate, which may include 1) the return on investments used to pay claims expected to be realized over the period the claims are expected to mature; 2) a risk-free rate; and 3) highly rated corporate bonds with maturities matching the average length of a malpractice payment, all of which may need to be periodically adjusted for future expectations.
  • Percentile
    Some healthcare entities record malpractice liabilities and fund for these losses with a contingency margin, such as at the 75th percentile, selected by management based on the nature and loss experience of the entity. ASC 954-450-25 provides that the liability recorded is independent of funding considerations. ASC 954-450-30 states that an entity should use all relevant information, including entity-specific data and industry experience, in estimating the liability.
  • Gross vs. net presentation
    FASB Accounting Standards Update (ASU) 2010-24, Healthcare Entities (Topic 954): Presentation of Insurance Claims and Related Insurance Recoveries, requires healthcare entities to report medical malpractice and similar liabilities on a gross basis, separately reporting any receivable relating to anticipated insurance recoveries. One of the outcomes of such gross presentation is to more clearly reflect the entity’s exposure to credit risk from the insurer, as the healthcare entity generally remains primarily liable for payment of claims until the insurer makes payments. ASU 2010-24 must be applied to all policies, including ground-up commercial policies, where the entity has a gross liability even though the net liability is $0.
  • Tail liability
    As addressed in ASC 720-20-25 and ASC 450-20-25, entities that maintain claims-made coverage must accrue for incurred but not reported claims and incidents as of the reporting date if the related loss is probable and reasonably estimable. Some believe the tail should be estimated based on an unlimited basis while others assume a limit based on the entities’ historical loss experience (also known as the “working layer”). Regardless of the limit assumed, the entity cannot assume that claims-made coverage will continue to be purchased in the future.
  • Conservatism in estimates
    Management should understand the amount of conservatism in the actuary’s estimate. Understanding the impact of large losses, where estimates fall within a range, and how actual loss experience is used compared to relying on industry information is important.

Working With The Actuary And Auditor

Management should set a goal to have frequent conversations and in-person meetings with both the actuary and the auditor. Although actuarial analysis and financial reporting can be complicated, it is critical for management to have a full understanding and the ability to effectively communicate its program and story. Finally, management should not be afraid to ask questions of both the actuary and auditor as this often leads to a better understanding for all parties and supports a collaborative working relationship between management, the actuary, and the auditor.

Authors

Richard Frese collaborated with Pat Kitchen in writing this article. Pat Kitchen is an assurance partner in the Chicago office of McGladrey LLP’s Great Lakes health care and not-for-profit practice. Pat leads McGladrey’s health care practice in Chicago and in its Great Lakes region. He has more than 24 years of experience serving a variety of health care organizations, including hospitals and health systems, specialty hospitals, academic medical centers and faculty practice plans, physician practices, and continuing care retirement communities. Pat assists clients with financial statement audits and reviews, compliance audits, accounting consultation, internal control reviews, acquisition-related due diligence, agreed-upon procedures and debt and equity financings.

California Workers' Compensation Self-Insurance Update

Under the new requirements of SB 863, California private (non-public entity) workers’ comp self-insured employers and self-insured groups (SIGs) starting this year are required to submit an actuarial study and an actuarial summary form to the Department of Industrial Relation’s Office of Self-Insured Plans (OSIP). Private self-insured employers’ actuarial submissions are due on May 1 and SIGs are due on April 15. The new actuarial study and summary form must both be prepared by a qualified actuary, as defined by OSIP.

Under SB 863, the method for calculating OSIP’s required security deposits has changed from the old method involving the Estimated Future Liabilities (EFL) formula (multiplied by a factor of 1.35 – 2.00) to the new actuarial methodology. This is considered the “gold standard” by insurers, captives, and other state Guaranty Funds as well. Self insurers are still required to submit their self-insured employers’ annual reports to OSIP as they have always done. This annual report covers the self-insured entity’s open workers’ comp claims by calendar year.

Those 340+ self-insured entities in the Alternative Security Program (ASP) of the Self-Insurers’ Security Fund (SISF) are part of the annual composite deposit program wherein SISF provides OSIP with their security deposit guarantee. They post nothing. Therefore, their security deposits are “notional” since SISF covers them. SISF’s ASP member assessments in July, 2013 will be adjusted (i.e. rebalanced) to reflect the new actuarial standard. Some ASP entities may experience increases or decreases in their annual assessments as a result of their restated open claim liabilities using a uniform actuarial standard. Currently, SISF member security deposits are based on factors of 135% to over 200% of their total EFL.

SISF's excluded entities are those that are required to post collateral (cash, LOC, securities, or security bonds) with OSIP. The 25 active California SIG's already post security deposits based upon an actuarial figure, but in 2013 SIG security deposits — like individual self-insureds — is at the undiscounted “expected level” versus the previous standard of an 80% confidence level.

Each self-insured's actuarial report must include: Incurred But Not Reported (IBNR) liabilities, Allocated Loss Adjustment Expense (ALAE), and Unallocated Loss Adjusted Expense (ULAE), less any credit for applicable excess insurance. Each of these amounts will be reported on the actuarial summary form. There are currently 55 single-entity self-insureds that will now be required to post their OSIP security deposit based upon their 2012 actuarial report submittal.

The new OSIP self-insured actuarial summary form was just placed on the OSIP website on February 14, 2013. (Note: These new requirements do not apply to government entities and JPA's).

The actuarial valuation report of the self-insured's open workers' comp claims must be as of December 31 of the previous year (i.e. 12/31/2012). Actuaries may roll forward liabilities to the December 31 date instead of having a separate study performed if the self-insured already has actuarial studies that use a different valuation date.

It's important to note that with nearly 500 self-insured entities being impacted in 2013 by SB 863 changes, exceptions to the requirement to file an actuarial summary are being developed and will be contained in a regular rulemaking package that should be publically announced within the next four to six weeks. The proposed exceptions will most likely only pertain to self-insurers that have a few open claims or a very low total ELF.

David Axene, a healthcare actuary and an Insurance Thought Leadership author and advisory board member, recommends Jeffrey R. Jordan and Frederick W. Kilbourne as actuaries who would be able to help you with the actuarial study and actuarial summary form now required as a result of the passage of SB 863:

Jeffrey R. Jordan, FCAS, MAAA
Phone: 818.879.1299
Send Jeffrey an Email

Frederick W. Kilbourne, FCAS, MAAA, FSA
Phone: 858.793.1300
Website: www.thekilbournecompany.com
Send Frederick an Email

Additional Resources To Help You Find An Actuary
Society of Actuaries
Online Directory of Actuarial Memberships