Valuation Actuary Symposium September 25-26, Session # 30 PD: Premium Deficiency Reserves for Health Insurance

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1 Valuation Actuary Symposium September 25-26, 2008 Session # 30 PD: Premium Deficiency Reserves for Health Insurance Michael Weilant Norman Zwitter Moderator: Larry Pfannerstill

2 Premium Deficiency Reserves for Health Insurance (with a focus on Long Term Care) 2008 Valuation Actuary Symposium Session 30 Washington, D.C. September 26, 2008 Michael E. Weilant, FSA, MAAA Consulting Actuary Milliman - Tampa Office: michael.weilant@milliman.com Important Notice The information in this presentation is general in nature, is not intended to provide specific accounting or tax advice, and is not intended to represent any specific company. The information cannot be relied upon and must be validated by the actuary to arrive at their own opinion. 2 1/22/2008 1

3 LTC PDR Model The NAIC Health Insurance Reserve Model Regulation states With respect to any block or contract, or with respect to an insurer s health insurance business as a whole, a prospective gross premium valuation (GPV) is the ultimate test of reserve adequacy as of a given valuation date. Such a gross premium valuation will take into account, for contracts in force, in a claims status, or in a continuation of benefits status on the valuation date, the present value as of the valuation date of: all expected benefits unpaid, all expected expenses unpaid, and all unearned or expected premiums, adjusted for future premium increases reasonably expected to be put into effect. Most companies develop a GPV to test for LTC PDRs Start with Stat and then build GAAP 3 Model Assumptions Best Estimate vs. Conservative For GAAP, FAS 60 states No loss shall be reported currently if it results in creating future income. This implies that the assumptions should not be conservative for GAAP purposes. The HRGM states reasonable enrollment assumptions, future rate increases should be reasonable, the interest rate used should be reasonable. Auditors and regulators may want to know how much margin in the assumptions would lead to a PDR situation 4 1/22/2008 2

4 Grouping In the HRGM, LTC is specified as an applicable line of business Considerations when analyzing LTC: - Aggregate all LTC business vs. segregate LTC blocks - Non-acquired vs. acquired (GAAP: HGAAP vs. PGAAP) - Older product generations vs. newer product generations - Home Health Care vs. LTC 5 Projection Period Section 18 of SSAP 54 states that deficiency reserves should be based on the remainder of a contract period The NAIC HRGM states The ending of the time period is more difficult to determine, and requires a substantial amount of judgment in many cases. GPV is typically over the lifetime of the contract or until the volume of in force business is insignificant LTC typically projected for a minimum of 30 years, sometimes as long as 60 to 80 years Need to consider adequacy of projection period for younger issue ages 6 1/22/2008 3

5 Interest Rates In the testing and measurement of a PDR, appropriate interest or discount rate assumptions are needed Important assumption for LTC Ideally model expected yield curve of existing and future assets Considerations - Existing investment portfolio - How market interest rates are likely to change during the projection period - Reinvestment/disinvestment strategies - How investment expenses, default costs, and asset options will be recognized 7 Premium Rate Changes Premium rate changes should be incorporated into the PDR calculation Reasonableness of rate increase assumptions - Does it reflect company rating philosophies - Is it reasonable given market competition - Have the projected increases been filed, are they pending, or are they approved - How far out into the future are the increases projected - Adequacy of projected increase relative to needed increase Consider regulatory rate approval - Consider location (state) of business - Assume less than 100% success on first requested increase - Even lower success on subsequent increases 8 1/22/2008 4

6 Termination Rates Termination rates are a crucial assumption for LTC Considerations - Voluntary lapses - Mortality - Termination due to expiration of benefits - Effect of rate increases - Underwriting (can lower expected mortality) Many companies have practical difficulties splitting total terminations between voluntary lapses and mortality (deaths) 9 Expenses The HRGM states Generally, the expenses considered for a particular grouping should represent a reasonable allocation of all the reporting entity s expenses If other lines of business can cover overhead, the test for a deficiency and the calculation of the deficiency reserves can be performed using only direct costs. The AICPA Audit and Accounting Guide for Health Care Organizations states maintenance costs should include fixed and variable, direct and allocable indirect costs. Special considerations - Start-up situations - Exiting a particular line of business 10 1/22/2008 5

7 Reinsurance The determination of the PDR is usually net of reinsurance with authorized reinsurers Actuaries typically calculate a PDR both gross and net of reinsurance Other considerations - Expenses allowances in excess of actual expenses - Securitizations 11 Federal Income Taxes The HRGM states The deficiency reserve should be calculated on a pre-tax basis; any tax impact related to the establishment of deficiency reserves should be incorporated into the calculation of deferred tax assets/liabilities under SSAP No. 10. A company should consider the tax impact of establishing a PDR versus strengthening the reserve basis 12 1/22/2008 6

8 Coordination with Other Reserves The HRGM states The deficiency reserve is in addition to claim reserves and contract reserves. The deficiency reserve is also in addition to rate stabilization reserves, retroactive premium liabilities, provider reserves, provider withhold or bonus pools, and other reserves not held to specifically make future benefit payments. The AAA discussion paper states There is an interaction among PDRs, contract reserves, and any additional actuarial reserves. Potential future losses that need to be recognized in current liabilities might be recorded in any of these. The concept of PDRs was extended to health products without addressing the interactions. The use of one rather than another of these options will affect current and future earnings patterns and how the reported loss is interpreted There is no single preferred approach, although accounting guidance may prohibit the use of a particular approach in certain cases. 13 Documentation Even if a premium deficiency reserve is not required, the testing and results that determined it was not necessary should be documented Information that should be included in the documentation (regardless of the need for a PDR) include: - Description of the groupings Rationale for the groupings Indication of lines of business combined due to immateriality Basis for change from prior years - All assumptions used in the projections - Discussion of the time periods chosen for the projections Review ASOP No. 41, Actuarial Communications 14 1/22/2008 7

9 Questions? 1/22/2008 8

10 Premium Deficiency Reserves for Health Insurance Norman Zwitter, FSA, MAAA Overview Concepts Assumptions Practical Examples 1

11 Premium Deficiency Reserve Established when future premiums and current reserves are not sufficient to cover future claims and expenses. Accounting Rules Statutory GAAP 2

12 Comparison Statutory to GAAP SSAP No. 54 Solvency Contract Grouping FASB No. 60 Income Statement Contract Grouping Calculation Methodology Contract Groupings Time Period Assumptions 3

13 Contract Groupings Both Statutory and GAAP define as manner of: Acquiring Servicing Measuring Groupings vary by Company NAIC Health Guidance Manual Defined broad groupings of: Comprehensive Major Medical Long Term Care Income Protection Limited Benefit Plans Guidance Only 4

14 Comprehensive Medical Lines Comprehensive Medical Medicare Supplements Medicare Risk (Advantage) Medicaid Dental High Deductible Medical Time Period of Calculation Remainder of contract period If loss over several periods, present value of the period producing greatest deficiency. For example Group losses for 2 years Individual Guaranteed Issue with long term losses 5

15 Other Assumptions Enrollment Premium rate increases Claim trends Risk Sharing arrangements Expenses Interest rate Investment income Practical Examples Health Company in Group Medical and LTC Health Company in Group and Individual Medical Guarantee Issue 6

16 General Considerations Present value broken into calendar year Discounted to valuation date Assume that losses due to overhead or marginal costs XYZ Company Underwriting Gain (Loss) (millions) Group Medical Individual Medical (15) (3) 4 8 LTC (5) (3) (2) 1 7

17 XYZ Company Premium Deficiency Reserve (millions) 2009 Group Medical 0 Individual Medical 0 LTC (10) XYZ Company Considerations Medical Gain on Group Medical greater Individual loss Can combine for determining PDR LTC losses Can not be combined with medical Losses for 4 years or 10 million 8

18 ABC Company Underwriting Gain (Loss) (millions) Group Medical Individual Medical (15) (3) (2) (1) ABC Company Premium Def. Reserve (millions) 2009 Group Medical 0 Individual Medical (16) 9

19 ABC Company Considerations Group Medical Gains in all years Only use current period Individual Period must cover all loss years Medical can cover part of losses 10