Society of Actuaries

1. Society of Actuaries Update on Health Reinsurance Market October 2002

2. Presenters - Dan Wolak General & Cologne Life Re - Lina Cheung Milliman USA - Michael Frank Aquarius Capital

3. Topics of Discussion • Overview of Reinsurance Market • History • Underwriting • Pricing • Reserving

4. Stop Loss Purchasers • Insurance Carriers - Program Managers • Managing General Underwriters (MGUs) • Third Party Administrators (TPAs) • Marketing Entities/General Agencies • Health Maintenance Organizations (HMOs) • Medical Provider Groups (“Risk Taking”) • Employer Groups (“Self-Funded”)

5. Need for Reinsurance • “Intellectual Capital” • - Entry into new markets • Risk-Based Capital Relief • Regulatory Requirements • Risk Transfer of Catastrophe Exposure • Leveraged Return on Capital • Not a vehicle to “dump loses on ignorant capacity”

6. Types of Reinsurance • Fully Insured Medical Plans - Quota Share - Portfolio Excess – Per Person & Aggregate • Self-Insured Employers - Specific & Aggregate Stop Loss - Written by primary carrier - May be ceded to reinsurer(s) • HMOs & Provider Groups - Per Person Excess of Loss • Specialty Medical Groups/Carve-Outs - Per Person Excess of Loss

7. INSURANCE CO. DIRECT BROKER/GA EMPLOYER The Health Insurance “Food Chain”

8. REINSURER INSURANCE CO. INTERMEDIARY DIRECT BROKER/GA EMPLOYER The Reinsurance “Food Chain”

9. More Reinsurance • May be multiple reinsurers on a program - A designated “Lead” reinsurer - Spreading risk among multiple parties • Reinsurers may purchase reinsurance (retro) - Quota Share - Excess of Loss - Aggregate Stop Loss - Multiple Layers

10. Retrocessionaire • The Reinsurer’s Reinsurer • Far away from the retail action • Not far away from the retail losses • Many expenses may be added to program by time it gets to “retro market”

11. RETROCESSIONAIRE REINSURER INTERMEDIARY INSURANCE CO. INTERMEDIARY DIRECT BROKER/GA EMPLOYER The Retro Reinsurance “Food Chain”

12. …AND SO ON…

13. Traditional Department Functions in Insurance Company • Marketing • Underwriting • Claims - Including medical management and provider networks • Accounting • Compliance • Actuarial

14. Insurance Functions Oversite • Marketing Program Manager • Underwriting Program Manager • Claims Program Manager • Accounting Program Manager • Compliance Insurance Carrier

15. Insurance Functions Oversite (cont’d) • Actuarial • Who is Responsible or Accountable for pricing and reserving? - Insurance Company - Reinsurer - Program Manager - Outside Actuary - Marketing Department • Who Should be Responsible or Accountable?

16. Retail Health PlansOverview of Market • Health Plans challenged to meet financial objectives - Limited “long term” ability to obtain rate increases above inflation - Continual changes in healthcare reform (state and federal) - Pressures to meet investor demands (profit and growth) - Managed Care Plans want to transfer more risk to providers - Insolvencies

17. Retail Health PlansOverview of Market (cont’d) • Employers concerned about cost of health benefits especially during economic hardships • Fully Insured Plans: 15% to 25% Rate Increases • Self-Funded Plans: 30% to 50% Rate Increases

18. History • Profitable Period(Late 1980’s- early 1990’s) • Less Capacity • Purchaser less focused on fees for reinsurance • - Smaller “slice of the expense pie” • Impact: • - High medical trend • - Market accepted high premium trend • - High margin allowed room for mistakes

19. History • Unprofitable Period(mid 1990’s – 2000) • Many reinsurers experienced • specific loss ratios > 125% • aggregate loss ratios > 200% • Major exodus in 1998 & 1999 • Retrocessionaires lose $ in pools (e.g., Unicover) • True-up of historical reserves – Unanticipated Losses

20. History (cont’d) • Unprofitable Period(mid 1990’s- 2000) • Losses were due to a combination of all of the following • - Capacity in mid 90’s significantly greater than the early 90’s • • Market Pressure drives rates downward • - Non-risk bearing entities (e.g., MGUs) were writing for fee income • - Uncontrolled expenses • - The market did not effectively underwrite and price for managed care • - Sold rates were materially below manual rates

21. History (cont’d) • Unprofitable Period(mid 1990’s – 2000) • 1990’s Market Pool Controlled • Stop Loss Facilities on rise • Mergers & Acquisitions “Increased” Capacity • - Special Accident High Excess Programs • - Moved to Low Layers on W.C. Carve-outs • Problems • - Trusted People with the wrong incentives • - Gave away underwriting control or lacked underwriting discipline

22. Companies Exit Medical Reinsurance Arena Company’s In Market in 90’s Out in 2002 • Swiss Re • Sun Life • Transamerica Re • CNA • Lincoln • D&H • General American • Guardian • Life Re • AUL • ManuLife • Phoenix Mutual

23. History – Today’s Marketplace • • Excess Market • - Provides good coverage when purchased for right reasons. • - Challenge: Buyer can know more about risk than Seller. (On Direct side, Seller, i.e. carrier, knows more.) • • Quota Share • - Few Players • - Requires dedicated staffing • • Right Reason to Buy Reinsurance • - Add to Gross result • - Desire Value added &/or technical expertise • - Capacity issues

24. Mergers & Acquisitions • Safeco (Swiss Re/Lincoln & ING) • HCCB (Centris/US Benefits) • Consolidation in MGU Market • Consolidation in the Retail Market • - Consolidations of Large HMOs

25. Development • Turning Point(2001 –2002) • Initial triggers: • Past losses • Economic downturn • Decrease Capacity (Retros & Reinsurance MGUs) • 9/11: • Decreased tolerance for unprofitable, non-core business • Tough ROE expectations

26. Development (cont’d) Hardening Market

27. Seventh Inning Stretch Questions????

28. Underwriting Issues

29. Underwriting Experience Profitability $0 Late 1980’s-early 1990’s Mid 1990’s to 2000

30. Underwriting“Tighter Guidelines” • Program Manager (Stop Loss) • - Minimum premium rate increases • - Minimum case sizes/deductibles • - Better Disclosure on Large Claims & Appropriate “Lasering” • - Defined methodology for experience rating aggregate stop loss

31. Underwriting“Tighter Guidelines” (cont’d) • Program Manager (All Products) • - Client effectively manages and audits its distribution (e.g., TPAs) • • Not everyone is a “preferred” market • - Better Analytics • - Better discounting discipline • • Value of Managed Care • • Preferred Distributions • • Higher Trend

32. Underwriting“Tighter Guidelines” (cont’d) • Reinsurers (All Products) • - Program managers and fronting carriers with “skin in the game” • • Assume risk • Program Manager contractually tied to reinsurer • - Expense Management (Reduced Fees) • Levels of “Food Chain” must provide value • - Analytics and Due Diligence • “Do your homework” • Is data management and reporting in place and is information being used to manage business? • Use Actuarial Intelligence

33. Underwriting“Tighter Guidelines” (cont’d) • Reinsurers (Continued) • - High premium increases/ROE objectives • Ensure pricing reflects profit margins • - More selective in choosing partners

34. Pricing Issues

35. Pricing Trend • CPI-M • - Historical development & outlook • First Dollar Trend • - Charge & utilization trends • - Provider arrangements • Stop Loss Trend • Considerations • First dollar trend • Distribution of claim costs • Benefit Coverage • Deductible level

36. Health Cost Index - Trend Source: Milliman USA - Health Cost Index Report

37. Medical Services CPI vs. HCI Price Component Source: Milliman USA - Health Cost Index Report

38. CPI – Hospital & Related Services Source: Milliman USA - Health Cost Index Report

39. Pricing Trend • Examples of deductible leverage effect • (Milliman 2002 Health Cost Guidelines – Reinsurance, Commercial, all benefits)

40. TrendFall, 2000 and Now Based on blend of several consultant manuals and General & Cologne Life Re analysis.

41. Pricing Large Claims PEPM by Deductible From SF 2002 Session on Large Claims

42. Pricing • Pricing of High Excess has seen rapid trend since 2000. • Drug coverage is now a pricing factor for Specific. • Rate to Manual relationship as a control item. • Monitor Network and Discounts applied. • - Has been used as hidden underwriting discount • Identify costly providers

43. Access to Outside Data???? • Lack of Uniform Industry Data • Stop Loss Claims Study in Early 90’s • Surveys • - Tillinghast • - Apex • - Aquarius Capital (in process)

44. Reserving

45. Reserving • Who Sets Them? • - Direct Writer vs. Reinsurance • Data Challenges • - Availability • - Quality • Technical Calculations • Business Considerations

46. Reserving • Technical Calculations • - Reserving cells • - Reserve Methodologies • Lag Development • Expected Loss Ratio • Definitions of “incurred claims” • - Premium deficiency reserve

47. Reserving • Utilize various reserving methods • - “Chain Ladder” • - By Risk Attaching Month • - Use Actual Rate Increases adjusted by Trend • - Never use Case Reserves

48. Reserving • A&H Reinsurance Reserves set in late 90’s have developed significant adverse development. • Due to: • - Soft market • - Medical trend • - Non-traditional A&H reinsurance coverages • - Issues with Pool Programs (Stop Loss & Workers Comp Carve-outs) • - No certifications of reserves • No actuarial accountability.

49. Okay…so what’s the actuaries’ responsibility for this?

50. Role of the Actuary • More Analytics • Obtain a better understanding of business considerations • More of a need for conservatism today • Stop Loss is a volatile coverage • - management must accept “lumpy” results to be in business.