GHDP 136-20: SOA Illustrative Examples on Experience Rating and Funding Methods

Question 1

Overview of Types of Rating

Answer 1

1. Fully Pooled Method
2. Experience Rating
   ▪ Prospective
   ▪ Retrospective
   * Deficit Recovery
   * Unilateral
   * Bilateral

Question 2

Types of Rating

Answer 2

1. Fully Pooled Method
a. Insurer takes all risk

b. Renewal based on overall client portfolio, not plan experience

c. Use manual rates – no credibility

d. Common for Life, Accidental Death & Dismemberment, Long-Term Disability

2. Experience Rating
a. Policyholder gets benefit or risk of past claims experience

b. Full credibility given to group

3. Prospective Experience Rated (Non-Refund)
a. Past claims, demographics and trend used to estimate future claims to get premium amount

b. Partial credibility given to small groups (rates partially based on manual rates)

c. Medical, Dental and Short-Term Disability usually use experience rating

4. Retrospective Experience Rated (Retention Accounting)
a. Past claims, demographics and trend used to estimate future claims (same as prospective)

b. Main difference – group has financial arrangement (retention agreement)
- Renewal rating process is the same
- Financial accounting process is different
▪ Group rated on own experience AND shares in experience

c. Key Types of Retrospective Rating
- Deficit Recovery Arrangement
▪ If deficit (costs exceed premiums) at end of year, deficit is
recovered with premium increase over given number of years
▪ Insurer risks being left with deficit if policy is terminated

• Unilateral Arrangement
  ▪ If deficit at end of year, insurer assumes deficit
  ▪ If surplus, client gets the surplus
• Bilateral Arrangement
  ▪ If deficit at end of year, plan sponsor assumes deficit and must reimburse insurer for full amount

Question 3

Numerical Examples

Answer 3

• See TIA video lessons for details
• [Note – formulas below are not all specified in the reading, but they are general points of the calculations.]
• Example #1 – Retrospective with Deficit Recovery Arrangement
  o Calculate accumulated surplus/deficit from client perspective and insurer perspective ▪ Pooled Claims and Pooled Premiums removed from Surplus/Deficit calculation
  o Calculate PMPM premium rates for future period
  ▪ Total Adjusted Premiums = Total Experience Premium x (PMPM Experience Premium of
  most recent year / PMPM Experience Premium of year t)
• PMPM Experience Premium (year t) = PMPM Paid Premium (year t) – PMPM
  Pooled Premium (year t)
  o PMPM Pooled Premium (year t) = Pooled Premium (year t) / (12 x Avg. #
  of Members)
  ▪ Trended Claims = Incurred Claims (year t) x (1 + Trend)^(Year – Year t)
  o Target Loss Ratio = 100% - Expenses – Fees – Taxes – Profit
  o RenewalIncrease=(WeightedLossRatio/TargetLossRatio)–1
  o Deficit Recovery Premium = Accumulated Deficit / (Expected # of Annual Members x 24 months)
• Example #2 – Retrospective with Unilateral Arrangement
  o In years where surplus is negative (i.e. there’s a deficit), the insurer covers the deficit
  o Most financials stayed the same
  o Bottom line numbers – insurer profit decreased due to having to cover the one year of deficit o TotalpremiumPMPMlowerbecausenodeficitrecoverypremiumneeded
• Example #3 – Retrospective with Bilateral Arrangement
  o Client assumes the surplus and/or the deficit
  o Most financials stayed the same
  o Highest insurer profit (they don’t take on the deficit amounts)
  o Same premium as Example #2 (still no deficit recovery premium needed)