Role of the Actuary in Self Insurance - Stop Losss

Question 1

Introduction

Answer 1

1. Stop-Loss Insurance (SLI) is an important tool that plan sponsors use to limit their plans’ risk exposures
2. A policy covering the excess claims exposures of the employee benefit plan, not the members of the plan
   themselves
3. A self-insured plan should consider a combination of two excess-of-loss-style protections
   a. Specific stop-loss insurance (S.S.L.) covers the plan’s exposure to large losses per member
   b. Aggregate stop-loss insurance (A.S.L.), covers the plan’s exposure to unexpectedly large losses of the entire plan not otherwise covered by specific insurance
4. How Does SLI Protect the Self-Insured Plan?
   a. Self-insured plans consider a budget for each contract year, and two primary sorts of events can ruin that budget
   ▪ High claims on a single individual beneficiary (a severity issue), or
   ▪ Unexpectedly high number of claims (a frequency issue) could cause actual claims to exceed the expected, or budgeted amount

b. The plan sponsor may seek protection against very large individual claims using S.S.L.
▪ For example, reimbursement of underlying losses that exceed $50,000 per member per year. (The given dollar amount is called the specific deductible)

c. Plan sponsors may use A.S.L. to protect against overall claims exceeding the expected plan benefits by more than a defined amount called the aggregate attachment point
▪ The aggregate attachment point is often set at 125 percent of the stop-loss underwriter’s estimate of the expected claims
▪ The aggregate attachment point is expressed as an annual dollar amount that adjusts based on actual plan enrollment during the plan year, i.e., it increases if the number of employees increases, and vice versa
▪ The adjustment is made by converting the aggregate attachment point into a monthly factor per defined exposure unit
▪ Most policies require a minimum aggregate attachment point
- This minimum is stated as a dollar amount, and is often 90% to 95% aggregate attachment point
- Minimums protect the carrier against anti-selection if there is a substantial decrease in enrollment
▪ The gap between expected claims and the aggregate attachment point is called the aggregate corridor, and it represents the plan’s maximum net possible loss
- The aggregate corridor is the risk the employer or plan sponsor takes on in exchange for the cost-savings opportunity when claims come in below that expected figure

d. Employers may opt to have both specific and aggregate. Integration of the combined risk is important, so as not to overlap protection
▪ The expected claims used to calculate the aggregate attachment point excludes claims projected to be reimbursed by the S.S.L., and is done through the use of a contract cap, called an aggregate loss limit per person within the A.S.L. contract
▪ The loss limit defines the maximum claims on an individual that are covered by the A.S.L.
▪ When S.S.L. and A.S.L. are written together, the loss limit is typically set equal to the
specific deductible

Question 2

The Stop-Loss Marketplace

Answer 2

1. Entities Involved in SLI Transactions
   a. Prospective insured
   ▪ The plan or the plan sponsor

b. Financial advisors
▪ This includes
* Employee benefits brokers
* Insurance agents or consultants
* TPAs
▪ They may place the SLI with an insurer or bring the prospective insured to a knowledgeable intermediary, such as a TPA

c. Plan’s administrator
▪ Self-administered
▪ Administered by an insurance company (often called administrative services only, or ASO)
▪ TPA

d. Underwriter
▪ An ASO administrator that issues policies covering its own ASO administration clients
▪ Direct insurer, such as an insurance company writing SLI as a line of business without providing administrative services
* Some ASO insurers also market SLI that is administered by TPAs. When they do, they are acting as a direct insurer
▪ Managing general underwriter (MGU), a third-party entity that produces, underwrites,administers and manages SLI on behalf of issuing insurer or reinsurer risk takers

e. Risk taker
▪ This group encompasses several parties: the issuing insurer, fronting insurers, reinsurer
▪ Issuing insurer
* The company that issues the stop-loss policy (also called the “writing” company/carrier) could be an ASO insurer, a direct insurer or a fronting insurer
* The issuing insurer may retain 100 percent of the risk or cede some portion to a reinsurer
▪ Fronting insurers
* Provide basic policy form compliance and payment of premium taxes, taking little risk on the stop-loss insurance itself
▪ Reinsurer
* Reinsurers participate on either a quota share or an excess basis
* Excess reinsurance is often used today to cover the risk from a high limit, say $1 million per person, up to the unlimited exposure mandated by the ACA
▪ Captive reinsurer
* A broker/producer, TPA, MGU, or even the self-insured employer may form a captive insurance company, called a captive reinsurer, to participate in the risk
* The captive reinsurer typically participates in the risk through quota share
* An issuing insurer or reinsurer usually cedes risk to a captive reinsurer in return for the captive’s capital as security against this loss exposure
* A group captive is mutually owned by a group of self-insured employers to pool and share in the risk of their SLI policies

f. Broker/producers
▪ May participate in the risk through alternative structures
* Funds withheld
* Trust funds
* Letters of credit

2. SLI Business Functions
   a. Marketing, Sales and Distribution
   ▪ Usually some entity assists the prospective self-insured client with choosing the type and amount of SLI to purchase and through what insurance entity
   ▪ A broker or consultant may obtain quotes
   ▪ The entity that performs the underwriting, sets the rates and issues the quote
   ▪ The stop-loss broker or TPA may play the role of wholesaler, with the ultimate client’s broker/agent/consultant serving as the retailer
   ▪ The more layers that exist between the plan and the underwriter, the greater the amount of commissions, fees and overrides
   ▪ The actuary for the ultimate risk takers must be aware of the compensation and market pressures before a case is underwritten

b. Stop-loss Underwriting
▪ Involves either rejecting a risk or offering rates and terms
▪ It is performed by the direct or ASO insurers or an MGU that underwrites on behalf of an issuing insurer and its reinsurers, if any

c. Stop-loss Policy Administration, Claims Administration and Reporting
▪ Tends to be done by the same party, and that party tends to be the same as the one performing the underwriting function
▪ The MGU is usually a “total solution” for carriers, offering a complete outsourcing of traditional insurance company roles of underwriting and product administration

d. Stop-loss Policy Compliance and Insurance Accounting
▪ All issuers, whether ASO, direct or fronting, retain responsibility for policy filing, other regulatory reporting requirements, statutory and GAAP accounting, and premium tax payments
▪ For this work, fronting insurers receive what is called the fronting or issuing fee

e. Risk-Taking
▪ In the regulatory sense, the only entity responsible for payment of stop-loss claims is the issuing insurer
▪ Stop-loss programs are also constructed with several risk takers behind the issuing
insurer, in the form of reinsurance
▪ Actuaries are often involved in many of these levels, as well as evaluating experience, and
need to understand all the interworking elements

Question 3

Classification and Description of Stop-Loss Coverage Types

Answer 3

1. Key Variables Within Stop-Loss Insurance
   (1) Benefits Covered (e.g. major medical, prescription drugs)
   (2) Contract Basis
   ▪ The term contract basis refers to how we determine the time element in the definition of claims covered by SLI.

▪ There may be limits to any lag allowed in payment time between an incurred date and the paid date of an underlying plan claim

▪ Paid contracts are intended to cover claims paid in a policy year and may limit how far back these claims could have been incurred.
* An 18/12 contract allows six months of run-in claims, in addition to claims incurred during the given 12-month policy year itself
* An 18/12 SLI contract coverage effective on January 1, 2018, would cover claims incurred during the 18 months between July 1, 2017, and December 31, 2018, but only if they are paid during calendar year 2018
* Many variations on this theme are possible, such as 15/12, 18/12, 24/12, 36/12

▪ A “pure” paid contract leaves the prior incurred period open, implying the claim will be covered simply if it is paid during the contract period

▪ A.S.L. may also place a dollar limit on the total amount of run-in claims that will be covered from incurred dates prior to the effective date
* Occurs most commonly if there is a change in TPA and carrier at the same time

▪ Incurred contracts cover claims incurred in a policy year and then may allow the payment date to extend beyond that given 12-month incurral period
* The 12/12 contract basis limits coverage to claims that are both incurred and paid in the same 12-month policy period; a.k.a. an “incurred and paid” contract
* A policy that allows for an extended period during which an incurred claim may be paid is called a run-out policy
* A 12/15 contract issued for calendar year 2018 reimburses claims incurred during 2018 as long as their associated paid dates are within 2018 or the first three months of 2019

▪ Fully insured contracts are written on a fully incurred basis, since there is usually no formal limit on when claims may be reported, processed and paid by the carrier
* It is very rare for a stop-loss contract to offer a fully incurred contract basis

(3) Known Versus Unknown Risks and Lasers
▪ SLI is designed to protect against the occurrence of “unknown” risk contingencies

▪ The SLI carrier may offer to neutralize a known risk (e.g. pre-existing condition) by not covering that portion of the risk (a.k.a. applying a laser)
* A laser is an exception written into the stop-loss coverage, stating that certain coverage exceptions apply to the claims of specified individuals covered by the self-insured plan

▪ Known contingencies that might otherwise have a laser applied to them may instead simply be added to the expected claims component of the S.S.L. premium
* Those additional claim amounts will generally be loaded for expenses to arrive at gross premium
* This extra loaded premium is sometimes called a laser load

▪ When several known contingencies arise for the same employer group for the same prospective contract period, the stop-loss carrier may consider laser pooling
* Suppose an employer plan is purchasing a specific deductible for the coming year at $100,000, and the underwriter determines that lasers are required on four individuals, as indicated here
* The employer plan has $795,000 in total exposure of anticipated, but not guaranteed, claims for the four persons
* While the likelihood is high that at least one of the individuals will reach their laser amount, it is far less likely that all four will. The underwriter may combine the four into a laser pool with a total of $700,000
* For purposes of A.S.L., the loss limit is applied to all individuals, regardless of whether any were subject to a laser, and the amount of the laser that lies in excess of the loss limit is excluded from accumulating toward the aggregate attachment point

(4) Maximum Liability Covered by SLI
▪ S.S.L. may include a maximum benefit defined on a per person per year basis. Less common after ACA
▪ A.S.L. has traditionally been written with maximum benefit expressed on a per contract per year basis
* Historically, the typical limit was $1 million, with the rare “buy up” to $2 million or more per contract year

2. Specific Stop-loss Variations
   a. Carriers that apply lasers may offer protection from new lasers in renewal years, something called a no-laser guarantee
   ▪ Situations to which lasers are applied in the initial policy period may be subject to continuing laser terms on renewal, as the no-laser guarantee applies only situations that arise after the original issue date

▪ To prevent a no-laser guarantee from simply shifting the expected costs of known claims situations into a premium load applied to the specific coverage, many no-laser guarantee options are paired with a limit on the renewal premium rate increase, as a no-laser rate cap

▪ The stop-loss actuary must recognize the risks associated with both guaranteeing no new lasers and limiting future rate increases

b. Aggregating specific
▪ By choosing a specific deductible, the underlying plan claims may be split into two components (i.e. Expected claims that are at or below the specific deductible AND Expected claims that are excess of that deductible amount)

▪ If the expected claims > specific deductible are large enough to be considered partially credible, a carrier may offer to split the expected specific claims into two further components: An aggregate amount for which the self-insured plan retains the risk AND Expected claims exceeding the aggregating specific deductible, which the stop-loss carrier uses as the basis for determining the premium it will charge

▪ By shifting some of the risk retained to the self-insured plan, premiums are reduced

3. A.S.L. Variations
   a. While the aggregate attachment point has typically been 125 percent of the expected claims, underwriters offer lower attachment points of 120 percent, 115 percent or even 110 percent, depending on the size of the employer group and the predictability of the expected claims

b. Some firms also offer aggregate-only SLI (A.S.L. insurance without any specific protection)
▪ Specific coverage protects the predictability of the aggregate coverage and, therefore, reduces the required premium for the aggregate itself

▪ Aggregate-only increases the likelihood that the aggregate attachment point will be breached, and therefore, the premium is materially higher

b. It is possible to have the aggregate attachment point below 100 percent of expected claims
▪ Often used in the smaller employer group marketplace

▪ Names such as retained corridor or “inner aggregate” or “submerged aggregate” are used to describe such vehicles

c. For aggregate-only products, it is important for the actuary to note the maximum benefit per person in the underlying plan and the maximum coverage being provided by the SLI

4. Optional Features of Stop-loss Products
   a. Advance funding, specific accommodation, specific reimbursement or specific advance
   ▪ This provides a device to maintain the technical terms of being a reimbursement contract, while providing cash-flow relief to the self-insured plan

b. Other variations exist to protect cash flow during the year underneath A.S.L., called aggregate accommodation
▪ Offers the potential for A.S.L. benefits to be advanced monthly

▪ Each month, aggregate insurance benefits are calculated on a year-to-date basis
* For example, if after the sixth policy month, total claims subject to aggregate insurance exceed the year-to-date attachment point, insurance benefits are advanced to cover the necessary current claims to be paid
* If claims are low the following month, the aggregate policyholder may have to repay amounts previously advanced

▪ These features often require additional premium

5. Terminal Liability
   a. A self-insured plan that purchases stop-loss coverage on a paid contract basis potentially puts the plan into the position of being responsible for all run-out claims

b. Terminal liability option (TLO) offers the self-insured plan that purchases SLI on a paid contract basis the option to add run-out protection at the end of the policy year

c. The decision to purchase the option must be made at the beginning of the year. For example, add three months of paid claims protection as long as those original plan claims were incurred prior to the end of the policy period

d. The stop-loss actuary needs to be aware of how and when a plan might choose to first purchase, and then exercise, an option to trigger the TLO, and must also consider adverse selection

6. Level Funded Products
   a. A “package” of SLI and related features of a traditional fully insured medical expense policy, like a stable cash flow and the budgetable cost that results

b. The generic terms for such products are level funded and level funding

c. Many small-group fully insured carriers that also write ASO business on larger groups found level funding an interesting alternative to offer their smaller clients

d. Since claims experience and even medical underwriting can be used by SLI underwriters for any size group, level funded vehicles are one way that insurers can offer small groups with good experience more competitive renewal terms than community rating would dictate

e. As such, level funding is used primarily as an alternative to fully insured policies for employers below 150 employee lives (especially below 75 lives)

f. Total contributions required for each employee coverage tier and plan option stays the same throughout the policy year, just like a fully insured policy

g. Level funding, in simplest terms, requires the following:
▪ Some form of SLI that involves aggregate insurance (with or without specific insurance)

▪ Clearly defined and robust specific advance funding and/or aggregate accommodation options for the SLI coverage being provided
* The plan cannot be asked for additional money during the contract year
* Shortfalls that occur must be smoothed out by the advance and accommodation features

▪ The aggregate attachment point must be fully funded
* Each month, the self-insured plan remits all fixed costs and an allowance for claims, which = the aggregate factor multiplied by the number of exposures
* The potential aggregate attachment point is accumulated whether actual claims have accrued for payment or not
* The allowance for claims is deposited into a claims fund

▪ The ASO/TPA administrator uses the claims funding from the full funding requirement and the advance or accommodation options to pay all the covered plan claims, implying that no further funds are required from the self-insured plan

▪ Any balance in the claims fund after full settlement of all plan liabilities may be subject to an additional “contingent” charge by the stop-loss carrier

h. While level funding provides the self-insured plan with a “level” payment (subject to changes in enrollment) like a fully insured plan, the plan is a true self-insured plan
▪ The employer plan is self-insured, and it is an ERISA-based employee benefit plan

▪ The policy is a true form of SLI and it simply has additional features

▪ Actuarial analysis of SLI written in conjunction with level funding is mostly the same as that for the actual SLI vehicle used

▪ The self-insurance actuary must understand the interactions of the SLI with the risk and profit, as well as any trade-off between aggregate and specific premium and the residual charge feature that may exist on a level funded product

7. Summary of Stop-loss Coverage Types
   a. The self-insurance actuary is involved in pricing and ongoing evaluation of SLI variations on premium rate guarantees, no-laser guarantees, multiple-year guarantees, multiyear policy terms, experience refunds, carve-outs for certain medical conditions or treatments, and other features created by a competitive marketplace

Question 4

Developing Stop-Loss Manuals

Answer 4

1. A rating manual can be established using one or a combination of the following approaches
   a. Creating the manual through analysis of an insurer’s own or acquired data;
   b. Purchasing or leasing the manual from a consultant; or
   c. Obtaining it from a supporting reinsurer
2. The actuary will modify the manual for three key areas
   a. Specific premium rates
   b. Aggregate expected claims factors (to set attachment points)
   c. Aggregate premium rates
3. Specific Premium Rates
   a. The first step to developing a S.S.L. manual: collect the claims and exposure data from which claims distributions may be derived

b. Important to relate a particular claim to a particular exposure with its demographics

c. Important to have exposure information on persons with no claims

d. Claims data may be from the company’s own claims or from outside providers, including:
▪ Other insurers or reinsurers;
▪ Claims payers such as TPAs;
▪ Claims data aggregators; and
▪ Consulting firms

e. These claims need to be compiled into claims probability distributions (CPDs), typically split into rating tiers such as employee, spouse or child

f. The compilation typically starts with claims from groups that have been covered for more than one year. This removes the effect of including policies with claims paid and incurred in the same policy year (i.e., 12/12 policies)

g. Adjustments to the claims amounts include several factors:
▪ Trending from the claims dates to the midpoint of the prospective rating period;
▪ Adjusting from the claimants’ relative cost areas to the manual average cost area;
▪ Adjusting the claims to a common plan of benefits; and
▪ Adjusting the claims to an allowed-charge basis or a standard assumed network discount

h. These adjusted claims are assembled into CPDs by assigning each claim to a “bucket”
▪ The first bucket is for exactly $0.00 claims, which includes plan beneficiaries who either submitted no claims or submitted claims but no benefits were payable

i. A claims probability distribution is then created (Image from text Appendix A)

Question 5

Appendix A (Continued)

Answer 5

j. Adjustments to Specific Base Claim Rates
▪ S.S.L. manual rates are determined by applying adjustment factors related to group risk characteristics, underlying benefits, contract provisions and claims cost controls

▪ Adjustments for Group Risk Characteristics
* Age and gender profile of the employee population
* The geographical location of the employees
* The industry in which the employer is engaged
* The effective date of the stop-loss contract (trend)

▪ Adjustments for Underlying Benefit Plan
* The principal consideration for specific manual rating purposes is the employee out-of-pocket maximum under the plan vs. the standard assumed in the base-cost rates

▪ Adjustments for Stop-loss Contract Provisions
* Contract basis- The base-cost rates assume a standard contract basis, typically paid or 12/15, and if a different contract basis is quoted, the rates must be adjusted
* Contract length- the majority of stop-loss policies are sold for a 12-month period, but between six and 18 months, are also offered
* Benefit carve-outs- the two common carve-outs are for organ transplants and prescription drugs

▪ Adjustments for Claim Cost Controls
* The impact of provider network discounts
* Population health management, disease management and other cost-containment programs
* Reference-based pricing structures adopted by the benefit plan that define the plan’s costs based on an external benchmark such as Medicare fee schedules

k. Deductible Leveraging
▪ A given percentage increase or decrease in claims costs will have a greater increase or decrease in rates as the deductible increases
* For example, a $48,000 first dollar claim is not a stop-loss claim when the policyholder has elected a $50,000 specific deductible
* However, if first dollar claim costs are estimated to increase by 10 percent, that first dollar claim becomes $52,800, which generates a $2,800 specific claim
* Deductible leveraging causes the frequency of claims exceeding $50,000 to increase

l. Loads for Expenses and Profit
▪ Loads need to be applied to determine the final gross manual rates, and they need to cover profit, risk margins, and expenses

▪ Profit margins for S.S.L. may increase as specific deductibles increase because stop-loss claims at higher specific deductibles tend to be more volatile

▪ Profit margins for S.S.L. may decrease as S.S.L. premium increases because the experience of policies with more premium should be less volatile

▪ Expected profit margins tend to be higher for S.S.L. than for fully insured health coverage because of higher anticipated volatility

▪ Expenses included in final gross rates are expressed as a percentage of gross premium
* Commissions and other producer compensation
* Premium taxes
* Administrative expenses
* Corporate Overhead

2. Manual Aggregate Attachment Point Factors
   a. Aggregate attachment point factors for specific groups are commonly determined solely based on that group’s experience

b. Actuaries are often involved in projecting claims based on experience

c. Stop-loss carriers may also wish to employ a manual calculation of aggregate attachment point factors for a number of reasons
▪ Writing of smaller groups where group experience is not 100 percent credible;
▪ Benchmarking experience-derived factors;
▪ Providing an ability to write groups for which experience is not available; and
▪ Determining adjustments to account for changes in benefit plans and provider networks

d. Whether expected claims are derived based on experience, a manual or a blend of the two, some elements are unique to setting aggregate factors
▪ The expected claims need to be reduced by claims expected to be covered by S.S.L.
▪ Expected claims must be adjusted by the stop-loss contract basis to account for differing
paid and incurred periods
▪ The aggregate corridor being quoted needs to be added to the expected aggregate claim rates to determine the attachment point factors
* This is done by multiplying expected aggregate claims costs by a factor such as 125 percent * Aggregate Premium Rates

e. Aggregate premium rates, typically expressed as a percentage of expected first dollar claims, are developed using a Monte Carlo simulation of first dollar claims that starts with the CPD

f. The actuary needs to run the Monte Carlo model for combinations of each of these factors
▪ The number of employees covered by the plan;
▪ The aggregate factor to be quoted, such as 125 percent of expected first dollar claims;
▪ The S.S.L. deductible; and
▪ The aggregate benefit limit, for example, maximum aggregate claim of $1 million

g. Consideration may be given to further adjustments for parameter and process risk
▪ Process risk relates to potential variations of actual claims levels relative to the expected levels
▪ Parameter risk relates to the potential for the stop-loss underwriter to misestimate the expected claims for a given group
▪ Parameter risk includes the risk that the trend factor used period may be low

h. To determine the aggregate premium rate to be charged, the risk percentage rate is applied to the group’s expected claims, either from experience rating or through a manual, to determine the aggregate risk premium
▪ The risk premium is then divided by the number of employees and months to determine a PEPM
▪ For carriers that allow a specific deductible outside the prescribed range, an additional risk load may be applied
▪ The monthly risk rates are then loaded for expenses and profit to arrive at the final aggregate gross premium rates to charge
▪ Additional fees may apply when the carrier offers monthly aggregate accommodation