Claim Reserving in Health Insurance Market

1. Claim Reserving in Health Insurance Market Michael L. Frank Aquarius Capital ASNY Meeting: October 2, 2003

2. Topics of Discussion • Type of Companies with Health Reserves • Overview of Healthcare Market • Reserving Methodologies • Challenges in Industry

3. Types of Companies with Health Reserves • Insurance Carriers • Health Maintenance Organizations (HMOs) • Reinsurance Companies • Retrocessionaires (“Reinsurer’s Reinsurer”) • Captive Insurance Companies • Medical Provider Groups (“Risk Taking”) • All Services or Unique Set of Services • Incl. Disease Management/Capitation Vendors • Employer Groups/Trusts (“Self-Funded”)

4. Overview of the Healthcare Market • Health Plans • Employer Groups • Reinsurance • Disease Management Companies

5. Health Plans in the Marketplace • 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 • Significant Pressure to Limit Margins in Reserves for Bottom-Line Objectives vs Regulatory Need for Adequacy

6. Health Plans & Disease Management Cos. – “Financial Difficulties” • Some Health Plans Going Insolvent • Most Risk Bearing Provider/Disease Management Companies Going Insolvent • Some Large Insurance Companies Exit Medical Lines of Business • Sale of Division • Closing/Running Off Existing Business (or Regions)

7. Current Employer Practices & Impact on Healthcare Inflation • Employers absorbing significant cost increases (annual trend in 14-15% range) • More cost shifting onto employees - All Employees: Higher employee contributions - Utilizers Only: Higher benefit cost sharing to employees (increasing deductibles/coinsurance/out-of-pocket maximums) • These plan changes will result in new trends in experience patterns and reserves

8. Who’s accountable for reserves?

9. Answer The Actuary !

10. Reserving Goals • Convert Paid Claims to Incurred Claims & Determine Ultimate Claims Liability (Report Financial Results) • No Statutory Required Approach • - Method depends on line of business and availability of information • Goals: • - Accuracy • - Efficiencies (Data, Knowledge & Automation improving with time) • - Timeliness (Must Fit in Financial Close Calendar) • - Defensibility

11. Reserving Methodology • Technical Calculations • - Reserving Cells • - Reserve Methodologies • Lag Development (“Completion” Factors) • Expected Loss Ratio • Definitions of “incurred claims” • - Premium Deficiency Reserve

12. Reserving Methodology (cont.) • Types of Data • - Historical Claims & Enrollment Experience (“per capital claims” patterns) • - Utilization Statistics • Bed Days per 1,000 members • Admits per 1,000 members • Critical for completion factors that are not credible

13. Reserving Methodology (cont.) • Borrow Techniques from Other Disciplines • Life (e.g., Medicare Supplement – Active Life Reserves) • Property Casualty (e.g., Stop Loss & Reinsurance Claims) • Utilize various reserving methods • “Chain Ladder” • By Risk Attaching Month • Use Actual Rate Increases adjusted by Trend • Never use solely Case Reserves • Completion Factor Methods (Example)

14. Employer Self Funded 1st $ Medical Claims – Sample Case #1

15. Business Considerationsfor Reserving (& Pricing) • Historical loss experience & medical trend • Sold premium rates & premium trend • Changes in underwriting practices • Written premium volume and expected premium changes in rate setting • Known Claims: Actual & Potential • Available Data: Inclusions/Exclusions (e.g., capitation)

16. Other Considerations • Claim Backlogs • System Definitions & Edits for Incurred & Paid Dates • System Conversions • Claims Paid at Different Pace (Faster?) • Change in Case Mix • Underlying Risk Attaching Business • Immature Lines of Business • Change in Risk Arrangements, Network Contracts or Claims Payors

17. Special Considerations for Disease Management Cos. • Similarities as Health Plans •Availability & Age of Data • Reliance on Partners for Reserving • Understand Experience & Covered Items - Inclusions/Exclusions - Handling of Potential Litigious Items (Contractual Issues) • Unique Characteristics of Claims - Prescription Drugs (Complete Faster) - Post Acute Services (Complete Slower) • Later Discharge/Billing Dates

18. Disease Management Co. – Sample Case #2 (Post Acute Services)

19. Disease Management Co. – Sample Case (Post Acute Services)

20. Completion Factor Approaches for Less Credible Periods • Use of Weighted Average Per Capita Cost for Current Periods & Trend Adjustments • Use Current Utilization & Average Severity Data • Utilization: e.g., Bed Days per 1,000 members • Severity: e.g., Average Per Diems (Cost Per Day)

21. Current Regulatory Impacts • HIPAA Reform of 1996 - Privacy of Medical Information - Compliance Required for 2002/2003 • Business Considerations - Shifting of Resources from Reporting (Data) Initiatives • Develop Consistent Reporting/Claims Codification - “Home Grown” codes to be changed to standard industry codes - Larger business issues for specialty companies (e.g., home health)

22. Reserves and COBRA • Consolidated Onmibus Budget Reconciliation Act • Formula = Maximum of 102% of Fully Insured Equivalent Premium Rate • Different Interpretation of COBRA pricing based on regulatory interpretations • Inclusions of Reserves in Calculation? • Use Incurred Claims vs Matured Paid Claims

23. Disease Management Cos. • Actuarial is ultimately responsible for Reserving • Who’s Actuary is Responsible or Accountable for Reserving? - HMO - Disease Management Co. (if they have one) - Outside Actuary • Who Should be Responsible or Accountable?

24. Reserves Transfers • Health Plans/HMOs passing risk to Provider/Disease Management Companies need to get reserve credit • Provider Groups/DM Cos. may not have best financials so will be require to securitize reserves amounts • Amounts vary on who holds cash/pays claims • Reserve Securitizations • Letter of Credit or Cash Escrow • Financial Guarantees/”Keepwell Agreements” • Reinsurance Transactions

25. Role of the Actuary • More Analytics • Obtain a better understanding of business considerations • More of a need for conservatism today • Management must accept “lumpy” results to be in business.

26. Claim ReservingQuestions or Comments? Thank you! Michael L. Frank Aquarius Capital Phone: (914) 921-3516Fax: (914) 967-9099 E-Mail: michael.frank@aquariuscapital.net www.aquariuscapital.net