A MERICAN ACADEMY of ACTUARIES

Transcription

1 A MERICAN ACADEMY of ACTUARIES Actuarial Solvency Issues of Health Plans in the United States February 1994 Monograph Number Four M O N O G R A P H S E R I E S O N H E A L T H C A R E R E F O R M

2 A MERICAN ACADEMY OF ACTUARIES The American Academy of Actuaries (Academy) is a national organization that was formed in 1965 to bring together, into a single entity, actuaries of all specialties in the United States. In addition to setting qualification standards and standards for actuarial practice, a major purpose of the Academy is to act as the public information voice of the profession. This paper was prepared for the Academy by a 10-member work group. The precise composition of this group was necessitated by the nature of this project and the importance of the work involved. The Solvency Work Group comprises representatives from the entire range of health actuarial practice, including consultants, and not-for-profit and for-profit insurance company actuaries. The members of the Solvency Work Group include: William F. Bluhm, F.S.A., M.A.A.A. (chairperson), Peter L. Perkins, F.S.A., M.A.A.A. (vice chairperson), Janet M. Carstens, F.S.A., M.A.A.A. Alan D. Ford, F.S.A., M.A.A.A. Darrell D. Knapp, F.S.A., M.A.A.A. Leonard Koloms, F.S.A., M.A.A.A. Karl Madrecki, A.S.A., M.A.A.A. Phillip J. Myhra, F.S.A., M.A.A.A. William J. Thompson, F.S.A., M.A.A.A., and William C. Weller, F.S.A., M.A.A.A.

3 A MERICAN ACADEMY OF ACTUARIES TABLE OF CONTENTS EXECUTIVE SUMMARY...1 ACTUARIAL SOLVENCY ISSUES...2 What Are the Risks?...2 Who Takes the Risk?...3 Tools for Managing the Risk...3 Current Solvency Structure of Health Plans...5 When Solvency Safeguards Fail...6 Recommendations...6 Other Solvency Concerns...7 Conclusion...8

4 A MERICAN ACADEMY OF ACTUARIES EXECUTIVE SUMMARY Health insurance reform legislation may increase the risk of insured health care plans becoming insolvent, particularly at the outset of health care reform. There are fundamental changes underway in how the private insurance market operates even without health insurance reform. Such changes raise concerns that threaten the success of health care reform. This monograph addresses those concerns by focusing on the actuarial issues related to the monitoring and regulation of insured health care plan (health plan) solvency. Our intent is to assist policy makers and the public in understanding and dealing with these issues. There are many risks inherent in the insurance market. This monograph explains the risks and discusses how they impact the solvency of health plans. Section I examines the sources of insolvency risk and the development of appropriate methods for better managing insolvency risk in a reformed health insurance environment. Section II describes the many kinds of risk takers in the health care delivery insurance marketplace. There are many tools available to manage and control the risks discussed in the monograph. Section III describes tools to manage risks. Effective regulation of solvency will require a framework with certain characteristics, which are discussed in Section IV. Section V discusses what happens in cases where the standards fail to be adequate. Our recommendations are explained in Section VI. There may be alternative solutions to the policy goals of solvency regulation, but we believe the recommendations in this monograph are sound, practical, and can be implemented within the available time frame. These recommendations are appropriate for most reform proposals today, assuming that there will continue to be a private marketplace for health care financing and delivery. Our major recommendations are: Solvency should be monitored and regulated in the entity that is directly providing coverage, because it is here that actions can be taken to influence capital and the business it must cover. In most reform proposals this would be at the health plan level. Capital standards should depend on the level of risk assumed. Standards of solvency, capitalization levels, and reporting requirements should be applied uniformly across all health plans, and should not vary by type of sponsor or by state. All states should be encouraged or required to adopt minimum capital standards and a standardized financial statement. An annual actuarial report on surplus and rate adequacy should be required of all health plans. In addition to solvency standards, another major area of concern is whether there will be enough capital available in the post-reform market to create the increased capacity called for under some health care reform proposals. This major concern needs to be addressed by policy makers. The Academy s Solvency Work Group concludes that there is great need for uniform solvency standards and uniform regulation in a reformed health care environment. These standards should be used to determine whether a health plan can begin operation and continue operation, and should be based on the level of risk being taken on by health plans. 1

5 A CTUARIAL SOLVENCY ISSUES ACTUARIAL SOLVENCY ISSUES Health insurance reform legislation may increase the risk of insured health care plans (health plans) becoming insolvent, particularly at the outset of health care reform. There are fundamental changes underway in how the private insurance market will operate. These changes raise concerns that threaten the objectives of health care reform. This monograph addresses those concerns by focusing on the actuarial issues related to the monitoring and regulation of health plan solvency. Our intent is to assist policy makers and the public in understanding and dealing with these issues. What Are the Risks? Health plans either guarantee reimbursement for health benefits or, as in the case of HMOs, guarantee to provide care directly. There are a variety of financial risks connected with these guarantees. These include insurance risks, risks inherent in managed care arrangements, business risks, antiselection risks, regulatory and legal risks, and various investment risks. While each risk does not necessarily occur everywhere, they all exist somewhere. (The scope of this monograph does not include solvency issues related to self-insured plans.) Insurance Risks. Insurance risks arise from the insurance process; the pooling of risks and the advance funding of expected average costs. Foremost among insurance risks is that the funding of those risks (be it premiums to an insurer, or contributions to an employer s self-funded program) may be inadequate for the costs that actually occur. This can arise either because the average cost was mis-estimated in advance, or because the cost was accurately estimated but the actual costs had an unusually large number of high-cost claims. Insurance risks may be greatly impacted by health care reform in a variety of ways. For example, limitations on increases in premium levels (premium rate caps) could significantly increase the risk of inadequate income by health plans. Also, unanticipated assessments by health alliances, as called for in some legislation, may be impossible to predict and fund adequately. This issue is discussed further by the Academy Work Group on Health Plan Pricing. Risks from Managed Care. Managed care can involve additional financial risks because of the managed care process. This includes risks regarding the provider network (such as insolvency of the participating providers), and the financial risks associated with provider reimbursement (such as mis-estimation of the amount of care to be provided by particular providers.) Managed care arrangements can also reduce the risk to the health plan by passing part of the insurance risk on to providers, such as through capitated reimbursement arrangements. It is becoming more common for managed care plans to provide rate and performance guarantees to large policyholders. This increases risk to the health plan, since the health plan may not be able to operate within those guarantees. Business Management Risk. While all the risks being discussed could be considered business risks, there are specific financial risks arising from the management of health plans. One basic risk is that management will not have the experience or capability to effectively manage the benefit delivery system. Plan management must choose a strategic plan and effectively combine the various expertises that are necessary to provide health care benefits. This includes marketing and advertising, benefit design, legal issues, accounting and auditing issues, financial and actuarial management, customer relations, claim processing, and government reporting. Another major business management risk is that the capital and surplus levels chosen by company management in the conduct of business will not be sufficient to absorb incursions due to other financial risks. Another major risk to certain types of managed care plans is that the health plan may not be able to attract sufficient covered persons to cover its fixed costs under declining enrollment. This may be a particular problem if the health plan operates in an area served by a single health alliance, and if that health alliance de-certifies the health plan due to its premium rates or for other reasons. Antiselection Risks. Sometimes people are given a choice regarding their health plan. It might be a choice of deductible, choice of a rich plan versus a poor plan, a plan with specific benefits versus another without those benefits, and so forth. Those choices might involve different coverage levels and different premium costs. For example, insureds might have to pay more per month in order to have a lower deductible plan. 2

6 A MERICAN ACADEMY OF ACTUARIES Typically, people tend to be fairly good at evaluating the cost of various choices in light of their probable value. Generally, when people make choices that are financially beneficial to them, the same choice is financially harmful to the health plan. Actuaries refer to this as antiselection or adverse selection. The management of this risk is a major part of how actuaries help benefit providers manage their risks. Regulatory and Legal Risk. One major risk that is currently threatened by health care reform is that of rate caps which may limit the income of health plans. In the absence of an effective mechanism to fund or otherwise pass that risk along to others, premium rate caps may increase the risk of health plan insolvency. Other mandates regarding premiums, benefits, or other contractual provisions may have a similar impact. Involuntary assessments against the health plan can add risk. Assessments can occur from guaranty funds, health alliances, state reinsurance pools, or others. A similar risk is created by cost shifting from Medicare and Medicaid to health plans. There are particular risks associated with mandates and controls promulgated to make a transition from the current market to a reformed market. The American Academy of Actuaries work group on transition issues addresses these issues in a separate monograph. Currently, health plan premium rates are highly regulated in many states. If rate regulation continues under health care reform, there are added risks associated with potentially unreasonable regulatory actions. Investment Risk. The basic formula underlying corporate solvency is: (Assets) minus (Liabilities) = Capital and Surplus A corporation s assets may take various forms. There are financial risks associated with these assets that the assets will not produce income as expected or be worth what was expected. An additional risk is that the cash flows from the asset will not be available at the appropriate time, including being illiquid when needed as cash. Who Takes the Risk? There are many kinds of risk takers in the health care delivery insurance marketplace. This includes providers of benefits and those who contract with those providers. The providers of benefits include insurance companies, health maintenance organizations (HMOs), health service corporations (like Blue Cross Blue Shield plans), physician-hospital organizations, self-insured employers, trusts of various types, health care providers themselves, and possibly new benefit providers (referred to as health plans in the Administration s Health Security Act.) Those entities that contract with benefit providers are also at risk. These include the insureds themselves, reinsurers (who are insurers to insurance companies), and health care providers. The primary purpose of solvency standards is to protect risk takers from the possible catastrophic consequence of those risks that the benefit provider becomes insolvent and is then unable to fulfill its obligations. Of particular concern to regulators is keeping the insureds themselves from bearing the risk of insolvency. Tools for Managing Risk There are many tools available to manage and control the risks previously discussed in this monograph. Sharing of Risks: Historically, the most important tool for managing risk has been sharing the risk with others. Benefit providers can share some risk with insureds through the use of copayments, deductibles, and coinsurance. Such copayments, however, are usually used for their value in utilization management and expense management, rather than for their minimal value as a risk management technique. Risk is shared with health care providers, primarily through reimbursement methods that are designed to share risk. This includes withhold arrangements, capitations, episode-based reimbursement, and others. Risk is shared by reinsurers. Reinsurers take risk beyond the level that providers, insurers, or others are willing to take themselves. They are insurers to the insurers and provide a pooling of the less frequent, catastrophic claims that health plans sometimes incur. One variation of this reinsurance process is the reinsurance risk pools created under some state small group insurance reforms. However, this process is fundamentally different because it is not intended to be self-supporting. 3

7 A CTUARIAL SOLVENCY ISSUES Rather, it is a voluntary pooling of catastrophic risks, needed because of the reform law itself, and it intentionally requires separate, additional subsidies from the marketplace. Risk adjustment is an actuarial mechanism used to reallocate income among health plans based on the risk characteristics of the population each plan is insuring. This is necessary in a community-rated environment or in other environments where insurers charge premiums that do not reflect the characteristics of individuals being insured. For example, if health plans are prohibited from basing premiums on the age of the insureds, then each health plan must choose one average rate which implicitly assumes an average age of its insureds. If a health plan could attract younger, lower-cost insureds, then it could either make more profit or charge a lower premium and be more competitive. Either result would be beneficial to the health plan. The opposite holds true for health plans that end up attracting older, higher-cost insureds. Thus, in absence of a correction mechanism (risk adjustment), insurers would have incentives to attract low-cost risks and avoid high-cost risks the very situation health care reform is designed to avoid. Risk adjustment mechanisms are designed to redistribute premiums among plans with different average costs, charging health plans with low-cost risks and paying health plans with high-cost risks, so that the health plans should be indifferent as to the cross section of population that enrolls with them. An effective risk adjustment mechanism will pay out the same amount of money it collects, so that the average cost to the total population remains unchanged. Further discussion of risk adjustment is included in the American Academy of Actuaries Monograph Number One: Health Risk Assessment and Health Risk Adjustment Crucial Elements in Effective Health Care Reform. Financial Reporting and Monitoring: The National Association of Insurance Commissioners (NAIC) financial statement process, and the associated audit and examination processes have historically been important tools in regulating the solvency of health plans. They have provided a common measuring stick against which all health plans could be measured. They have also provided the mechanism for early warning measures of companies in financially risky situations. As part of the uniform reporting required in the financial statement process, an important element has been the accrual-based nature of insurance financial reporting. This is critical in measuring the financial health of health plans. For example, many claims are not submitted to a health plan for payment until after the reporting period is over, although they are attributable to that reporting period. This is added to claim figures under accrual-based insurance financial reporting, using actuarial techniques. Investment Policy. A health plan s investment policies can be an important tool for management in managing investment risks, including asset default risks, investment return risks, and the risk of mismatched asset and liability maturities. This is particularly true with respect to life insurers that tend to have substantial invested assets. Surplus and Margins. Margins are intended to provide a cushion against adverse circumstances, and thus reduce financial risk. Margins can be included in many aspects of a health plan s operations. For example, the assumptions historically used in setting annual statement liabilities have included margins as a measure of conservatism. Without such margins, the estimate of future payments would have only a 50% chance of being adequate and a 50% chance of being inadequate, which is an unacceptable level of risk. The margin kept by the health plan for unspecified or overall use is called surplus. Some entities (not-for-profit corporations and health service corporations, most notably) call this value free reserves. The appropriate level of capital and surplus needed by a health plan once reform takes place is of critical concern in the current debate. The American Academy of Actuaries Technical Advisory Task Force on health care risk-based capital is currently developing recommendations to the NAIC on this subject. Rate Increases. Typically, health insurance premiums are set for only one year. The ability to adjust premiums annually limits an individual health plan s financial risks. Any restriction that limits the ability to raise rates or the frequency with which rates can be adjusted, including premium caps, will increase a health plan s risk. Licensure Requirement. The regulators of insured health plans today (state insurance departments and health departments) have certain financial and other standards that a health plan must meet before beginning operations. These standards are intended to ensure the probable viability of the plan and generally are quite effective. Usually, separate standards are used for ongoing monitoring of health plans. States have the ultimate threat of removing a health plan s license if it fails to meet those standards. 4

8 A MERICAN ACADEMY OF ACTUARIES Plan Administration. A plan can manage its risk through administrative actions that relate to delivery of the care itself. The most notable example of the managed care techniques available to mitigate a health plan s risk is the practice of large case management. In this situation, the health plan works proactively with the care givers and the covered person to find effective, appropriate, and cost-effective care for that person. Current Solvency Structure of Insured Plans The goal of a solvency structure under health care reform is to provide a regulatory and industry framework to measure, monitor, and ensure that health plans have the financial capacity to provide health care for insureds. To understand the structure needed after health care reform, it is useful first to understand the current structure. There are widely differing solvency structures in place today, depending on the nature of the health plan. For example, a self-insured employer-sponsored health plan is exempt from state insurance regulation by federal law. Such a plan is subject to the financial constraints of federal law only, which are more concerned with avoiding overfunding than underfunding. This monograph assumes that health plans will be treated uniformly and will be regulated as insurance. For that reason, this discussion centers on the solvency standards of insurers. Most of the solvency standards applicable to health plans today are part of the state regulatory framework in many states, for plans subject to these standards. These include: Risk-Based Capital Requirements. Under risk-based capital, a minimum surplus level is calculated for each health plan, based on its unique characteristics. The characteristics used reflect the health plan s insurance products, assets, and their relationship. Various multiples of this minimum surplus level are used to justify differing regulatory actions. Those actions become more stringent at lower capital levels. Such standards exist today for life insurance companies and casualty insurance companies. Work is currently underway by the NAIC and an American Academy of Actuaries Technical Advisory Task Force to develop a unified standard for all types of health plans. Insurance Financial Statements. The NAIC has prescribed a reporting form for the annual reporting of financial information about health plans. Instructions for completing the form and determining the values to be reported are also prescribed by the NAIC. This strict and specific reporting requirement provides consistent, reliable financial numbers for use in monitoring solvency. Currently there are separate reporting standards and formats for life insurers, casualty insurers, HMOs, and health service corporations. Licensing Requirements. As part of the licensing procedure of health plans, most states check the qualifications of owners, directors, and officers. Also, a plan of operations is required, covering projected sales and operating results, management strategies, and sources of capital. Reinsurance Regulations: Such regulations include restrictions on recognizing the value of certain assets arising from reinsurance, licensing of reinsurers, and regulation of reinsurance contracts. Asset Investment and Asset Evaluation. These laws regulate the type, amount, and quality of assets in which health plans invest, and the basis of those assets carrying values. Insurance Regulatory Information System (IRIS). Using information from annual insurance statements, the NAIC has developed a series of ratios intended to monitor the solvency expectations of health plans. This system provides various financial indicators used as early warning of potential solvency problems. Insurance Company Examinations. On a regular basis, state insurance departments audit health plans statements and marketplace activities. This is both a check on the accuracy of the insurance statements and a more indepth solvency review of company operations. (State insurance department examinations are separate from the annual audits of financial statements performed by the insurer s independent auditors.) Valuation Laws. The NAIC has promulgated, and many states have enacted, laws and regulations concerning the premium, policy, and claim reserves required to support various products. These laws and regulations provide a minimum basis to be used in setting these reserves. They also require actuarial certification of reserves. 5

9 A CTUARIAL SOLVENCY ISSUES Premium Regulation. Premium regulations today tend to focus on limiting rate increases. They tend to ignore the adequacy of rates, at least as they are typically administered. This can be a significant threat to solvency, particularly if premium caps are imposed during reform. Two elements of current solvency controls that are not part of the official regulatory structure are: Capital Management Policies. Many companies use risk-based capital modeling techniques to determine their capital needs, which impacts their business activities. In this way, the chosen level of capital becomes a factor which limits the new business capacity for a health plan. Outside Rating Agencies. Many companies are rated by third-party rating agencies on their claims-paying ability or quality of their bond issues. These ratings include an assessment of long-term viability and solvency. They also establish additional measures that management and regulators can use to monitor the health plan s financial strength. When Solvency Safeguards Fail There are a number of elements in current solvency standards that are intended to be utilized if the other standards do not provide for adequate solvency. Guaranty Funds: These are statewide funds that provide protection for members of health plans when those plans become insolvent. They operate by using the other health plans in the state for the costs of the benefits that would otherwise be unpaid. One important consideration regarding guaranty funds is the perverse incentive they create. A particular health plan s management could intentionally underprice its benefits in order to obtain market share, and thus hurt the more fiscally responsible and well-managed health plans. If the underpriced plan becomes insolvent, the other responsible plans are hurt again, by paying assessments to fund the insolvent plan s shortfall. Today, the coverage and treatment of various types of health plans is inconsistent by state and by type of plan. Bankruptcy Priority: Under today s bankruptcy laws, some types of unreimbursed health care costs get priority over certain other unsecured creditors. This may provide some measure of protection at the time of insolvency. Other Protections at Bankruptcy: There are other protections that exist for insureds today. For example, an HMO may purchase an insolvency rider from its reinsurer to cover the cost of benefits to its insureds in the case of insolvency. As another example, New York State requires stop-loss insurers to cover the cost of outstanding claims when the employer policyholder becomes insolvent. Sometimes there are also provider agreements and state laws that force others to extend protections to the insureds of a bankrupt health plan. Recommendations Effective regulation of solvency will require development and adoption of a framework with specific characteristics. While there may be alternative solutions to the policy goals of solvency regulation, we believe the recommendations described below are such a framework. They are sound, practical, and can be implemented within the time frames needed. These recommendations are appropriate for most reform proposals today, assuming that there continues to be a private marketplace for health care financing and delivery. First, we believe solvency is best monitored and regulated in the entity that is directly providing coverage, since it is here that actions can reasonably be taken to influence capital and the business it must cover. In most current reform proposals this would be at the health plan level (what we are calling the insured health plan ), which is the corporation providing the insurance contracts. Next, standards of solvency, capitalization levels, and reporting requirements should be applied uniformly across all health plans, and should not vary by type of sponsor or by state. All states should be required to adopt the same standards. For this to happen, a standardized financial statement with instructions must be developed, since one does not exist today. 6

10 A MERICAN ACADEMY OF ACTUARIES Third, plan management should be required to obtain annually a written report on surplus adequacy and rate adequacy by a member of the American Academy of Actuaries. The report should evaluate the plan s financial status, both currently and under a range of likely future financial conditions. The long-term nature of insurance risks and the increasing volatility of the U.S. economy dictate that the report should include a long-range view of a plan s financial health, instead of just a year-end snapshot. Actuarial reports are particularly important because actuaries are experts in estimating future contingent liabilities. Based on these estimates, actuaries determine whether health plans have adequate reserves which, together with future premium, will cover those future losses. The actuarial opinion on rate adequacy is needed to ensure that in a competitive marketplace, health plans do not intentionally underprice their products to gain market advantage. Without such controls, irresponsible plans could gamble on gaining market share. If they lose the gamble, the rest of the market and the public would pay the consequences. We recommend the following standards for both initial and ongoing evaluation of a health plan: An annual actuarial opinion on the adequacy of rates, the reserve bases and methods used, and the adequacy of surplus in the annual statement. An evaluation of the source of capital, including any debt service to be taken on. An evaluation of the plan s investment policies, including asset liquidity and quality. Fiduciary standards that include prohibition of any self-dealing. Risk-based capital standards that take into account the risks assumed and retained by the health plan. An actuarial evaluation of the health plan s risk adjustment situation, including potential assessments from any applicable risk adjustment mechanism. An evaluation of other assessments that are likely to occur, including expected assessments from state guaranty funds. For ongoing evaluation of health plans, in addition to the above, the following standards are important: Periodic regulatory examinations by the insurance commissioner or other agency of the state of domicile. These are audits of the financial statements and of the market conduct of health plans. Valuation standards comparable to today s standard valuation law, including asset valuation. Risk-based capital standards, to determine levels or trends in capitalization that indicate the need for a regulatory action or oversight. (These standards may be different than the standards required for initial licensing of the plan.) The determination of risk-based capital standards under a reformed health insurance delivery system is a significant undertaking, and will need much debate. As previously mentioned, the Academy has formed a task force to assist the NAIC in its development of such a standard. Other Solvency Concerns In addition to solvency standards, another major area of concern is whether there will be enough capital available in the post-reform market to create the increased capacity called for under some health care reform proposals. If today s self-insured plans and Medicaid population become part of the insured population, and if today s capital standards were required to insure those health plans, this would require many billions of extra capital be added to the system, and would increase the cost of insurance to pay for that capital. Another concern is how the solvency of health plans will be impacted by other entities. These include the health alliances or purchasing cooperatives, reinsurers, health care providers, other health plans in the same service area, health plans in other service areas in the state, other lines of business of a multiline company, and so forth. The financial health of these other entities can cause a financial impact on a health plan. The impact will also depend on the ultimate form that reform takes. 7

11 A CTUARIAL SOLVENCY ISSUES Conclusion The Solvency Work Group believes there is great need for uniform solvency standards and uniform regulation in a reformed health care environment. These standards should be used to determine whether a health plan can begin operation and continue operation, and should be based on the level of risk being taken on by health plans. The greatest risk to health plan solvency under health care reform will occur during the initial years of implementation. In order to minimize this risk the regulatory structure must be reexamined, and careful thought must go into determining whether a guaranty fund is necessary or appropriate. Under certain reform proposals, guaranty funds are an important safety net that should protect consumers and providers in the event of an insolvency. Under other scenarios, guaranty funds are less critical to consumer protection. Appropriate solvency safeguards with adequate oversight and enforcement could greatly reduce the potential for increased insolvency risk. Consistent, national solvency standards are critical to the success of any reformed system. Actuaries serve an important role in the solvency of health plans by providing expertise in solvency management. The Academy continues to be ready and willing to assist policy makers in developing solvency safeguards in a thoughtful and effective way. 8

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