Group and Health Specialty Flashcards
Types of antiselection
- External - occurs as the person is first becoming insured. Those with expensive health conditions will seek insurance.
- Internal - occurs while the person is insured
- Durational - occurs as people make decisions about whether to end coverage. Higher cost insureds tend to keep their coverage in force longer.
What is the buy-down effect?
Buy-down effect = upon receiving a rate increase, some policyholders switch to lower cost plans, so the actual premium increase will be less than expected.
What is premium leakage?
Premium leakage = unhealthy individuals are less likely to buy down their benefits. So the claim cost reduction is less than the premium reduction and not enough premium is collected.
Mechanisms for controlling external antiselection:
- Individual underwriting before issue.
- Pre-existing condition limitations.
- Requiring an enrollment mechanism that doesn’t permit anti selection, such as requiring a minimum participation percentage for associates.
Tools used in underwriting process
- Individual application- includes medical history, financial information, and a release to obtain information from third parties
- Attending physician statement- insurer may choose to request APS from any physician listed in the application
- Commercial databases (e.g. MIB)- used to check information provided in the application
- Internal data - such as prior applications and claim databases
- Telephone interviews - can replace the need for requesting third party information, thereby speeding up underwriting process
- Inspection reports - any information obtained through direct contact with the applicant or other related to the applicant
- Lab testing - may detect tobacco, illegal drugs, or the presence of some medical conditions
- Medical exams - due to high costs, rarely used in underwriting for medical coverages
- Tax returns - often the best source of financial information
- Pre-existing condition provisions - used to protect against antiselection
Actions available to the underwriter
- Offer full coverage with no restrictions
- Decline coverage
- Offer coverage at a higher premium rate, either temporary or permanent
- Offer a standard policy with an exclusion rider for a specific body system or condition
- Offer a different policy than the one applied for, such as one in a substandard risk pool
- Offer a different benefit plan than the one applied for, e.g. longer elimination period or shorter benefit period
Criteria for selecting claims to investigate
- timing - do not investigate claims beyond the time limit for rescinding a contract
- conditions - certain conditions can be ruled out as being a pre-existing condition
- size - don’t investigate a claim if the cost of investigation exceeds the cost of the claim
- sentinel conditions or procedures - some conditions are related to others that lend themselves to antiselection (e.g. HIV)
Situations when the CAST model doesn’t work well
- In the first 3-4 durations, when impact of underwriting wear off overwhelms the CAST effects. The solution is to apply additional underwriting selection factors.
- In later durations, where only a fraction of the original population remains. The solution is to choose a higher value of k2 and recalibrate the model.
- At all durations, when a rate spiral is severe and volatile.
Shock Lapse formula
Shock Lapse = [Rate increase - Trend] / [(Rate Increase - Trend) + (1 + Trend) / EF]
Uses of health insurance financial models
Hint: Please read my story featuring actuaries
- Pricing - financial and sales models are used to determine premium
- Reserve calculations and reserve basis evaluation - some reserves such as gross premium reserves are calculated by forecasting models
- Monitoring of results - to validate assumptions, to warn of deviations from expected values, and for resource planning
- Solvency testing - may indicate a need for gross premium reserves
- Financial forecasting - corporations forecast results for various reasons
- Actuarial appraisals - these are studies of the value of a block of business, typically used when transferring ownership
Characteristics of a good model
Hint: ASSER
- Reliable accuracy - must be good at predicting the future. Must also be robust
- Suitability for use - model should produce results it was designed for, without adding unnecessary complications
- Appropriate precision - this relates to how many decimal places should be kept in the values
- Sensibility - the model should reflect a logical construction of what is being modeled
- Effectively communicated - this includes communicating everything necessary to understand and use the model’s results
Steps in building a forecast model
Hint: Sing in an eloquent voice. Don’t cough.
- Choose basic structure. Tools can include spreadsheets, databases, and sequential programs. Model types include asset share models and reserve development models.
- Choose information to be carried. the information needed will depend on the purpose of the model.
- Choose assumptions and building a prototype projection. Starting values and assumptions must be built into the model. A prototype cell is defined, and then projected to the end of the forecast period.
- Extending the prototype - after the prototype cell is built, the model must be extended to other cells which represent the different subsets of the business being modeled.
- Validate the model
- Document the model - allows model to be evaluated by professionals, and makes it easier to modify
- Design output and communicate results - output can be useless unless it is in the context of the question being asked
Model validation methods
- Starting values are compared to actual values for that year
- Year to year changes in the model are compared to actual past historical results
- Model results are checked for reasonableness by people familiar with the business
- Stress testing - analyze how the modeled results behave when some of the underlying assumptions are changed
Assumptions needed for forecasting
HINT: let me call every pretty man
- Lapse assumptions
- Mortality - some models combine mortality and lapse
- Claim costs - best to use actual experience. Trend assumptions are needed to predict future claim costs.
- Expense assumptions - expenses are usually expressed on a per unit basis.
- Profit - ROI, ROE, or % of premium
- Model office assumptions - define he proportion of the block of business represented by each model cell
Bases used as expected amounts for AtoE analysis
HINT: only parrots can talk
- original pricing assumptions - management expectations are often based on this
- profit targets - bottom line that most senior management is interested in
- current pricing - useful for inflation sensitive products
- tabular - for DI and LTC, companies with large amounts of data may develop their own internal tables for comparisons
Types of reserves in disability income insurance
Active life - exists for policies priced on a level-premium basis. Consists of the excess premiums charged in early years to cover the premium shortfall in later years
Disabled life reserve - established to cover each disability claim and its projected length
Factors that stimulate product development for disability income
- Responding to competition - marketplace is product sensitive, so must react to competitors’ product changes
- Consumer demands - as the consumer has become more aware of the need for DI, this product has evolved
- Claims experience - must be monitored on an ongoing basis
- Governmental influence - regulatory and tax changes can also impact disability income insurance
Areas that participate in the product development process
- Sales and marketing - closest to consumer, which results in product ideas competitive info
- Actuarial - determines pricing and safeguards for new products
- Underwriting - determines if new UW approach is necessary
- Claims - determine what new risks and factors it will face in administering claims
- Data processing and systems - new products may require substantial modification to existing systems
- Legal - able alternative approaches to avoid problems with state approval
- Investments - investment returns on new products
Types of disability income claim experience studies
- Actual to expected morbidity - most preferable, but often not enough data
a. rate of disability - # disabled lives per 1000 exposed
b. rate of recovery - # of disabled lives that recover, per 1000 disabled lives - Loss ratios - most studies based on this
a. cash ratio - claims dollars paid out / earned premium
b. incurred claims ratio (preferred) = (claims + active life reserve + claims reserve)/ earned premium
Parameters to consider in a disability income claims or persistency study
Hint: Abis is deep gap. Oo
- Occupation class
- Occupation
- Policy form
- Extra benefits
- Age
- Duration
- Elimination period
- Benefit period
- Indemnity (benefit amount)
- Income
- Geography
- Agent and agency
- Sex
- Mode of premium payment
- Smoking status
- Combinations of above parameters
Considerations in establishing morbidity assumptions for LTC
Hint: If you drink too much RUM, consume too much DIRT, listen to too much RAP like MM, or get the CLAP, you might end up in long term care. Consider that.
- Data sources - insured data is best, but can use population data adjusted for bias and other issues
- Integration of coverages
- Reinstatements
- Transfers
- Coordination with other coverage such as Medicare
- Pre-existing requirement - not going to save much b/c of heavy UW
- Level of care - daily costs vary by type of care
- Area - affects utilization and charges
- Policy options and benefit triggers - richer plans lead to more adverse selection
- Age/ gender - older = more expensive. female = more expensive.
- Marital status
- Morbidity improvement - debateable that population experience improving over time
- UW - strongly impacts experience in early durations
- Marketing - broker and agents
- Reinsurance - arrangements include coinsurance, modified coinsurance, yearly renewable term
- Regulatory considerations - actuary must certify that rates are sustainable under moderately adverse experience
Considerations in pricing LTC
Hint: SMILE MPL
- Morbidity
- Investment earnings
- Expenses excluding profit
- Voluntary lapses
- Mortality - 1994 GAM table is used in NAIC model, but many actuaries feel rates in this table are too high
- Surplus strain - reserves have significant impact on pricing due to conservatism required and long duration of policies
- Profit - takes 7-10 years to emerge
- Loss ratio requirements - most states require 60%
Loss ratio formulas for LTC
In order of lowest LR to highest LR:
- PV of paid claims / collected premium
- PV of discounted incurred claims / earned premium
a. this is the approach required by most states - PV of undiscounted incurred claims divided by earned premiums
a. recognizes investment income on claim reserve - PV of discounted incurred claims + PV of change in policy reserve divided by PV earned premium
- PV of undiscounted incurred claims + PV of change in policy reserve divided by PV of earned premiums
Medicare supplement pricing assumptions
Hint: Mama Pisseo
- Morbidity
- Mortality - not significant, frequently combined w/ persistency
- Persistency
- Investment earnings - credited to various types of reserves held
- Selection factors/ underwriting
- Age and sex distribution
- Smoker vs. non-smoker
- Area factors
- Expenses and taxes
- Other considerations - modal factors and policy fees
Steps for developing critical illness incidence rates
- Start with general population age-specific incidence rates from government sources and research
- Adjust these rates to fit the condition definitions in the policy
- Apply any applicable trends
- Use ratios of insured lives to population mortality to adjust rates from the general population to an insured population
- Use ratios of nonsmoker to smoker mortality to segment rates into nonsmoker and smoker rates
- Use ratios of select to ultimate insured mortality to create select and ultimate rates
- Compare the rates to any available insurance experience and adjust as deemed necessary
Types of critical illness policies
- Standalone - offers coverage only for critical illness
a. Basic - cancer, heart attack, strike, and coronary artery bypass graft
b. Enhanced - 15-20 additional conditions and costs about 30% more - Acceleration - combines coverage for both critical illness and death. Pays the face amount on the earlier to occur of critical illness or death
a. An alternative is partial acceleration. 25-50% of face amount is paid for critical illness, after which the remaining face amount remains in force as death protection only
Definition of critical illness insurance. It pays when…
- Insured is diagnosed with a condition covered in the policy. Diagnosis must be made by a doctor and must be supported by objective evidence
- The condition meets the definition in the policy and is not excluded by any other policy provision
- The insured survives for a specified period (~30 days) after diagnosis
Conditions covered by basic critical illness insurance
- Life-threatening cancer
- Heart attack - may exclude mild heart attacks
- Stroke - requires a measurable neurological deficit that persists for 30 consecutive days
- Coronary artery bypass graft - similar procedures that do not involve grafts are excluded
Conditions in enhanced critical illness insurance
- Multiple sclerosis
- Kidney failure requiring dialysis
- Major organ transplants
- Cardiovascular - heart valve replacement and aortic surgery
- Degenerative: motor neuron disease, Parkinson disease, Alzheimer disease
- Brain: coma and benign brain tumor
- Head: blindness, deafness, and loss of speech
- Body: loss of limbs, paralysis, major burns, and occupational HIV
- Loss of independence (covered by some companies)
Optional product features on critical illness policies
- Return of premiums on death
- Return of premiums on expiry, if policy still in force
- Return of (% of) premiums on surrender. % may increase to 100% over time
- Face amount increasing to keep up with inflation or decreasing to match declining principal remaining on loan
- Partial benefits (10-25% of face amount) payable for some non-life threatening conditions which have been excluded in the policy
- Assistance benefit - provides medical consulting advice for the diagnosed critical illness
- Guarantee that premiums will not change
Tools used for financial management
Informational tools
- Financial Analysis - collect historical information on financial results, mortality, investments, and sales
- Modeling - ability to project future financial results. Can be combined with historical information to help make business decisions.
Risk transfer options
- Reinsurance - can be used for transferring risk and for shifting earnings, capital, revenue, benefits, expenses, assets, and liabilities
- Acquisitions of businesses
Regulatory action levels for Health RBC ratios
- Company Action Level (150-200%) - requires company to submit a corrective action plan
- Regulatory Action Level (100-150%) - allows the commissioner to examine the company and issue an order specifying corrective actions
- Authorized Control Level (70-100%) - allows commissioner to place the company under regulatory control if deemed to be in the best interests of policyholders and creditors
- Mandatory Control Level (<70%) - requires commissioner to take regulatory control of the company
Parts of RBCAC formla
H0 = Asset risk for affiliates, the risk that stock on affiliate may lose value
H1 = Asset risk for other assets, the risk that investments may default or decrease in value
H2 = Underwriting risk, the risk of having inadequate premiums
H3 = Credit risk, the risk of not recovering amounts owed to the insurer
H4 = Business Risk, includes several miscellaneous types of risk, such as administrative expense risk and excessive growth risk
Authorized control level (ACL) capital =
RBCAC / 2
Health RBC ratio =
total adjusted capital / ACL capital
H2 Underwriting risk =
claim experience fluctuation risk + other underwriting risk
H2 claim experience fluctuation risk =
Sum of risk charges for
- comprehensive
- Medicare Supplement
- Dental and vision
- Medicare Part D
- Other
Risk charge = premium * ratio of incurred claims to premium * risk factor * managed care risk adjustment factor
H2 other underwriting risk includes:
Coverages not included in claim experience fluctuation risk such as disability income, LTC, stop loss, and AD&D
Adjustments for rate guarantees and premium stabilization reserves
Features of ERM that distinguish it from traditional risk
Hint: ELF HORN
- ERM creates organization [resilience] in achieving corporate goals
- ERM views the organization [holistically], rather than in silos
- ERM is [embedded] within management framework, rather than being the responsibility of a single risk manager
- ERM provides a common [language] to discuss risks and opportunities
- ERM provides a [framework] for identification and evaluation of potentially harmful conditions and events
- ERM ensures the organization assumes [no more] risk than necessary to achieve goals
Process of typical risk management
- Identify risk - circumstances and events that may cause harm to the organization. This is where most programs fail, because they only focus on known risks.
- Evaluating risk - determine likelihood and severity
- Mitigating risks - applying methods that reduce likelihood or severity of risk events
Reasons why organizations fail to detect emerging risks
Hint: I Fuji
- Uncertain [future]
- Poor [information] about current conditions in organization and environment
- Poor [understanding] of organizational complexity makes it difficult to understand the meaning of the information available
- Poor [judgement] in deciding how to respond to organizational challenges
- Financial [incentives] given to management do not align with other stakeholders
ERM process for managing enterprise-wide risks
- ERM expands the risk profile by searching for unknown risks. Consists of:
a. Developing a detailed description of the business system
b. Constructing the risk hypothesis, which is a structured understanding of the organization’s risk profile and its ability to achieve corporate goals under both normal and stressed conditions - Traditional risk management used to evaluate and mitigate known risks, with ERM ensuring that an integrated response is used
a. Risk evaluation includes developing ranges of the likelihood and severity of potential harmful events
b. Risk mitigation involves deciding what to do about the various potentially harmful conditions - An appropriate risk capital is determined - regulators mandate minimum capital requirements, but insurers should hold additional surplus to reduce the likelihood of regulatory intervention
- ERM follows up with monitoring and oversight by the board of directors and senior management
Possible indicators of emerging risks
- High employee turnover
- Frequent reassignment or replacement of project managers for major initiatives
- Frequent downtime of computer systems
- Frequent manual overrides or intervention required
- Numerous manual processes
- Frequent complaints from internal or external customers
- Significant variance of key indicators from normal or best practice
- Reactive, rather than proactive, approach to problem solving
- Frequency of suprises
Typical information contained in a risk register
Hint: PROM IS A DRAG
- [Description] of risk scenario
- Details of how and when the scenario was [identified]
- Which corporate [goals] the scenario affects
- Description of the [method] used to quantify risk exposure and the time horizon for modeling
- The range of [outcomes] considered
- The outcome of a [reverse stress test], which identifies the conditions that would cause risk capital to be exceeded
- Assessment of likelihood and impact [prior] to mitigation under normal and stressed environments
- Description of mitigation [strategies] and assessment of their effectiveness and cost
- Assessment of likelihood and impact [after] mitigation
- Assignment of [responsibility] for monitoring the risk scenario
- Details regarding [action] plans
Risk mitigation strategies
Hint: ATC
- Risk avoidance - e.g. not expanding into new areas. Most business risks are unavoidable
- Risk transfer - usually through insurance, such as reinsurer
- Risk control - done through performance improvement. E.g. internal policies and best practice methodologies
Characteristics to enter into the risk dashboard for each identified risk
- Brief description of the risk
- LOBs affected
- Gross likelihood
- Gross severity
- Gross risk rating - combination of likelihood and severity
- Control effectiveness - ability of mitigation strategies to reduce likelihood or severity
- Net likelihood after mitigation
- Net impact or severity after mitigation
- Net risk rating - includes effect on capital
- Tolerance - willingness to accept the risk remaining after mitigation
- Net risk rating vs. tolerance
- Action plan status - implementation status of mitigation strategies
Senior management responsibilities for implementing ERM
- Communicating support of the ERM process to the rest of the company
- Maintaining a culture of performance improvement and learning from successes and failures
- Allowing for open discussion of risk
- Providing direction to the risk management committee and CRO
- Determining risk appetites and limits
- Establishing limits of authority for risk assumption
Responsibilities of the CRO
- Being chief champion of ERM process
- Leading the risk management committee
- Directing the ERM process by guiding business units as they prioritize, evaluate, and mitigate risk
- Guiding information collection and performance monitoring
- Testing the perceived risk profile
- Modifying the risk profile and risk models using emerging experience and knowledge
- Ensuring the organization continues to learn from emerging experience and that the risk profile is continuously updated
Benefits of ERM
- Credit agencies may be willing to lower borrowing costs
- Regulators and the board of directors may allow management more flexibility in managing the company
- Management will better understand the business system
- The organization will know how much corporate risk capital should be held
- There will be fewer unknown risks
Common features of ERM
Hint: Mic Mac D
- An assessment of the [context] in which the framework is operating. Includes understanding the internal and external environments and the interests of stakeholders
- Consistent risk [classification]
- Risks to which the organization is exposed must be [identified]
- The risks must be [assessed] and compared to target levels of risk
- A [decision] must be taken on how to deal with risks that exceed targets
- [Measures] to manage risk are implemented
- The process needs to be [monitored], documented, and communicated
Models of risk management
Hint: 3 odd pp(l)
- Three lines of defense:
a. Day-to-day management by first-line business units
b. Ongoing monitoring by the central risk function (CRF)
c. Occasional audits of first-line business units and the CRF - Offense and Defense - says first line business units should take as much risk as they can to maximize returns while CRF should reduce risk as much as possible to minimize losses. Should be avoided b/c 1st two lines are in opposition.
- Policy and policing - says CRF should set risk management policies and then monitor compliance with those policies. But often results in the CRF being too “hands-off”
- Partnership - says the first-line business units and the CRF should work together closely to maximize returns subject to an acceptable level of risk. This may leave the CRF too involved to give an independent assessment of first-line units.
Categories of risks
Hint: SMILED FOR CN
- Market risk - e.g. fluctuations in value of assets held
- Economic risk - e.g. price and salary inflation
- Interest rate risk - risk arising from unanticipated changes in the overall level of interest rates or in the shape of the yield curve
- Foreign exchange risk - the risk when cash flows received are in a currency different from the cash flows due
- Credit risk - default risk
- Liquidity risk - the risk that a firm cannot easily trade its assets or that it cannot raise additional financing when required
- Systemic risk - risk of failure of financial system
- Demographic risk - mortality risk and longevity risk
- Non-life insurance risk - related to incidence of claims and their intensity
- Operational risks - risks that impact the way in which a firm carries on business
- Residual risks - risks that remain once an action has been taken to treat a risk
Types of systemic risk
Hint: clef
- Financial infrastructure - e.g. bank not being able to pay back loans from other banks
- Liquidity risk - if run on banks occurs
- Common market positions - feedback risk is the risk that change in investment’s price will result in further changes in the same direction
- Exposure to a common counter party - the risk that a relatively small failure will cascade through several layers of investors
Types of demographic (mortality or longevity) and non-life insurance risk
- Level risk (life insurance) or underwriting risk (non-life insurance) - the risk that the average level of claims of a particular population will differ from what was assumed
- Volatility risk - the risk of claims differing from assumed due to volatility in a small population
- Catastrophe risk - the risk of large losses due to some significant event (natural disaster)
- Trend risk - risk that claims rates will change unexpectedly from current levels
Types of operational risks
Hint: Bringing rufies to dance clubs might result poorly. Should probably bring lighter pills.
- Business continuity risk
- Regulatory risk
- Technology risk - risk of failure, loss of data
- Crime risk
- People risk
- Bias - type of systemic risk. Deliberate if key risks are intentionally downplayed or omitted. Unintentional if due to overconfidence in one’s ability to complete a difficult task.
- Legal risk
- Process risk - uw and claims handling
- Model risk
- Data risk
- Reputational risk
- Project risk
- Strategic risk
Types of people risk
- Employment-related risks - wrong people are hired or promoted
- Adverse selection
- Moral hazard - people who are insured are less likely to avoid risk
- Agency risk - agents may act on their own behalf
Broad areas in risk identification process
- Risk identification tools
- Risk identification techniques
- Assessment of nature of the risks. Quantifiable risks can be modeled. Unquantifiable risks can often be analyzed by groups that identify them.
- Recording risks in a risk register - should be constantly updated to reflect the changing nature of risks and evolving environment
Risk identification tools
Hint: S CC PP TT
- SWOT analysis- strengths, weaknesses, opportunities, threats
- Risk checklists - used as reference for identifying risks in a particular organization or situation
- Risk prompt lists - similar to checklists, but simply identify risk categories
- Risk taxonomy - more detailed than prompt list, contains description and categorization of all risks that may be faced
- Risk trigger questions - lists of situations or areas in an organization that can lead to risk
- Case studies - can suggest specific risks to consider, particularly if there are similarities to the organization in the case study
- Risk-focused process analysis - involved constructing flow charts for every process used by the organization and analyzing the points at which risks can occur
Risk identification techniques
- Brainstorming - unrestrained or unstructured group discussion
- Independent group analysis - without collaboration, all participants write down ideas on risks that might arise. Then discuss ideas. Anonymously rank risks.
- Surveys - participants are given a list of questions about different aspects of the organization to try to draw out the risks faced
- Gap analysis - consists of a survey that asks two types of questions: desired level of risk exposure and actual level of exposure
- Delphi technique - begins with initial survey of experts who comment on risks anonymously and independently. Followed by subsequent surveys that are based on earlier responses.
- Interviews - individuals are interviewed independently to identify the organization’s risks
- Working groups - comprised of a small number of individuals who have familiarity with the risks identified. They investigate more fully the risks which have been identified already.
Information to include in the risk register
Hint: At the register, I saw a guy buying PILLS, Q tips, a CD, a gift card to Golden CORRAL, and something for STDS.
- A unique [identifier]
- The [category] within which the risk falls
- The [date] of assessment for the risk
- A clear [description] of the risk
- Whether the risk is [quantifiable]
- Information on the [likelihood] of the risk
- Information on the [severity] of the risk
- The [period of exposure] to the risk
- The current [status] of the risk
- Details of [scenarios] where the risk is likely to occur
- Details of others risks to which this risk is [linked]
- The risk [responses] implemented
- The [cost] of the responses
- Details of [residual risks]
- The [timetable] and process for review of the risk
- The risk [owner]
- The entry [author]
Purposes of an internal economic capital model
Hint: HINT E PDF
- Determine how much capital a firm should [hold] to protect it against adverse events
- To price [new products] and decide how to allocate capital across business lines
- To assess the amount of economic capital that should be held over [time]
- To assess the [impact of changes] in investment strategy and capital structure
- To look at how an organization copes in the face of [extreme events]
- To help measure [performance]
- To carry out [due diligence] for corporate transactions
- To provide information on the [financial state] of the organization to a regulator
Considerations for designing an economic capital model
- Must agree on what the model will be used for
- Must agree on what risks will be modeled
- Must decide which approach to use
a. Factor table - requires a certain amount of capital to be held for each unit of a particular activity
b. Deterministic approach - stress test that considers the amount a firm would lose under different scenarios
c. Stochastic approach - use a stochastic, parametric, or empirical model to produce a large number of simulated results - Decide whether the model will be run on an enterprise-wide basis, or if individual models will be used in each business line
- Consider what output is required from the model
Economic capital and risk optimization measures
Risk-adjusted return on capital (rA) = risk-adjusted return / economic capital
Economic income (EIC) = (rA - rH) * EC
Shareholder value SV = EC * (rA - rG) / (rH - rG)
Shareholder value added = SV - EC
Categories of risk for health insurance companies
- Environmental risk
- Financial risk
- Operational risk
- Pricing risk
- Reputational risk
- Strategic risk
Environmental risks for health insurers
- Buyer environment
- Competition
- Economy
- Fraud (external) - fraud by providers or customers
- Legal
- Regulatory and legislative
- Supplier environment - suppliers strengthen or lessen their market position
Financial risks for health insurers
Hint: MRR Advil
- Asset default
- Data - insufficient data to assess a given risk
- Financial [viability]
- Interest rate
- Liquidity
- Model - risk of not reflecting process being analyzed
- Reinvestment risk
- Reserve adequacy - the level of reserves held is inadequate or excessive
Operational risks for health insurers
Hint: For real surgery news, (watch) BCC HD TV
- Billing and collections
- Claims processing
- Contract wording
- Data technology and management - IT system failure
- Fraud (internal)
- Human resources - the firm does not hire the right people to perform needed tasks
- Network management - networks providers give poor service
- Reinsurance
- Sales force being ineffective
- Training - the firm’s employees being inadequately trained
- Vendor relations - not selecting the right vendor or TPA
Pricing risks for health insurers
Hint: DVR TARA M CUM
- Anti-selection
- Authority - premium rates deviate from pricing policies
- Competition
- Data - inadequate, incomplete, or inappropriate
- Financial viability of capitated provided
- Model risk
- Mortality
- Regulatory and legislative
- Reinsurance
10: Trend: inflation - Trend: intensity and severity
- Trend: technology
13: Trend utilization - Underwriting
Reputational risks for health insurers
- Disgruntled policyholder
- Rating agencies - risk of rating downgrade
- Stock analysts - analysts misinterpret information ore are impatient for profits
- Claims adjudication - slow claim payments
- Corporate governance
- Distribution - poor sales tactics destroy reputation
- Fraud - control measures do not properly prevent fraud
Strategic risks for health insurers
Hint: CGI N RAM
- Capital management - company cannot get capital to support its strategy
- Growth is mismanaged
- Incentives - misaligned with corporate strategy
- Management failure
- Mergers and acquisitions - acceptable merger and acquisition candidates are unavailable
- Network management - company is unable to contract with providers
- Reinsurance - coverage is not available at an acceptable cost
Financial uses of reinsurance
Hint: Financial challenges sometimes good business reinsurers
- Increase financial capacity - enables the insurer to write larger amounts than otherwise
- Catastrophe protection - prevents financial
destabilization from a single catastrophic claim - Stabilize earnings - strategies include:
a. Control exposure to loss on each individual
b. Control of aggregate losses
c. Managing the mix of business
d. Increasing the spread of risk - New business growth - can help to grow a new product line quickly
- Improve balance sheet position - can move some liabilities to reinsurer’s balance sheet
- Reinsurance as a guarantor - reinsurer is ultimately responsible for its share of the business
- Retrocessional reinsurer - reinsurance companies also use reinsurance for the same reasons just listed
Non-financial uses of reinsurance
- Increase intellectual capacity - useful for a new line of business or a small existing one
- Joint ventures - situations where reinsurance is used to achieve marketing cooperation
a. Fronting - because the reinsurer is not licensed as a direct insurer, a ceding company sells the product and then cedes nearly 100% to the reinsurer. Not allowed in NY.
b. Lack of ceding company commitment - a direct writer may be selling the product only as an accommodation product, so it would cede nearly 100% of th erisk to a company with more expertise with that product
c. Mutual interests - if both companies want to sell the product and be involved, could use coinsurance - Acquisition - the buyer assumes the obligation of the seller through an assumption reinsurance agreement
Limitations of reinsurance
- Cannot make uninsurable risk insurable
- Cannot make an inadquate premium adequate
- It can be misused - reinsuring too much risk results in giving away profits
- It can be used for improper and illegal purposes
Types of reinsurers
- Reinsurance companies - offer products and services to other insurance carriers
- Insurance carriers - some have reinsurance divisions specializing in various products
- Reinsurance facilities or pools - a group of companies that band together to accept risk
Methods of reinsurance risk transfer
- Facultative reinsurance - each risk is submitted the reinsurer for acceptance or rejection
- Automatic or treaty reinsurance - all business meeting certain underwriting rules is accepted by the reinsurer
Types of reinsurance programs
- Proportional reinsurance - a fixed percentage of the ceding company’s risk is reinsured. Coinsurance or quota share is most common form. The reinsurer receives a fixed percent of the premium less a ceding allowance, or decides the premium to charge to cover its portion of the risk.
- Non-proportional reinsurance - the ceding company is reimbursed if a loss exceeds a certain amount. Includes excess of loss and aggregate excess (specific and aggregate stop loss).
Ceding program considerations in designing a reinsurance program (reinsurer qualities)
Hint: SUFFE(R)
- Financial condition and continuity
- Flexibility in terms of arrangement
- Experience and ability - the reinsurer’s own portfolio should be profitable
- Services provided
- Underwriting
Ceding program considerations in designing a reinsurance program (other than reinsurer qualities)
Hint: RAD PB
- Rates and terms
- Administration costs - will be affected by retention amount and minimum ceding amount
- Degree of management involvement - should be reduced if the reinsurer is knowledgeable and helpful
- Profits lost to the reinsurer
- Business relationships - must have good faith on both sides
Reinsurer considerations in underwriting proposed business
Hint: PUF BAM MAP
- Ceding company [business objectives] like growth and profits and how they affect reinsured business
- Ceding company [management] - strong and experienced? What is appetite for risk? Attitudes towards reinsurance?
- Reinsurance [program objectives] (stable earnings, access to services, minimize risk of new product)
- [Financial condition] of the ceding company - should be well capitalized with good ratings
- [Administration] - will premium and claims be promptly reported, are procedures always followed
- [Underwriting] - does ceding company have competence to underwrite the business
- Claim [adjudication] - what is the claim payment philosophy, does claim processing reflect policy provisions
- [Marketing] and sales - is the marketing strategy focused, does reinsurer know the market
- Expected reinsurer [profit] - will the reinsurer have an adequate spread of risk and adequate premiums
Keys to reinsurer success
- Rating - re-rate and renew business periodically
- Expertise - must have uw, claims, and pricing expertise to provide services and evaluate the direct company
- Client mix - a large number of average-sized ceding companies will produce a better spread of risk than just a few large claims
- Credible size - quote only coverages that fit reinsurer’s marketing niche
- Consistency - must exercise sound risk management techniques, throughout market ups and downs
Uses of reinsurance for group medical benefits
- Reinsurance for a ceding company - may be done through either quota share reinsurance (ceding percentage between 20 and 100%)
- Reinsurance for the employer’s risk under a self-funded medical plan. Done through stop loss plans. Most reinsurers require both specific and aggregate stop loss.
Types of reinsurance for disability income insurance
- Automatic excess - direct writer retains first $X of benefit per individual. Preferred by large insurance
a. variation 1: extended elimination period - ceding company retains all the risk for the first n months, so retention is based on a period of time
b. variation 2: specified dollar amount - reinsure cumulative individual losses in excess of a specified dollar amount. This is not used much. - Facultative (quota share) - favored by small and medium-sized companies who need the reinsurer’s services and expertise. The reinsurer provides net rates to which the ceding company adds its expense loads.
Long term care characteristics that make it desirable to use reinsurance
- Low frequency, high severity
- Insured claim cost data is scarce
- It is a new product - benefit structure is still evolving and liberalizing
- The claim cost slope is steep - will delay the emergence of actual experience for decades
- The future direction of claim costs is debatable
a. Some expect costs to increase as medications keep sick people alive longer
b. Others expect costs to decrease due to cures for diseases such as Alzheimer’s - The product is capital intensive - steep claim curve leads to substantial active life reserves
- Reinsurers have an advantage - they have access to numerous direct carriers and thus have the opportunity to help all clients avoid past mistakes
MCCSR is the sum of
Hint: MCCSR = AMMFISL
My car can’t start regularly. A mechanic must fix it sometime later.
- Asset default risk (C-1)
- Mortality, morbidity, and lapse
- Changes in interest rate environment (C-3) risk
- Segregated funds risk
- Foreign exchange risk
Minimum total ratio for life inurers
120%, with supervisiory target of 150%
Majority of the capital held should be in tier 1. Minimum Adjsuted net tier 1 ratio is 60% with a supervisory target of 105%
Components of gross tier 1 capital
Hint: SPIN, FLIP, LP
- Common [shareholders’ equity]
- Participating accounts
- Qualifying non-cumulative [perpetual preferred shares]
- Qualifying non-controlling [interests in subsidiaries] arising on consolidation from tier 1 capital instruments
- Qualifying [innovative tier 1 instruments]
- Non-participating accounts
- Accumulated [foreign currency translation adjustments] reported in Other Comprehensive Income
- Accumulated net unrealized [loss on available-for-sale equity securities] reported in OCI
- Accumulated changes in [liabilities] reported in OCI under shadow accounting
- Accumulated defined benefit [pension plan] remeasurements reported in OCI
Net tier 1 capital = Gross tier 1 capital minus the following
- Goodwill
- Intangible assets in excess of 5% of gross tier 1 capital
- Adjusted negative reserves calculated policy by policy and negative reserves ceded to unregistered reinsurers
- Cash surrender value deficiencies calculated on a grouped aggregate basis
- Back-to-back placements of new tier 1 capital between financial institutions
- Each net defined benefit pension plan recognized as an asset on the insurer’s balance sheet net of any associated deferred tax liability
Adjusted net tier 1 capital = net tier 1 capital minus:
50% of deductions/ adjustments
Deductions from tier 2 capital in excess of total tier 2 capital
Types of tier 2 capital
2A: Hybrid capital instruments (hybrid equity and debt)
2B: limited life instruments
2C: other capital items
Net tier 2 capial is total tier 2 capital minus
50% of deductions/ adjustments
Back-to-back placements of new tier 2 capital between financial institutions
Characteristics of the ideal insolvency process
- Good relationships between the task force and the receiver
- Good policy records
- Few uncovered obligations
- Facts and solutions are clear and agreed on by the receiver and task force
- Joint solicitation of proposals and negotiation of an assumption reinsurance agreement with strong reinsurer
- No resistance to a court order of liquidation with a finding of insolvency
- Prompt regulatory approvals of agreements among the receiver and the affected guaranty associations
- Quick closing to move policyholders to a solid insurer
- Guaranty associations’ obligations fully satisfied at closing
- Task force involvement in asset recovery
Major steps in ERM process
- Risk identification and classification - classify risks into categories, such as market risk, credit risk, and operational risk
- Risk measurement and prioritization - includes identifying unfavorable outcomes and the likelihood they will occur
- Risk management and aggregation - involves establishing risk tolerance levels and developing action plans relative to the risks that have been identified
Definition of ERM
ERM is the discipline by which an organization in any industry assesses, controls, exploits, finances, and monitors risks from all sources for the purpose of increasing the organization’s short and long term value to its stakeholders.
Hint: FACE M
Processes included in the ERM control cycle
Hint: ICE LAMB
- Risks are identified
- Risks are evaluated
- Risk appetites are chosen
- Risk limits are set
- Risks are accepted or avoided
- Risk mitigation activities are performed
- Actions are taken when risk limits are breached
Considerations when performing services related to risk evaluation
- Information about financial [strength], risk profile, and risk environment of the organization
- Information about the organization’s risk [management] including
a. Risk [tolerance]
b. Risk [appetite]
c. [Components] of the organization’s ERM control cycle
d. [Knowledge] and experience of management and the board of directors regarding risk assessment and risk management
e. Actual [execution] of the organization’s ERM control cycle - The [relationship] between the organization’s financial strength, risk profile, and risk environment and the organization’s risk management profile
- The intended [purpose] and uses of the actuarial work product
Hint: smacker pt
Required disclosures for communications subject to ASOP #46
Hint: ME CARES
1 .Results of [economic capital model], their intended use, and any known limitations of the model
- The results of the [stress and scenario tests], their intended use, and any known limitations of these tests
- The [methodologies] and sources of information for identifying and evaluating emerging risks
- Any material [changes] that have been to the system, process, or methodology since previously used
- Significant [assumptions] and their dependencies and statistical distributions
- The [risks] included in the risk evaluation and their relative significance, and risks not included and why they are not included
- Whether and how the modeled future [economic conditions] have been reviewed and tested for reasonability
Circumstances that lead to a proper fit between and seller and buyer of a block of business
- Non-core business for seller, but core for buyer
- High administrative expenses for seller
- Poor management by the seller
- Seller’s reputation prevents effective corrective actions (such as high rate increases)
- Conservative reserves - the seller may have extra conservative reserves and unwilling to release them
- Regulatory fire sales - buying this type of business could be risky but the buyer may be able to get a very good deal
The role of the actuary in the merger and acquisition process
Hint: Darma
- Being an active member of the [due diligence] review team
- Interviewing [management]
- Interfacing with [regulators], reinsurers, and investors
- Acting as an [advisor] to management regarding the M&A process
- Creating an actuarial appraisal
Code of professional conduct criteria for an actuary to perform appraisal services
- Actuary’s ability to act fairly is unimpaired
- There has been disclosure of any conflict to all principals whose interest would be affected
- All such principals have expressly agreed to the performance of the actuarial services by the actuary
Steps for calculating the value of an inforce business
Hint: please see a psychiatrist
- Develop a [projection model]
a. Windshield appraisal model - appropriate where time is very limited and data is scarce
b. Intermediate detail model - these often result from a lack of detailed data
c. Full-blown appraisal model - the preferred approach when there is appropriate time and data - Determine [starting in force value] - should reflect impact of actions already taken
- Create a specific set of [assumptions] that reflects reasonable expectations for the business
- Perform the [projection] by applying the starting values and assumptions in the model
Items included in the actuarial appraisal report
Hint: stupid little bitch violated my vagina and it’s partially dead
- Description of [scope] of assignment
- Reliances and [limitations] the actuary has placed on his or her work product
- A description of the [business] being valued
- Actuarial appraisal [value]
- [Methodology] and assumptions used
- The [validation techniques] and results
- [Adjustments] made when valuing net worth
- How federal [income taxes] were considered
- The annual [projection results]
- Disclosure of any [deviations] from actuarial standards of practice
Challenges in determining the value of an insurance company
Hint: Some people in CA are challenged and think NIRD is a word. To this, I say RRR.
- Long [duration] of liabilities
- Sensitivity to [interest rate fluctuations] and the performance of capital markets
- Subjective art of loss [reserving]
- [Cyclical] nature of insurance
- Impact of [reinsurance recoverables]
- Challenges associated with [non-market competitors], such as state funds
- Varying state and sometimes federal [regulation]
- Impact of statutory [accounting] on operational decisions
- Influence of [rating agencies]
Techniques used by investment bankers to determine the value of a company
- Comparable company analysis - the value of the company is estimated based on the values of a peer group of comparable companies
- Comparable transaction analysis - the value is estimated based on results of recent insurance mergers that are similar
- Discounted cash flow analysis - the projected cash flows and terminal values are discounted to a net present value using the WACC rate
Distributable cash flow =
after-tax earnings - increase in required capital
WACC =
rD * %D + rE * %E
where % based on market value
Components of an actuarial appraisal value
- Adjusted book value - this is the net worth of the insurance company on a statutory basis, adjusted for the value of miscellaneous items not captured elsewhere
- Value of inforce business - equals the present value of future profits arising from business that is on the books as of the valuation date. An adjustment is included to reflect the cost of capital.
- The value of future business capacity - this equals the present value of future profits arising from business that is expected to be written following the valuation date. An adjustment is included to reflect the cost of capital.
Uses of an actuarial appraisal
Hint: B Vamp
- Help [value] the company - potential buyers will make adjustments based on their internal views
- Form the basis for [alternative accounting methods] for cross-border transactions
- Can be adjusted to calculate [pro forma earnings] and to establish the opening purchase of GAAP [balance sheet]
- [Measure ongoing performance] after the acquisition
Assumptions needed for actuarial appraisals
Hint: MOMP DIRT
- Mortality - typically based on company experience compared to industry standard
- Morbidity - also based on company experience
- Persistency - lapse assumptions and any shock lapses should be considered
- Investment returns and spreads - consider expected investment returns, reinvestment rates, and interest rates credited on insurance policies
- Operating expenses - this assumption should be based on various approaches (most commonly based on target unit expenses plus an unallocated expense)
- Discount rate - seller typically gives a range of reasonable rates instead of a specific rate (the CAPM model may be used to determine this rate)
- Cost of required capital - the company will have an opportunity cost associated with setting aside capital to comply with required capital regulations
- Taxes - the actuarial appraisal should reflect a deduction for federal income taxes
Components of the adjusted book value of an insurance company
Hint: CAN SLAM ID
- Capital and surplus - includes statutory capital stock, contributed surplus, and retained earnings
- Asset valuation reserves (AVR) - this liability is part of surplus and is allocated to the lines of business
- Interest maintenance reserve (IMR) - this liability represents past interest-related capital gains not yet amortized into income
- Deferred tax asset - the admitted portion of the statutory deferred tax asset is deducted from adjusted book value
- Non-admitted assets - the realizable value of assets that were non-admitted for statutory purposes, if they will contribute to earnings over time
- Surplus notes and other debt - a reduction is appropriate for any debts owed to another party
- Mark-to-market on assets allocated to adjusted book value - this component reflects some riskier assets that are allocated to adjusted book value
- Adjustment in the value of certain [admitted assets] that the user values differently than the reported statutory value
- Adjustment in the value of certain [liabilities] that the user values differently than the reported statutory value
Approaches for using reinsurance to sell a block of business
Hint: AIM
- Assumption reinsurance - contracts are transferred from the seller’s books to the buyer’s books. Policyholders must be notified, and some states required policyholder consent to transfer the policy
- Indemnity coinsurance - the financial interest is transferred to the buyer, but the policy stays with the seller. Seller remains in the middle of future transactions and policyholder doesn’t need to be notified.
- Modified coinsurance - similar to indemnity coinsurance, except that the assets backing the liabilities remain with the selling company
Techniques for estimating property and casualty loss reserves
- Loss development method - same as development method for health insurance
- Expected loss method
a. Expected loss = forecasted exposure * expected ultimate loss rate
b. Expected loss = earned premium * expected loss ratio - Bornheutter-Ferguson method:
For each accident year, Reserve = [1 - (1 / paid loss dev factor)] * expected loss from the expected loss method
Diagnostic tools for evaluating claim reserve
- Assessing the convergence of the various loss reserving techniques - when estimates from various techniques diverge, it may be a sign that there has been a change in claim development
- Analyzing various reserving statistics - such as development triangles of settlement rates, and development patterns of average size claim
- Testing the runoff of prior reserve estimates
Formulas for market value of equity
- Market value of equity = market value of assets - market value of liabilities
- MV(E) = franchise value + MV(tangible assets) - PV(liabilities) + Put option value
For a block of business, embedded value =
EV = PV(after-tax profits) + cost of capital
For a block of business, cost of capital =
COC = PV future tied capital releases minus increase + PV after-tax investment income earned on tied capital - tied capital
PV future tied capital release minus increase = -PV increase in locked-in capital
For company as a whole, embedded value =
EV = PV after-tax profits + cost of capital + tied capital + free capital
Hint: ACTF
Uses of EV for block of business
- To set a value on a block of business for sale or purchase
- As part of the calculation of the value of a company. The company’s value would also include the value of the future new business
- To ensure that new business is sold is generating an increase in value
- To determine compensation for sales staff
- To measure the impact of specific management actions on the long-term value of the company
Definition of embedded value
- A calculation of the value of a block of business, based on the present value of surplus distributable to shareholders
- Is based on current in-force business only (not on new business)
- Equals the value of in force business plus the value of free capital. Free capital is the capital in excess of regulatory capital requirements (locked-in capital)
Profits to shareholders method EV =
EV = free capital + PV(profits to shareholders)
Profits to shareholders method Profits to shareholders =
Profits to shareholders = after-tax profits + after-tax investment income on capital - increase in locked-in capital
Profits to shareholders method After-tax profit =
A-t profit = premiums + investment income - benefits - expenses - increase in statutory reserve - tax on income
Cost of capital method EV =
EV = free capital + locked in capital + PV(after-tax profits) - PV(cost of capital)
Cost of capital method COC =
COC = h * locked-in capital - after-tax investment income on capital
EV(t+1) =
EV(t) + normal increase in embedded value + value added by new sales - dividends paid + unexpected change in embedded value
Normal increase in embedded value =
(EV(t) - free capital) * (1+h) + free capital * (1 + i)
i = after-tax investment income rate
Value added by new sales =
PV(future after-tax profit on new sales) - PV(future cost of capital to support new sales)
Risk factors that indicate whether a person may have high claims
Hint: MILE F
- Inherent risk factors, such as age, sex, and race
- Medical condition-related factors, such as diaetes or cancer
- Family history for inheritable conditions
- Lifestyle risk factors, such as smoking, lack of exercise, and poor nutrition
- External risk factors, such as industry, location, and education
Types of medical management interventions
- Care coordination - focuses on system. Includes case management, discharge planning, and in-hospital care coordination
- Condition management - focuses on patient. Includes disease management and risk factor management.
- Provider management - Includes provider profiling, pay-for-performance, and accountable care organizations
Areas where condition-based models are used in healthcare financial applications
- Program management - identifying high-risk individuals, financial modeling and resource allocation, and program evaluation
- Provider or health plan reimbursement - normalizing populations to pay providers or plans for the risks they accept and to evaluate provider effectiveness. Profiling providers to assess quality and efficiency
- Actuarial and underwriting functions - pricing health plans, underwriting groups, and projecting future claims costs
Types of predictive models that are not based on medical conditions
- Age/ sex - rates based on average age/ sex factor of the members in the group
- Prior cost - prior year’s claims are used to project future costs. Reasonably accurate for large groups, but not small groups
- Combinations of age/ sex and prior cost - often used for rating smaller groups