Pricing Medical Insurance Individual and Group

1. 1 Pricing Medical InsuranceIndividual and Group Meeting-cum-Seminar on Preparedness Towards De-tariffing in Non-life Insurance Hyderabad, March 14, 2006 Edgar P Balbin, Senior Manager, BearingPoint

2. Setting Premiums for Medical Insurance A. Overview: The rate analysis process B. Individual Medical C. Large Group Medical a. Prospective b. Retrospective c. Administrative services only D. Summary of Key Concepts

3. Overview. Rate Analysis Process The premium rates, plus investment income earned on invested premiums, needs to generate adequate revenues to cover expenses and meet company margin requirements. Revenue and expenses will both depend on the nature and characteristics of the population being insured. Premium calculation must include an analysis of the claims costs plus expenses appropriate to the population to be insured.

4. Individual Medical Insurance Type of Individual Medical Community Rating (uni age, uni sex) Guaranteed Issue (uni-health) Underwritten. rates vary by age, sex, health condition, some applicants are rated substandard, perhaps 10-15% are turned down.

5. Rate Analysis Process for Individual Medical Costs and Expenses are: Policyholder Claims Administration costs Agent Broker Costs Taxes and Fees etc. So in health insurance the actuary spends a lot of his/her time analyzing likely future claims costs levels for the insured population.

6. Rate Analysis Process – 5 step process 1. Look at Past Experience – for claims, premiums and expenses 2. Restate past premium to reflect expected rate levels. 3. Project past claims into the future to reflect trends and changes in policy design. 4. Compare projected versus desired 5. Apply regulatory limits

7. Step 1. Look at Past Experience What Happened? Suppose 2005 results were: Premiums earned 1.08 crore Rs Claims incurred 1.20 crore Rs. Loss Ratio 111% crore = $220,000 and about $1 million purchasing power equivalent.

8. Always use: Earned premium NOT collected or paid. Earned = Collected + change in reserve for unexpired risk (unearned premiums reserve) Incurred Claims NOT paid. Incurred Claims = Paid + increase in case reserves + increase in IBNR

9. If data is poor? Use Data on similar blocks of business Buy a rate manual. Both Tillinghast and M&R have rate manuals applicable to U.S. Miscellaneous Data sources Government Other vendors Sometimes data from other countries might be helpful. (“Rate relativities” by age and sex can be useful. For example, U.S. rates for males increase 4 times between age 20 & 60, and females increase 3 times). Male rates are slightly lower than females at ages 20-55 and slightly higher at 55-64.)

10. Actuarial Help The M&R and Tillinhast manuals apply to U.S. but the actuarial consulting firms have branch offices in other countries. www.soa.org has data on health insurance. World health organization has statistics on many countries.

11. Basic Actuarial Formula Pricing on medical insurance is usually done on Rs. “per member per month” PMPM. For individual insurance the members include family members. (Children might be estimated using 2-3 children per family policy) Formula: Annual Cost for 1000 members = # procedures per 1000 members x average charge per service PMPM = annual cost for 1000 members / 12,000

12. Example of computation. 1000 people average 224 hospital inpatient days per year Cost per day 2500 Rs. PMPM = 224 * 2500 Rs / 12,000 = 46.67 Rs 1000 people average 8750 prescriptions per year Cost per prescription 280 Rs PMPM = 8750 * 280 Rs / 12000 = 204.20 Rs PMPM

13. “Utilization” needs to be defined If you have 1000 members and someone tells you their utilization is 58, what does this mean? 58 members had surgery 58 surgical procedures were performed 58 members submitted their claim 58 claims received

14. Definition of Benefit Amount Some benefits are fixed – so many Rs per day in a hospital Some benefits are tied to charges billed charges allowed charges sometimes another carrier is primary certain individuals are not covered some fees are in excess of the negotiated price

15. Step 2. Restate premium to current level Suppose: average annual premium = 1080 Rs average claim = 1200 Rs average expense = 200 Rs. desired profit = 50 Rs We are short 370 Rs. But 1st six months average premium 480 Rs and 2nd six months average premium 600 Versus the 1200 annualized premium we are short only 250 Rs.

16. Step 3. Project past claims Look at claim trends policy changes population changes durational effects (for small group and individual) “leveraging effect” of deductibles.

17. Step 3. Applying Trend Suppose Claims in Year 2004 are 1000 Rs /policy Suppose claim costs increase at 10%. We want to project claims to Year 2006. From midpoint to midpoint we have 2 years Projected Cost increase = 1.10 ^ 2 = 1.21 or 1210 Rs /policy

18. Step 3. Leveraging effect of deductibles Suppose claim before deductible of 100 Rs was 1000 Rs. After two years claim before deductible is 1221. Suppose deductible remains at 100 Rs. Then costs increase from 900 Rs to 1121 Rs which is 24.55% not 21.1%

19. Duration of a policy Newly underwritten policies are “select” Claim costs increase by duration for same attained age Durational effects very important on life insurance and important on health insurance (Life Insurance: selection last 15-25 years. 1st year select rates could be 30-40% of “ultimate” rates)

20. Loss Ratios are affected by the durational effects Suppose premium = 1000 Rs First year claims = 650 Rs Second year claims = 850 Rs Third year claims = 950 Rs. Fourth year claims = 1000 Rs. The loss ratio first year is 65%, but the company needs to charge 1000 Rs to cover 4th & later claims

21. Step 4. Compare projected versus desired Once rates are determined one can apply them to the existing inforce to see if they cover past claims and projected future claims.

22. Step 5. Apply regulatory constraints Regulatory constraints include Guaranteed renewability Sometimes mandated benefits Most individual health premium are “risk rated” premiums vary by age, sex and health Sometimes Community rated (uni-age, uni-sex) Sometimes Guaranteed Issue (uni health; take the sick)

23. Underwritten Policies or “risk rating” Premiums vary by age, sex and health condition. Premium vary by area and family composition (as in community rating) Many individual health policies are “guaranteed renewable” – price may go up with attained age and medical inflation but the insurer cannot cancel

24. Sample Variation by Age and Sex.Connecticut Premiums .

25. M&R costs – relative costs

26. Community Rating Rates are same by age and sex. Those over 65 are excluded – covered by other insurance. Rates vary by area Rates vary by family composition: single, 2 adults, 1 adult + children, family

27. Guaranteed Issue Policy must be issued to all that apply. Typically pre-existing conditions are covered after 6-12 months. May have greater effect on increasing rates than than community rating Community Rating and Guaranteed issue was employed by some Blue Cross plans in 1930s 1940s Community rating and guaranteed issue do not work well in voluntary markets Younger and healthier just don’t buy policies

28. Example Community Rating and Guaranteed Issue New York City monthly rates

29. Example Guaranteed Issue premiums but vary by age and sex, Aetna New Jersey Basic & Essential Plan

30. More Details on Pricing Underwritten Policies For each sex separately determine the claim cost for each age group Interpolate between the various ages For example, suppose average claim rates are: male, age group 40-49 = 204 Rs /month male, age group 30-39 = 145 Rs/month male, age group 20-29 = 110 Rs /month For age 45 use 204 Rs; age 35 use 145 Rs; age 25 use 110 Rs; For other ages use a linear or quadratic interpolation method.

31. Example of durational factorsPercentage of duration 5

32. Potential rating factors Age Sex Area Medical History Smoker / Non smoker Occupation - be aware of the duration effects

33. Rating Individual medical - usually by attained age Individual disability income – usually by issue age Community rate (uni age, uni sex) younger persons may drop out Guaranteed Issue (uni – health) healthier and younger persons may drop out

34. Substitutional Effectsfrom community rating and guaranteed issue younger persons might migrate to HMO which have gate keepers. younger persons might go for a higher deductible healthier persons may for “association groups”

35. LARGE Group Sometimes defined as more than 100 employees and sometimes more than 50 employees If families are covered, the number of members might be double the number of employees Usually the employer subsidizes the employee – to encourage participation

36. Pie Chart Group Health 1999 data

37. Investment Income Investment income was about 4-5% -- which meant the companies broke even on group health The group health includes group LTD, dental, vision, as well as group medical.

38. Definitions and Goals A. Group Insurance Characteristics B. Key Principles C. Large Group D. Basic Goals for premium rating E. Alternative methods for premium rating

39. A. Group Insurance Characteristics Insurance sold to a group covering its members Most groups are employer groups Rules are established to determine Eligible members to be covered Amounts of coverage The group is intended and expected to produce a cross section of risks Some are very healthy, others are not Employers often screen new employees for health risks.

40. B. Key Purpose of Group Insurance The group was formed for purposes other than insurance A large proportion of the eligibles are enrolled Cost of insurance to each member is low relative to the value Employer groups usually subsidize the cost Transaction costs are minimized

41. C. Large Group Characteristics Groups is of sufficient size that individual medical underwriting is not needed or used. Rating often considers the actual experience (claim cost) of the group. Definition of large group current (US) over 50 employees

42. D. Basic Goals for Pricing the Group Have adequate premium to cover claim cost operating expenses (commissions, enrollment, loss adjustment, taxes) profit Margin Stable rates and predictable gains new lives stabilize the experience Competitive

43. D. Basic Goals con’t. Acceptable rate variations year to year appropriate for group explainable stable over time equitable meet legal and regulatory requirements

44. E. Pricing the Group The initial price set by the insurance company might be based on a census by age, sex, area, even smoking class Renewal rates might be based on experience Very large groups often “self insure” most or all of the risk

45. E. Type of Pricing 1. Prospective 2a. Retrospective 2b. “Dividend” or Bonus Plan 3. Administrative Services only 4. “Defined contribution”

46. E. Pricing – seldom used Community rating (uni age, uni sex) Only variations by benefit levels geographic areas family composition (single, 2 adults, 1 adult and children, family) Problem: anti-selection

47. 1. Prospective Experience Rating The projection of future experience is based on the group’s actual past experience Use to set up rates Past experience might be modified to remove “one shot” claims and for “credibility”

48. 2a. Retrospective Rating The employer is charged a basic premium plus say 120% of claims subject to a minimum and maximum charge Certain claims might be excluded The 20% of claims covers loss adjustment expenses The basic premium covers the cost of the maximum premium charge plus the cost of excluding certain claims

49. 2b. “Dividend Plan” The insurance company charges a premium up front If experience is very good, then the group receives a bonus – also called an “experience refund” or a “dividend” Sometimes the dividend is discretionary with the company Dividend plans are common on workers compensation and sometimes used on group health

50. 3. Administrative Services Only Very large groups might self insure and pay almost 100% of their own claims ASO may be provided by a health insurance carrier Sometimes ASO agreements carrier XL cover and/or provide “catastrophe” to the self-insured employer plan.

51. 4. Consumer Directed Plans Health Reimbursement Accounts (HRA) Health Savings Accounts (HSA) The traditional group plan was a “defined benefit” plan The newer versions are sometimes called “defined contribution” plans

52. 4. HSA policies Under an HSA plan the employer gives each employee some funds which can be used to individual covers buy wellness and diagnostic cover buy a catastrophic plan (2500 to 5000 deductible for an individual) fund a “health savings account” (about $2000) to cover the costs under the deductible.

53. 4. HRA The employer earmarks some funds for each employee Those that do not use medical services are typically allowed to roll the excess over into future years The HRA fund remains with the employer when the employee leaves, while the HSA and the high deductible policy belong to the employ

54. Indian version of HSA A new drug program provides the poor with a passbook in which to buy drugs The government funds the passbook each year The person suffers if he/she is overcharged

55. Tax policy is important Employer group health coverages were deductible by the corporation and not taxable to the employee The advantage (US tax model) is about 50.3% tax rate federal Alternative minimum = 28% tax rate state = 7% Social Security = 15.3% Total 50.3%

56. India taxation Employer deduction (section 36(1)(ib) Some individual deductions 80D, 80DD, 80DDB – maximum limit from 10,000 Rs to 60,000 Rs. Fringe benefit proxy tax applies to certain fringes, some of which have a “health benefit”. Service tax (over 10%) on non life insurance premiums.