Objective 2 - Manual Rates

Question 1

Components of gross premiums

Answer 1

1. Claim costs
2. Administrative expenses - includes the costs of deigning, developing, underwriting, and administering the product, as well as an allocation of overhead costs. Frequently much higher in the first year than in renewal years.
3. Commissions and other sales expenses - include special bonuses, incentives, and advertising. Generally expressed as a percentage of premium.
4. Premium tax
5. Other taxes and assessments - includes federal and state income taxes and new assessments due to the ACA
6. Risk and profit charges - depends on the degree of risk involved, the amount of capital allocated to support the product, and the expected return on the capital
7. Investment earnings - typically credited based on assets held

Question 2

Considerations in developing administrative expense assumptions

Answer 2

1. How expenses are allocated to the product - allocation methods include
   a) Activity based allocation - distributes expenses according to some measure of use (eg. actual postage expenses can be charged to the function that generated the mail)
   b) Functional expense allocation - determines how expenses are split by line of business for new and renewal business (done by surveying employees to determine how time is spent)
   c) Multiple allocation methods - a combination of the other two methods
2. How administrative expenses should be allocated to groups - should differentiate between first year and renewal expenses. Various allocation bases exist (see separate list)
3. What the competition includes as expenses in its pricing - adjustment may be needed to match what others are doing in the marketplace

Question 3

Types of bases used for allocating expenses

Answer 3

1. Percent of premium
2. Percent of claims
3. Per policy
4. Per employee (certificate)
5. Per claim administered
6. Per case (some expenses are charged directly to the case for very demanding groups)

Question 4

Common rating characteristics included in manual rates for group health insurance

Answer 4

1. Age
2. Gender
3. Health status
4. Rating tiers (see separate list)
5. Geographic factors
6. Industry codes
7. Group size
8. Length of the premium period

Question 5

Common rating tiers for group health insurance

Answer 5

1. One tier: composite
2. Two tier: employee only, family
3. Three tier: employee only, employee and one dependent, family
4. Four tier: employee only, employee with one dependent, employee with children, family
5. Five tier: employee only, couple, employee with child, employee with children, family

Question 6

Considerations in developing a manual table for life insurance

Answer 6

1. Two approaches can be used:
   a) Manual premium tables - calculate the manual premium rate, then adjust for group size. This adjustment will reflect the margin, profit, and expenses appropriate for the group size, relative to the averages built into the table
   b) Manual claim tables - calculate the manual claim rate, then add the appropriate margin, profit, and expenses
2. Data sources - could use SOA studies, industry mortality tables, population statistics, or own company experience (which is the best source, if credible)
3. Changes in mortality - expected future mortality improvement should be reflected
4. Reinsurance - the net cost of reinsurance should be factored into the claim table or expenses
5. Conversions to individual life policies - these create severe antiselection, which should be reflected in the manual rates
6. Manual adjustments are made for group-specific traits (see separate list)
7. Rates for the group are based on age and gender mix, but groups typically end up charging a composite rate to all employees

Question 7

Uses of general population data for pricing life insurance

Answer 7

1. Estimating annual improvements in mortality
2. Determining ratios of mortality by age bracket
3. Comparing male and female mortality
4. Developing rates for the non-working population (the very young and the very old)

Question 8

Manual claim table adjustments for group life

Answer 8

(could also be referred to as group rating characteristics for life insurance)

1. Disability factors - an adjustment is needed if a group has a different waiver of premium approach than is assumed in the manual rates
2. Effective date adjustment - an adjustment is needed if the central date of coverage is not July 1
3. Industry factors - usually based on SIC codes
4. Regional factors
5. Lifestyle factors - eg. adjustments based on the percentage of employees that smoke
6. Marketing considerations - eg. added charges for rate guarantees
7. Contribution schedules - eg. a 5% discount if the employer pays the entire premium (since that reduces antiselection)
8. Case size factors and volume adjustments - largest groups may have lower mortality or expenses
9. Plan options - optional benefits and allowing lots of employee choices will create antiselection

Question 9

Types of living benefits for life insurance

Answer 9

This benefit (also called accelerated death benefits) pays a portion of the face amount prior to death, with the remaining benefit paid at death

1. LTC benefits - provides a monthly benefit of 2% of the face amount, beginning when the insured is permanently confined to a nursing home
2. Critical illness benefits - typically pays 25% of the face amount upon the occurrence of a listed disease, such as stroke or cancer
3. Terminal illness benefit - pays 25% to 50% of the face amount when the insured has been diagnosed with a terminal illness with less than 6 (or 12) months to live

Question 10

Steps for developing claim costs for use in a rate manual

Answer 10

1. Collect data - data should be collected for a period of at least 12 months (to avoid seasonality issues). The best source of data is a company’s own experience
2. Normalize the data for important rating variables (see separate list)
3. Project experience period costs to the rating period - claim costs need to be trended from the experience period to the rating period

Question 11

Important rating variables when normalizing data for use in the rate manual

Answer 11

1. Age and gender - it may be appropriate to have separate age and gender factors for different major service categories or different plan types (such as HDHPs)
2. Geographic area - the data should be adjusted to reflect one specific geographic area
3. Benefit plan - adjust the data to reflect a common benefit plan (commonly the richest plan)
4. Group characteristics - the manual rate should represent the “average group” with respect to group characteristics, sucha as industry and group size
5. Utilization management programs - adjust for any changes in these programs
6. Provider reimbursement arrangements - adjust for any changes in provider arrangements
7. Other risk adjusters (based primarily on claim, diagnosis, encounter, and pharmacy data) - these may eventually become the primary method of risk adjustment

Question 12

Methods of adjusting manual rates for specific benefit plans

Answer 12

1. Claim probability distributions - these are typically used to estimate the impact on claim costs of deductibles, coinsurance, out-of-pocket maximums, and annual benefit maximums
2. Actuarial cost models - these models build estimated total claim costs by developing a net claim cost (after member cost sharing) for each detailed type of services and summing to get the total

Question 13

Data sources for estimating disability claim costs

Answer 13

1. A company’s own data is the best source if the data is reliable and credible
2. Rate filings of competitors
3. Research of governmental and business publications
4. Data from consulting firms and reinsurers
5. Insurer studies - such as loss ratio studies and actual to expected incidence or termination rates
6. Industry data and tables (typically base on intercompany experience studies
   a) 1987 Commissioners Group Disability Table - adopted by the NAIC as the statutory minimum reserve basis for LTD
   b) SOA 2000 Basic Experience Table - from studies performed during the 1990s
   c) TSA reports - contain exposure and actual to tabular ratios by industry classification
   d) 1985 Commissioners Individual Disability Table A (1985 CIDA) - is the basis of active life reserves and claim reserves for individual policies
   e) SOA Individual Disability Experience Committee 1990-1999 study

Question 14

Types of disability income experience studies

Answer 14

1. Calendar year loss ratio study
   a) Compute the ratio of incurred claims to earned premium for a given calendar year
   b) Incurred claims are calculated as paid claims plus the increase in claim reserves
   c) May not provide a clear picture of historical trends because results may be affected by reserve changes
2. Incurral year loss ratio study
   a) Compute the ratio of incurred claims to earned premium for a given incurral year
   b) Incurred claims are calculated as the present value of claim payments made to date plus the present value of the current claim reserve
   c) Shows historical trends because the full cost of a claim is attributed to the year the claim was incurred
3. Study of actual-to-expected incidence or termination rate - ratios of a company’s actual claim incidence or termination rates compared to expected rates from published industry tables or company data

Question 15

Formula for disability income net monthly premium

Answer 15

1. Net monthly premium = IncidenceRate * SUM(Benefit * Continuance * InterestDiscount)
2. The summation runs for the entire length of the benefit period
   (offsets will also need to be reflected, discussed in a different list)

Question 16

Group characteristics that impact disability income claim costs

Answer 16

1. Age and gender
2. Occupation - may need to adjust claim costs for:
   a) Hourly vs. salaried
   b) Blue collar vs. grey collar vs. white collar
   c) Union vs. non-union
   d) Commissioned sales personnel
3. Industry - for group insurance, it is more appropriate to rate based on industry than on occupations
4. Average earnings per employee - claim rates decrease as average earnings increase
5. Area - claim costs vary due to the legal environment and the general attitude and culture of the area
6. Size of group - claim costs follow a “U” shaped curve, with higher costs for the largest and smallest employers

Question 17

Data sources for developing dental claim costs

Answer 17

1. Own company data (best source)
2. Outside databases - Prevailing Health Care Charges System, MDR Payment System, National Dental Advisory Service, ADA “Survey of Dental Fees”
3. Consulting firms (have manuals containing utilization data)
4. Rate filings of other carriers
5. Third party administrators
6. Reinsurers

Question 18

Plan characteristics that impact dental claim costs

Answer 18

1. Covered benefits - plans often have a missing tooth provision and limit the replacement of dentures to once every 5-7 years
2. Cost sharing provisions - these provisions are important because receiving proper dental care is very elective from the insured’s point of view. Provisions include deductibles, coinsurance and copays, and maximum limits
3. Waiting period - used to discourage individuals from enrolling for one year to treat significant dental problems and then dropping coverage
4. Period of coverage - will need to project past experience into the future. Dental trend should not be assumed to be the same as medical trend.

Question 19

Network and care management practices that impact dental claim costs

Answer 19

1. Provider reimbursement levels
   a) FFS reimbursement may be based on usual, customary, and reasonable levels (UCR)
   b) PPO networks contract for reduced fees from a limited number of dentists. The dentist may not bill above those levels.
   c) Capitation is common with dental HMO plans
2. Care management practices - these will depend on the reimbursement method used. Practices include preauthorization and self-management (for capitated providers)

Question 20

Insured characteristics that impact dental claim costs

Answer 20

1. Age and gender - adults have higher costs than children, females have higher costs than males
2. Geographic area - can be a significant factor
3. Group size - smaller groups can have higher costs (due to adverse selection)
4. Prior coverage and pre-announcement - groups without prior coverage will have high costs in the first year due to utilization by those who had put off having dental work done. If the plan is announced many months prior to becoming effective, this problem becomes even worse
5. Employee turnover - high turnover increases cost since some new employees didn’t have prior coverage
6. Occupation or income - entertainers, professionals, and groups who are more aware of their benefits have higher costs
7. Contribution and participation - groups with less that 100% participation will have higher costs due to antiselection. The level of participation is inversely related to the required contribution level.

Question 21

Major effects of the year 2000 changes in the NAIC LTC Model Act

Answer 21

1. Requires disclosure of rating practices at the time of application - eg. including a statement that the policy may be subject to future rate increases
2. Requires an actuarial certification at the time of initial rating - must include a statement that the initial rates are sufficient to cover anticipated costs under moderately adverse experience
3. Eliminates minimum loss ratio requirements in the initial rate filing
4. Places limits on expense allowances in the event of a rate increase - if a rate increase is required, the lifetime loss ratio must not be less than the weighted average of 58% of the initial premium and 85% of the premium increase
5. Requires reimbursement of unnecessary rate increases - this could result if the revised premium schedules are more than double the initial rates
6. For policies in a rate spiral, guarantees policyholders the right to switch to currently-sold insurance without underwriting
7. Authorizes the commissioner to ban companies for 5 years if they persist in filing inadequate initial premiums

Question 22

Major effects of HIPPA on LTC

Answer 22

1. Defined qualified plans
2. Clarified taxation of premium and benefits - established that a qualified LTC insurance contract shall be treated as an accident and health insurance contract for tax purposes
3. Standardized benefit triggers (see separate list of benefit triggers)
4. Allowed tax reserves to be calculated on a one-year preliminary term basis for tax-qualified plans

Question 23

Major stakeholders in the group LTC policy design process

Answer 23

1. Employer group
   a) LTC is appealing because it complements other products (such as disability and life coverages) and relative to medical is a low-cost benefit with stable pricing
   b) May not be able to offer guaranteed issue to all active employees, since this could make the premium more expensive than similar individual policies
2. Insurance company
   a) Concerned with up-front acquisition costs, the risk of low enrollment, and the need to sell to both the employer and employee
   b) Costs vary significantly by participation level, making this a key assumption
3. Employees
   a) May not yet be aware of the risk covered by LTC insurance
   b) Concerned with the significant cost, which may even exceed the cost of individual policies
4. Insurance brokers - have found that group LTC insurance provides the opportunity to open the door to competitive life and disability markets

Question 24

Assumptions needed for a LTC pricing model

Answer 24

1. Voluntary lapses - lapse rates are much lower than for other types of health insurance. Premium are very sensitive to changes in lapse assumptions, especially for products with inflation protection
2. Mortality - most companies use the 1994 Group Annuitant Mortality (‘94 GAM) table. Selection factors may be needed if underwriting is good.
3. Morbidity - the major variables that impact claim costs are:
   a) Marital status - costs are lower for married individuals because of the presence of a potential caregiver at home
   b) Gender - females have significantly higher ultimate costs than males
   c) Benefit trigger
   d) Area - utilization patterns of LTC services vary by geographic area
   e) Case management - companies using a case manager usually experience lower claims
4. Selection factors - to reflect underwriting wear-off. Depends on the level of UW performed.
5. Expenses - start-up expenses are high relative to other types of business
6. Interest - the investment rate on assets is a key assumption because of the large amount of reserves
7. Reserve basis - important considerations include the level of margins and how these margins are achieved
8. Other assumptions - including the average daily benefit and the premium mode
9. Profit - typically based on lifetime goals for pre-tax profits, post-tax profits, return on investments, or return on equity

Question 25

Reasons for experience rating

Answer 25

1. Groups want it - at least those with good experience want the premium to reflect it
2. The insurer wants to quote and charge premiums that are as competitive as possible
3. The insurer wants to avoid antiselection (good groups are going to competitors and bad groups staying)

Question 26

Theoretical considerations in determining credibility levels

Answer 26

1. Coverages with low claim frequency are more volatile and will require a larger exposure base to be credible
2. Coverages with widely varying claim sizes will tend to be more volatile
3. The statistical confidence interval chosen by the insurer
4. Historically, statistical fluctuation was considered to vary inversely with the square root of the number of claims or lives. So it will take 4 times the exposure to double the credibility
5. For coverages with stochastically independent claims, longer experience periods can be used to increase exposure and therefore credibility

Question 27

Practical considerations in determining credibility levels

Answer 27

1. Competitive pressures
2. Ability of administrative and management areas to cope with experience rating
3. The trade off between the cost of experience rating and gains in the quantity and quality of new business
4. The effect on existing business of a change in credibility level
5. Management philosophy regarding experience rating
6. The need for consistency among classes of business

Question 28

Steps in prospective experience rating

Answer 28

1. Develop past claim experience - should be incurred claims for an experience year (restated)
2. Use pooling methods (see separate list) to dampen random statistical fluctuation
3. Calculate net premium (expected claim cost)
   a) Calculate a historical claim cost per unit of exposure
   b) Trend the historical experience to account for changes in claim costs - may be due to changes in morbidity, mortality, demographics, benefits, or antiselection
4. Calculate gross rates from net rates - apply loadings (retention) to the net premium (see separate list)
5. A final adjustment may be required when dealing with a politically-sensitive policyholder. Be sure to know the financial impact of any changes
6. Plan choice considerations - when employees can choose between an HMO, PPO, and/or indemnity, there is often antiselection against the indemnity plan
7. Small group considerations - need to recognize experience to some degree. May use one of the following:
   a) Formula-based methods (for groups with at least 10 lives) - a group is initially assigned to a rate class then reassigned at renewal if experience differs from a specified amount
   b) Re-underwriting method - look at outlier cases to see causes of bad experience to determine prospective rates

Question 29

Pooling methods

Answer 29

(regardless of the method chosen, a pooling charge must be applied to all groups being pooled to offset the average cost of claim modifications made during the pooling process)

1. Catastrophic claim pooling - forgive large claims
2. Loss ratio or rate increase limits - put a cap on one of the following: the loss ratio used in pricing, the rate increase proposed, or the aggregate claim dollars a group will be charged
3. Credibility weighting - weight with the experienced incurred claims for the entire pool
4. Multi-year averaging - combine several years of experience (may give more weight to recent years)
5. Combination methods - for example, use both catastrophic claim pooling and a rate increase cap

Question 30

Loadings in the net premium (retention)

Answer 30

1. Expense loadings - usually the largest portion of retention
2. Deficit recovery charge (may make rates uncompetitive) - charged to a specific policyholder to recover that policyholder’s past losses
3. Termination risk charge - charged to everyone to finance (in advance) the risk of groups leaving while in a deficit position
4. Pooling charges - usually covered in net premium
5. Profit charge or contribution to free reserves - may be built into other assumptions
6. Investment income - may be credited (net of investment management costs and taxes)
7. Explicit margin - reduces insurer’s risk
8. Charge to cover risk of rate guarantees. This risk arises due to misestimation risk and trend risk.

Question 31

Typical retrospective refund formula

Answer 31

Policyholder account balance = prior year’s balance + premium + investment earnings - charged claims - expenses - risk charge - increase in stabilization reserves - profit

1. Prior year’s balance - ending balance is carried forward if not eliminated at prior year end
2. Premiums - amount may be adjusted for interest based on the timing of payments
3. Investment earnings - very important for coverages with significant reserves
4. Charged claims = claims paid + increase in claim reserves - pooled claims + pooling charges + conversion charges + claim margins (may adjust claims for credibility)
5. Expense charges typically vary by duration to allow for the recovery of acquisition costs
6. Risk charge covers the risk that the policyholder will terminate coverage while in a loss position
7. Addition to premium stabilization reserve - to reduce the risk of a deficit on termination. The insurer may require certain level of reserve before surplus can be paid as an experience refund
8. Profit - usually built into other assumptions since the insurer is reluctant to show explicit profit in the formula

Question 32

Considerations in deciding whether to use retrospective experience rating

Answer 32

1. Group size - the group must be large enough to have credible data and to warrant the cost and time of experience rating
2. Contract provisions regarding the funding arrangement - some funding arrangements (like retrospective premium arrangements) will replace the experience rating formula
3. Company policies and practices - is an overriding factor
4. Company financial situation - crucial for insurers with small surplus (eg. the Blue plans)

Question 33

Special funding arrangements for group insurance

Answer 33

1. Reserveless plans (aka deferred premium or premium drag plans) - the insurer forgoes premiums equal to part of all of the claim reserves. In return, the insurer receives a terminal premium when the group terminates (risk of not receiving terminal payment). The policyholder chooses how to invest money
2. Fully insured plans - the standard arrangement. Policyholder pays insurer, who pays claims
3. Self-insured plans - a trust receives employer money and pays the claims (so there is latitude in the choice of investments). Stop loss is usually purchased from an insurer. Governed by ERISA (no premium taxes or state mandates)
4. Minimum premium contracts - fully insured plan that includes a minimum premium rider (provides for the employer to fund a trust which the insurer uses to pay claims). Avoids premium tax on the portion of premium used to pay claims.
5. Stop loss contracts (specific and/or aggregate) - trends are leveraged, so give them special attention
6. Retrospective premium arrangements - the policyholder pays some percent of the regular premium (eg. 90%). At the end of the period, the policyholder is liable for an additional premium up to some point (there is a risk of nonpayment).

Question 34

Components of medical trend

Answer 34

1. General macro economic factors (the “force of trend”) - the force of trend is the trend in average per capita reimbursement to providers of medical care services from all types of private payers
2. Changes in demographics and health status of the covered population
3. The structure of the carrier’s provider contracts, and changes in that structure
4. Managed care initiatives - some initiatives will have a one-time effect on trends, while others (such as implementing capitation) will have longer-term impacts
5. Benefit and cost sharing provisions, and changes in those provisions
6. Random fluctuations - is a major source of variation for small blocks

Question 35

External sources of trend information

Answer 35

1. Proprietary databases
2. Medicare - history of cost increases for the over age 65 and disabled populations. Distorted by eligibility expansions and legislative changes
3. National health expenditure portion of GDP - generally not helpful for current monitoring purposes because publication of the index is slow and subject to revision
4. Medical CPI/PPI - M-CPI measure the increase in out-of-pocket costs and the consumer portion of health insurance costs. PPI measures the cost of producing units of health care services.
5. Trend surveys - typically compiled by consultants. Provides a second opinion of internal trends

Question 36

Micro-economic variables for modeling health care consumption

Answer 36

These affect the individual consumption of health care, but have less impact on the force of trend

1. Health status of the individual
2. Availability and scope of insurance
3. Access to care
4. Actions of the primary care physicians

Question 37

Macro-economic variables that affect health care cost trends

Answer 37

1. Wealth - increased wealth is a leading indicator of increased consumption and also investment in research
2. General inflation
3. Physician supply - increased supply should decrease prices and increase quantity and quality of care (but past growth has not decreased prices)
4. More specialists - appears to have led to greater use of technology and more intense therapies
5. Population aging - causes consumption to increase
6. Effect of third party payers - decreases the consumer’s sensitivity to costs and increases in consumption
7. Managed care - has affected consumption (eg. shift from I/P to O/P care)

Question 38

Trend analysis techniques

Answer 38

1. Actuarial models - projects utilization and price data by type of service, but the result is mostly based on historical experience
2. Linear regression model of historical claim costs - basically projects the historical average trend, but does adjust for random fluctuations
3. ARIMA models - do not work for cyclical changes that affect trends, so they are only good for short periods
4. External indicator models - typically statistical in nature and rely on casual modeling techniques. Requires the use of a leading indicators of a coincident indicator that has specified future values (such as the Health Cost Index)

Question 39

Common challenges in trend analysis

Answer 39

1. Changes in claim processing and payment patterns
2. Seasonality - can smooth out by using 12-month moving averages
3. One-time events (such as high flu season) - can significantly change claims during one period, followed by a return to normal levels in later periods
4. Margins - in some situations, adding an explicit margin for uncertainty can be appropriate or even required
5. Changes in prior period estimates - the base period claim costs to which the trend is applied may not be complete when claims are projected, so the reserve estimate will impact projected claims
6. Legislative changes - rating laws, mandated benefits, and other changes can cause one-time and ongoing changes in trends

Question 40

Steps of the product development cycle

Answer 40

Product development is the process by which new products are created and existing products evolve

1. Innovate - consists of:
   a) Understanding the company’s strategic perspective
   b) Development of new ideas (see separate list of common drivers of product ideas)
   c) Idea screening - check for consistency with corporate goals and feasibility with the corporation’s abilities
   d) Market assessment - to determine if a market exists for the product (see separate list of questions answered by a market assessment)
2. Design the product - this phase consists of determining the product structure, plan design options, contribution requirements, and regulatory compliance
3. Build the product (see separate list of steps for building the product)
4. Sell the product - the product is often test marketed, after which revisions are done before it is mass marketed)
5. Assess the product - monitor financial results and consumer and market feedback
6. Revise the product - changes may be indicated by the product assessment, regulatory requirements, or consumer demand

Question 41

Common drivers of product ideas

Answer 41

1. Innovator or follower - some companies are successful at innovating, while others are successful at following and learning from competitors
2. Changing laws and regulations - new rules can lead to new products developed specifically to operate within the new set of rules
3. Consumer demand - companies may constantly seek consumer feedback and marketing intelligence
4. Marketing and sales - these teams can spot holes in the product spectrum where consumer demand is not being fully met
5. Leveraging insurer capabilities - product development teams must know what the insurer does well and find ways to grow in those areas
6. Social need - for example, Medicare Part D served the social need of helping seniors who were being overwhelmed by the cost of expensive medications
7. Changing demographics - leads to a shift in the types of products that will be marketable and saleable
8. Changing economy and financial markets - leads to changes in purchasers’ views of their need for insurance
9. Competitive advantage - product development ideas should utilize the company’s competitive advantages

Question 42

Questions answered by a market assessment

Answer 42

1. What exists in the market today?
2. What is the product objective for the consumer?
3. What is the regulatory environment for this product?
4. What are the financial value and other benefits for the consumer?
5. What are the prices targets? (the assessment may indicate a range of acceptable prices)
6. What is the likely reaction from competitors?
7. How will the sales team react?

Question 43

Steps for building a new product

Answer 43

1. Project enrollment - this is critical to helping senior management decide whether the product is worth pursuing
2. Price the product - includes an assessment of the market price sensitivity. After initial pricing, the projected enrollment should be reviewed again
3. Perform financial assessments - to determining whether the new product can meet the company’s required return on investment or return on equity
4. Implement the infrastructure needed to administer the product (process claims, bill and collect premiums, and service member inquiries)
5. Get senior management approval

Question 44

Key players in the product development cycle

Answer 44

1. Product development team - is responsible for generating new product ideas and studying the market
2. Senior management - sets the company goals and is responsible for making the decision to pursue a proposed idea
3. Marketing - is focused on advertising, name recognition, and sales branding
4. Sales - often has insights into price sensitivity and the types of products customers want
5. Underwriters - can help quantify the risk associated with certain plan features
6. Information technology (IT) - can help in understanding the feasibility of the infrastructure needed to administer the product
7. Operations - work with IT teams to administer the product
8. Compliance - ensures the product is compliant with laws and regulations
9. Actuarial - prices the product and works on the projections and feasibility studies
10. Finance - review the projected enrollment and pricing to determine whether projections meet corporate profit targets

Question 45

Desired characteristics of premium rates

Answer 45

1. Adequate - high enough to generate an acceptable return on equity
2. Competitive - low enough to enroll enough members to meet volume and growth targets
3. Equitable - to avoid an unreasonable amount of cross-subsidization among groups (which will improve persistency)

Question 46

Information gathered during underwriting for managed health care

Answer 46

1. Health status - determined based on:
   a) For individual and small group: physician exams, prescription drug histories, and medical questionnaires
   b) For large groups: medical cost experience and a listing of employees’ major health conditions
2. Ability to pay the premium- based on income verification and credit history
3. Availability of other coverage - information is needed for coordination of benefits with other insurance and workers’ compensation
4. Historical persistency - groups that frequently change carriers may not persist long enough for the insurer to recoup acquisition costs

Question 47

Steps in the rate formula for managed health care

Answer 47

1. Develop the projection period base rate PMPM - based on historical medical costs trended forward, and reflects the average characteristics of the block of business
2. Apply group-specific additive adjustments - such as the added cost of covering mandated services in a given state
3. Apply group-specific multiplicative adjustments - includes factors for the benefit plan, geographical area, age/gender, degree of health care management, and health status
4. Add retention loads - includes administrative expenses, a buildup of contingency reserves, coordination of benefit savings, and profit
5. Convert to a contract rate (per employee or subscriber) - for group coverages, this includes developing tiered rates (employee only, family, etc.)

Question 48

Rate setting approaches

Answer 48

1. Rerating - rating based on direct, existing experience (eg. the experience of an existing block)
2. Fundamental pricing - rating from other data sources (used as benchmarks), which are adjusted to apply to the current situation
   a) Tabular method - an existing table (or a modification of it) is used as the morbidity basis for pricing (eg. using the 85CIDA table for pricing DI). Typically used for long term, non-inflation sensitive products
   b) Buildup and density functions (see separate list) - a model is built to determining expected claims in the rating period. Generally used for inflation-sensitive products.
   c) Simulation - an existing distribution of expected claims is projected into the rating period, using all known information about the claimants (including prior claim experience)

Question 49

Major considerations in the rate setting process

Answer 49

1. The market - competitors’ pricing sets expectations for consumers, limiting pricing options
2. Existing products - expectations will exist for the company’s product, based on its current products
3. Distribution system - the compensation system, the structure of the distribution system, and the level of company control are all relevant in pricing
4. Regulatory situation - limitations may exist that impact how rates are set, and whether needed rate increases are allowed
5. Strategic plan and profit goals - pricing practices should reflect the company’s goals

Question 50

Major rating variables

Answer 50

1. Age - claim costs increase significantly by age for almost all health insurance coverages
2. Duration - durational trends are the trends in excess of those generated by insured age along. They typically come from initial underwriting and from cumulative antiselection.
3. Gender - most coverages vary rates by gender, unless prohibited by law.
4. Marital status - this is a big factor in LTC, since having a spouse at home can decrease the need for a nursing home
5. Parental (or family) status - rates must vary based on how many people are insured
6. Occupation - an important rating factor for DI coverages, but not for other coverages
7. Geographic area - rates may vary by area due to different patterns of care, provider contracts, availability of care, and legal requirements
8. Current health status
9. Past claim history - renewal rates are sometimes based on claim experience
10. Smoking status
11. Weight
12. Presence and nature of other coverage
13. Situation-specific factors - eg. whether the policyholder converted from another plan of the same insurer

Question 51

Types of age rating structures

Answer 51

1. Attained age rating - a policyholder’s rate is a function of his age at renewal. Also referred to as step rating if rates are grouped into age bands
2. Entry age or issue age rating - the rate reflects the age of the policyholder when the policy was issued
3. Uni-age rating - the rate structure doesn’t recognize age at all, leading to subsidization of other individuals. Most community rate structures are uni-age

Question 52

Tabular method formulas for calculating net premiums

Answer 52

1. Net premium = NP = SUM([from z=issue yr to final yr] Pr(Clm,z) * AC(z) * v^t *l(z)
   a) Pr(Clm,z) is the probability of a claim occurring (incidence rate) in year z
   b) AC(z) is the average claim cost (assuming a claim occurs) in year z
   c) v^t is the present value factor at duration t corresponding to year z
   d) l(z) is the proportion of originally issue lives still in force in year z
2. The average claim cost is calculated as follows: AC(z) = SUM([from s=1 to FnlCmPyt] Cm$(s) * Pr(1-Tn(s)) * v^s
   a) s is the claim duration
   b) Cm$(s) is the claim dollars payable at duration s
   c) Pr(1-Tn(s)) is the probability of a claimant at claim duration 0 remaining disabled at duration s
   d) FnlCmPyt is the claim duration of the final possible claim payment

Question 53

Using the buildup and density function approach for pricing

Answer 53

1. Buildup approach - each claim type (eg. I/P, O/P, etc) has its own claim cost calculation, as the product of claim frequency times average cost per services. The total claim cost is the sum of the various categories. Works well for benefits with copays
2. Density functions - calculates a distribution of the expected annual claims for an individual, with no calculation of the different categories of benefits. Is useful when calculating the impact of deductibles and out-of-pocket limits
3. Combining buildup and density functions - for PPO products, may calculate in-network costs using the buildup approach (due to copays), and out-of-network costs using the density approach (due to deductibles). The two are combined to get a final claim cost.

Question 54

Steps of the rerating approach for pricing

Answer 54

1. Gather experience on existing business - use incurred claims (preferably on a runout basis) and earned premiums/ The reliability of the data should be assessed before using it.
2. Restate experience - past premiums should be restated to the rate levels currently in effect
3. Project past results to the future - adjust for items that cause future experience to differ from past experience (see separate list)
4. Compare the projection against desired results - a rate increase is calculated by determining how much rates need to change to produce the desired loss ratio (which is based on the expected level of expenses and profit)
5. Apply regulatory and management adjustments (see separate list for reasons for management adjustments)

Question 55

Adjustments needed for using past claims to project future claims

Answer 55

1. Changes in the covered population
2. Changes in duration - should anticipate durational effects in the claim costs
3. Changes in benefits - changes may be explicit (such as a change in copays) or implicit (such as a change in how a policy provision is interpreted)
4. Changes in claim costs - must project changes in frequencies and changes in average costs
5. Leveraging - as trends change the average claim cost, the impact of deductibles and copays cause claims to increase at a rate greater than trend
6. Other changes - includes antiselection, changes in underwriting, and changes in business practices
   Projected claims(t) = Claim cost PMPM(s) * Number of members(t)
   * ((1 + leveraged claim cost trend)^(1-s) - 1)
   * Avg durational factor(t) / Avg duration factor(s)
   * (1 + Antiselection factor due to lapses(t-s))
   * (1 + Adjustment factor for other changes(t-s))
   -> it appears the -1 in the formula above is an error, but it is not yet listed in the errata

Question 56

Reasons for management adjustments in pricing

Answer 56

1. Competitiveness of the premiums for new business
2. Profitability in other lines of business
3. Relations with the public or the sales force
4. Social policy
5. Desire the manage the block from a long-term perspective (eg. phase in a large rate increase)

Question 57

Methods for calculating gross premiums

Answer 57

1. Block rating (short-term horizon) approach - claim costs are calculated for the rating period (typically a one-year period), and premiums are calculated by adding on expenses and profit charges. Gross premium = G = [N * (1+E(N)) + E(F)) / (1 - E(G))
   a) N = net premium (claim cost)
   b) E(N) = percent of claims expenses
   c) E(F) = fixed expenses
   d) E(G) = percent of premium expenses + profit as a percent of premium
2. Asset share approach - involves long-term projections of various items, in order to determine the necessary premium

Question 58

Items included in asset share projections

Answer 58

1. Exposure values - including the number of policies sold or in force, number of claims or claim payments, number of premium collections, and number of units sold or in force
2. Revenue values - including premium, investment income, and explicit subsidies
3. Claim values - paid claims, incurred claims, claim reserves, claim adjustment expense reserves, and policy reserves
4. Capital values - must model the cost of capital used by the line of business
5. Expense targets - expense loadings may be very detailed. The cost of capital is sometimes treated as an expense.
6. Profit targets - profit is calculated in one of the following ways -
   a) Percent of premium - present value of profits divided by present value of premiums
   b) Return on investment (ROI) - this is the interest rate at which the present value of future profits will exactly equal the initial investment
   b) Return on equity (ROE) - this is like the ROI method, except the initial investment is increased by the amount of capital that is set aside to cover the buiness

Question 59

Steps for manual rating of disability coverage

Answer 59

1. Determine the base rates/premium (base premium = base rate * benefit amount)
   a) LTD: Base rate(x,g,e,w) = I(x,g,e) * RSV(s,g,e,0) / 12
   RSV is the reserve at time 0, I is the probability of claim
   b) STD: Base rate (x,g,e,w) = I(x,g,e) * D(x,g,e) / 12
   D is the expected length of claim in weeks
2. Deduct offset credits - to get the net base premium
3. Demographic adjustments - adjust the net base premium to reflect the person’s salary, industry, occupation, and location
4. Plan provision adjustment - adjust for the definition of disability, maximum or minimum monthly benefits, pre-existing clause, and antiselection
5. Non-claim adjustments (retention) - the prior steps give the final claim cost. Add loadings for commissions, expenses, and premium taxes
6. Add profit - can be a percent of premium or a needed ROI/ROE

Question 60

Steps for experience rating of disability coverage

Answer 60

1. Determine the group’s manual rate with profit and expenses removed (this is the final claim cost)
2. Determine the experience-based rate using the last 3-5 years of data
   a) Discount claims and reserves to the midpoint of the experience period or to the actual date of disability
   b) Divide by exposure to get the experience-based claim rate
   c) If large claims are pooled, add a pooling charge
3. Blend the manual rate and the experience-based rate to get the case claim rate
   a) Blended rate = Manual claim rate * (1-Z) + Experience claim rate * (Z)
   b) Credibility (Z) = N / (N + K) where N = number of life years and K = constant (for example, 5,000 for LTD or 250 for STD)
4. Final case premium = blended rate / target loss ratio

Question 61

Steps in the claim process for disability

Answer 61

1. Determine eligibility for coverage - is the claimant insured and actively at work, is there a pre-existing condition?
2. Determine if the definition of disability is met - this is the most difficult step of the process
3. Determine the payment amount (usually straightforward) = Pre-disability income * benefit percent - offsets
4. Get ongoing proof of disabilities
   a) STD - often approved for a specified period based on the type of disablement. Reviewed at the end of the period
   b) LTD - reviewed annually, when the condition or treatment changes, or when the definition of disability changes

Question 62

Tools of the claim process for determining and handling disabilities

Answer 62

1. Medical evaluation - begins with an APS and can include independent medical exams
2. Rehabilitation plans - providing vocational training or physical rehabilitation
3. Financial evaluation of the claimant - verification of pre- and post-disability earnings
4. Settlements - these are risky, so be sure the insurer is not perceived as taking advantage of the claimant (ensure legal representation)
5. Fraud review - check information for consistencies or alterations
6. Managed disability - techniques are used to “manage” disability and encourage a return to work

Question 63

Uses of health insurance loss ratios

Answer 63

1. Evaluating an organization’s performance
2. Providing consumers with information on the relative quality of competing health plans
3. Projecting future earnings growth of HMOs
4. Testing products against minimum loss ratio standards
5. Comparing insurers and HMOs
   (the list of users of loss ratios includes more ways in which loss ratios are used)

Question 64

Users of loss ratios

Answer 64

1. Legislators use loss ratios to make sure that a reasonable percentage of premium is allocated to the cost of benefits
2. Regulators use loss ratios to monitor insurance companies (evaluating rate sand monitoring solvency)
3. Investors, investment analysts, and lenders use loss ratios to track trends in a company’s earnings
4. Rating agencies refer to loss ratio trends in their reports
5. Insurance companies and managed care companies use loss ratios to set target premiums. determine rate increase needs, assess product viability and performance, and to compare results with other companies
6. Consumer advocates use loss ratios to compare the performance of companies, reasoning that high loss ratios are best for consumers

Question 65

Payment mechanisms for prescription drugs

Answer 65

1. Average manufacturers price (AMP) - the price manufacturers use for selling to wholesalers. In Canada, this is called the manufacturer’s list price (MLP) and is regulated to ensure the prices charges are reasonable and in line with the prices of alternative treatments
2. Wholesale acquisition cost (WAC) - the manufacturers suggested list price, which may also be used as a sale price to the wholesaler
3. Average wholesale price (AWP) - is based on data obtained from manufacturers and distributors, but it’s not an average nor is it based on any actual prices paid by anyone
   a) WAC and AWP are the most widely accepted mechanisms. WAC must equal 80% of the AWP in the UW, due to legislation
4. Actual acquisition costs (AAC) - the price retailers pay to wholesalers, negotiated between the two parties. In some cases, pharmacies by drugs directly from manufacturers, in which case AAC = AMP
5. Usual & customary (U&C) retail price - the price consumers pay to retailers. It includes the retailer’s AAC plus a markup.
6. Maximum allowable cost (MAC) - is typically used for generic drugs and can be viewed as a fee schedule

Question 66

Layers (participants) within the prescription drug distribution channel

Answer 66

1. Manufacturers produce drugs and typically sell them to wholesalers based on AMP or WAC
2. Wholesalers act as middlemen because retailers generally prefer to purchase drugs from one source rather than negotiating with hundreds of individual manufacturers. They sell to retailers base on WAC plus a markup or a discount off AWP
3. Retailers (pharmacies) dispense prescription drugs to consumers, charging a U&C retail prices. But if insurance is involved, the retailer will negotiate pricing by the insurer or its contracted pharmacy benefit manager (PBM)
4. Consumers purchase drugs at the U&C price if there is no insurance. If insurance is involved, consumers typically pay a copayment or coinsurance and the insurer pays the rest of the negotiated price
5. PBMs and insurers are not involved in distributing drugs except for PBMs who own mail services or specialty pharmacy facilities

Question 67

Misconceptions regarding LTC rate increases

Answer 67

1. Misconception 1: these products are annually renewable
   a) LTC is guaranteed renewable and priced on an issue age basis
   b) Premiums are expected to remain level and cover all future costs
2. Misconception 2: using historical loss ratios to determine performance is appropriate
   a) Claims and loss ratios are low in early policy years, but this does not mean the product is profitable
   b) A large portion of early premiums need to be set aside as contract reserves to pre-fund future claims
   c) This can be addressed by including the change in contract reserves in the claims calculation
3. Misconception 3: companies have time to wait and see how experience will unfold
   a) As more time passes without a rate increase, the future premium base to which the rate increase would be applied shrinks
   b) This results in much larger increase needs in order to produce the targeted lifetime loss ratio

Question 68

LTC pricing assumptions that often drive the need for a rate increase

Answer 68

1. Morbidity - misses on this assumption may not become apparent for many years because of the gap between the average issue age and the average age of LTC claimants
2. Persistency - higher persistency leads to significantly higher claims because more policyholders remain in later years when claim costs are extremely high
3. Interest - investments are key to ensuring that the contract reserves grow enough to support the company’s future liabilities. The recent economic recession has resulted in investment earnings that are much lower than what was assumed.

Question 69

Actuarial standards for the use of data

Answer 69

1. Selection of data (see separate list)
2. Reliance on data and other information supplied by others - the actuary may rely on such information, but should disclose this reliance
3. Review of data - the actuary should review the data for reasonableness and consistency, unless such a review is not practical
4. Limitation of the actuary’s responsibility - the actuary is not required to audit the data or determine whether data supplied by others is intentionally misleading
5. Use of data - the actuary must decide whether the data is of sufficient quality, if adjustments need to be made, or if data defects prevent the analysis from being done
6. Documentation regarding data quality (see separate list)

Question 70

Considerations in selecting data for an actuarial analysis

Answer 70

1. Appropriateness for the intended purpose
2. Reasonableness, comprehensiveness, and consistency of the necessary data elements
3. Any known material limitations of the data
4. The cost and feasibility of obtaining alternative data in a reasonable time frame
5. The cost and benefit associated with using an alternative data set or data source
6. Sampling methods that were used to collect the data

Question 71

Required documentation related to data quality

Answer 71

1. The process the actuary followed to evaluate the data, and any limitations due to data that was not reviewed
2. A description of any material defects the actuary believes are in the data
3. A description of any adjustments or modifications made to the data
4. The source of the data
5. Any limitations on the use of the actuarial work product due to data quality issues
6. Any unresolved material concerns the actuary may have about the data
7. Any results that may be biased due to data quality issues, including the magnitude of the bias
8. Disclosures in accordance with ASOP #41 in the following situations:
   a) If any material assumption or method was prescribed by law
   b) If the actuary relies on other sources and thereby disclaims responsibility for any material assumption or method
   c) If the actuary has otherwise deviated materially from ASOP guidance

Question 72

Situations in which ASOP #25 applies

Answer 72

1. When the actuary is required by applicable law to evaluate credibility
2. When the actuary chooses to evaluate the credibility of subject experience
3. When the actuary is blending subject experience with other experience
4. When the actuary represents the data being used as statistically or mathematically credible

Question 73

Recommended practices for using credibility procedures

Answer 73

1. The actuary should use an appropriate credibility procedure when determining if the subject experience has full credibility or when blending the subject experience with the relevant experience. In selecting a procedure, consider:
   a) Whether the procedure is expected to produce reasonable results
   b) Whether the procedure is appropriate for the intended use and purpose
   c) Whether the procedure is practical to implement when considers its cost and benefit
2. The actuary should exercise professional judgement in selecting relevant experience to blend with the subject experience. This relevant experience should have characteristics similar to the subject experience
3. The actuary should use professional judgment when selecting, developing, or using a credibility procedure
4. The actuary should consider the homogeneity of both the subject experience and the relevant experience