Actuarial Needs of Self-Funded Health Care Plans

 

 

In General

 

Increasingly, self-funded plans are looking to the actuary for support services.  In this instance, services are recommended numbers supported by an actuarial signature. Actuary means a person recognized by membership in the American Academy of Actuaries, the Society of Actuaries or the Casualty Actuarial Society. Such actuarial services may be provided (1) on an insourced basis (TPA, insurer, intermediary, etc. has its own staff actuary) or on an outsourced basis (such entities use either a consulting or regularly retained actuary or (3) by the plan sponsor retained actuary and not part of the regularly-provided plan services.

 

Scope of Services

 

Each actuarial service described herein meets a legal or accounting requirement. The services herein described involve the following:

 

Government Plan Certification

 

Because self-funded governmental entity plans are basically unregulated

(they are non-ERISA and also non-insurance), several states (Iowa 1 and

Florida 2 and, regarding public school, California and Ohio 4 have specific statutes regulating such plans.  Also, New York requires an actuarial statement as to reserve adequacy, presence of acceptable stop-loss coverage and general actuarial plan soundness in regard to health benefit plans operating as consortiums.

 

Multiple Employer Welfare Arrangements (MEWA)

 

While there are numerous states which require the registration of

MEWAs5, there are also numerous states 6 which require an actuarial statement of reserve adequacy and/or general financial soundness of such. Of the states not shown below, some prohibit MEWAs outright while others allow them to operate unregulated.

Of the six states which require an actuarial certification, the logic of the laws is as follows: such entities are essentially miniature insurance companies and should be so regulated; this logic demands that reserves be adequately funded; that funding levels be reasonable; and that acceptable stop-loss be in place. The actuary's assignment is to see that the regulator's demands are met.

 

COBRA Premiums

 

The COBRA statute makes clear that COBRA premiums for self-funded plans shall be determined on an actuarial basis which takes into account factors to be prescribed in regulations. Such regulations 7 are, to date, not issued. While many non-actuaries calculate such premiums as they see fit, many others have been computed by a qualified actuary. The reasons for having a qualified actuary compute such are these: (a) increased protection for the plan sponsor; (b) such calculations are often very complex; (c) ancillary results (reserves, funding levels, benefit content analysis, etc.).  See the Actuarially-Determined COBRA Premiums sub-site for a more detailed analyses of such computations.

 

The determination of COBRA premiums is often a complicated calculation.  These items are challenging:

 

1.   Claims experience and stop-loss are composite, but the plan has a high-middle-low benefit structure.  Benefit content analysis is needed.  The difficulty of ending up with the low benefit plan costing more than the high benefit plan must be avoided.

2.   All data is provided two-tier but the client wants COBRA premiums to be four-tier, e.g.

3.   Need to separate non-core from core benefits.  Sometimes this is not easily done.

4.   Client wishes variations in COBRA premiums by geographic area; or by age, both of which are easy extensions of the actuarial service.

5.   Client wishes variations in COBRA premiums for reasons beyond COBRA such as (a) preparing 1099’s to highly compensated where benefits are discriminatory (b) a basis for derermining participant contributions; (c) for funding purposes; or (d) for intercorporate expenses transfers.

6.   Stop-loss is specific-only and experience data is limited or unavailable.

7.   Plan is a new plan with no prior claims experience.

8.   Managed care arrangements.  What are out-of-network COBRA premiums, e.g.?

9.   Unique computing challenges include the extra costs to be fairly added to COBRA premiums for (a) lasered participants, (b) aggregating specific, (c) seasonal variations in claims and (d) employer’s internal costs.

 

The practice of some practitioners to set COBRA at fixed cost plus the aggregate funding factor is, at best, risky and at worst illegal.  In one instance where COBRA premiums were challenged (sticky employment termination dispute) in a lawsuit, the presence of an actuarial signature, and the COBRA premiums below maximum proved to be critically favorable to the employer.

 

Benefit Content Comparisons

 

When plan benefits are modified, the effects thereof will appear at once in funding levels, stop-loss premiums, COBRA premiums etc. The measure of such plan costs changes are not measurable by the claims experience method; they are usually measured by a benefit content comparison. Actuaries are frequently called upon to make such comparisons.

 

Benefit content comparisons deal also with these cost issues;

·        Effect on plan costs where a cafeteria choice plan design such as a high v. low benefit is involved.

·        Effect on plan costs of the introduction of an indemnity v. managed care option (HMO, EPO, PPO, e.g.)

·        Effect on plan costs of wellness, behavior changing programs, etc.

·        Effect on plan costs of a decrease (plant closing ) or an increase (merger or acquisition) of plan participants.

 

Claims Reserves

 

The need for claim reserves arises for these four reasons:

 

·        Accountant under authority of AICPA FAS 5 8, wishes such claim reserve to be booked as a liability to a GAAP 9 statement of an employer with a general asset plan.

·        Accountant, under authority of AICPA SOP 92-6 10, wishes such reserve to be actuarially-determined by such standard for purposes of the independent accountant’s statement required by IRS/DOL Form 5500 11. 

·        Accountant, under authority of IRC §419A, wishes to have claim reserves actuarially determined in lieu of relying upon the 35% safe-harbor rules.

·        Actuary, in determining COBRA premiums, usues claim reserves on such computations.

 

Recommended Funding Levels

 

Actuarially-recommended funding levels arise for these reasons:

 

·        In a self-funded feasibility study (proposal), the proposal shows an actuarially-determined best estimate of paid claims along with the traditional dual-range of fixed costs and maximum costs.

·        A plan sponsor (either single employer or MEWA) wishes projected funding levels as part of its tax or funding polices.

·        The employer wants projected claims for the benefits which are provided by the plan, but outside the aggregate.  Examples: dental, vision or short-term disability.

·        The employer wishes participant contributions to be such as to meet certain conditions/restraints such as employer contributions to cover 80% of participant costs and 0% of covered dependent costs.

 

In determining the recommended funding levels, these factors are usually considered:

 

·        Credibility of data varies by size of group, exposure characteristics of participants, frequency of claims, duration of experience period and range of claims severity.

·        Aging of business; underwriting and preexisting influences wear off after a year or so.

·        Special factors; such include shockers and pooling.

·        Replace the actual experience of terminated participants with average experience; may help or worsen experience results.

 

 

Post-retirement Medical Care Benefits

 

The Financial Accounting Standards Board has issued FAS 106 which deals with accounting for post-retirement benefits other than pensions. These rules have had dramatic effect on the balance sheets of many employers, since they require the immediate accrual of post-retirement benefits as soon as they are earned by participants.

 

Change in Reporting Rules.  The new rules essentially treat post­retirement welfare and insurance benefits as a form of deferred compensation and require that the liability for unfunded current and future benefits be accrued as benefits are earned. The current practice of recognizing post­retirement benefits on a pay-as-you-go basis is no longer permitted since it does not provide investors with the information needed to assess the financial consequences of an employer's decision to provide these benefits.

 

In making the calculation of the costs of these benefits, the actuary must project what the future costs will be when each participant and beneficiary becomes eligible for benefits. The inclusion of the projected future costs produces a much larger accrued expense than the employer is now showing on the balance sheet.

 

Post-termination Benefits

 

Sick-pay, severance pay and short-term, disability benefits may all be affected by AICPA FAS 112; only short-term disability benefits are considered. The logic and aim of FAS 112 is different from those of FAS 106 (post-retirement benefits).

 

What triggers FAS 112 is any of these three conditions:

·        The claim cost per participant is one which increases with attained age.

·        The benefit is one which increases with the participant’s length of service.

·        The benefit may be paid while the participant is not deemed an employed worker.

 

The factors create a recognizable liability for the plan sponsor which may be recognized in either of two ways:

 

·        Risk Transference

The risks may be shifted to an insurer, in which event the post termination liability resulting from the above-cited factors is determined by the actuary of the insurer.  In lieu of insurance, an employer-sponsored trust may be used in which event the actuary of the trust, following mandates of AICPA SOP 92-6 will compute the liability.

·        Risk Assumption

Where the risk is assumed by the plan sponsor by funding such as a general asset plan, the effects of FAS 106 are directly seen. The liabilities which are recognized by the insurer or trust must be actuarially­-determined and reflected on the plan sponsor's books.

 

Demand Management

 

The actuary has a natural interest in demand management because such risk management tool should be properly designed, administered and measured. Health care plan demand management is a risk control technique that uses (a) self-help and self-care techniques, (b) wellness and preventive programs, (c) behavior modification initiatives, (d) utilization review programs dealing with both chronic diseases (diabetes, e.g.) as well as large claims such as AIDS and (e) benefit design amendments (antiduplication, high/low benefits, etc.).

 

Monte Carlo Simulation

 

By using computer-stored random numbers, the Monte Carlo Simulation technique creates a population and performs repeated samplings. For self­-funders, the technique is particularly useful for testing stop-loss premiums for different attachment points. Because the goal of the exercise is the testing of premiums, such exercise is generally done by an actuary.

 

Workers’ Compensation

 

Where employers are direct assumers of workers’ compensation risks, as self-funders, such employers must have such liabilities actuarially-determined to meet state requirements; the accountants would show such liabilities as an employer liability on such employer’s GAAP balance sheet in accordance with FAS 5 and FAS 112.  Only that portion of the liability for claims actuarially incurred and reported are deductible for federal income tax purposes 13; thus, a timing difference between corporate and tax deductions usually exists.

 

HMO Employer Contributions

 

If a health benefits plan offered by an employer (including a state or political subdivision) includes contributions for services offered under the plan, such employer shall make a contribution under the plan for services offered by a federally qualified health maintenance organization in an amount which does not financially discriminate against an employee who enrolls in such organization. For purposes of the preceding sentence, such employer's contribution does not financially discriminate if the employer's method of determining the contributions on behalf of all employees is reasonable and is designed to assure employees a fair choice among health benefits plans.

 

Capitation

 

Since capitation is a form of health premiums and since actuaries are trained to be model builders and compute correct premiums, it is natural that actuaries are being called upon to sign off on capitation. Typically, need will arise where the self-funder exchanges an unknown risk (mental/nervous, or prescription drugs, e.g.) for a known factor (capitation) and wishes to have an independent assessment of such capitation. Even though the assumer has the upside risk, the self-funder wishes to know whether or not the capitation is reasonably accurate. Thus, the actuary is requested to give an independent opinion.

 

Some, but not all, of the factors entering into the compilation are these:

 

·        Scope of Capitation

Primary care, special care, hospitalization, pharmacy, etc.

 

·        Capping Exposure with Stop-Loss

 

·        External Factors

Geography, how long providers have been in practice and community practice.

 

·        Practice Factor

Average age, income, profile of patients and practice characteristics of providers.

 

In the actual computation, often based upon a model, these factors are assembled and dealt with under these headings:

 

·        Business Control Risk

Good rule of thumb is to capitate only what s controllable.  The more the provider does in-house, the more of the practice risk may be capitated.

 

·        Morbidity Risk

Only a small percent of the patients cause the large majority of the costs. Critical here is the factoring of the seriously ill patients.

 

·        Administrative Risk

Expenses, as well as practice costs, must be covered.  Will capitation result in added expenses such as records, statistics, legal, etc.?

 

·        Pricing the Risk

Costs of outside vendors must be deemed to be non-controllable items; past experience of the providers is the only guide in pricing.  Pricing must contemplate contingencies.

 

 

·        Underwriting the Risk

Once the capitation is set, the provider must conduct its practice to not change its practices so as to make the capitation invalid.

 

 

End Notes

 

1.      Iowa Code §590A.15.

2.      Fla. Stat. § 112,08.

3.      Cal. Adm. Code §39602(e).

4.      Ohio Rev. Code §9.83,3 (General Provisions).

5.      Registration only: AR, IL, IN, KA, LA, MN, SC, VA,

6.      Actuarially-certified reserves and general financial soundness:

CA: California Insurance Code §740, et seq,

FL: Florida Statutes §62,4.436, et seq.

      GA:  Georgia Laws §33-501-1, et, seq.

      MI:  Michigan Insurance Code §24,17001, et seq.

      NC:  North Carolina General Statute §58-49.30.

      OH: Ohio Rev. Code Ann. §1739.0, et seq.

7.      ERISA §604(e)

8.      American Institute of Certified Public Accountants Financial Accounting Statement.

9.      Generally Accepted Accounting Principles.

10.  Statement of Position 92-6.

11.  ERISA §103 (a)(3)(A) and DOL Regs. §2520.103-7

12.  See EEOC Regs. §1630.16(f).  Such surcharges are acceptable if not inconsistent with state laws as regards underwriting and classifying risks, which generally involve direct actuarial involvement.

13.  US. v. General Dynamics Corporation, 415 U.S. 486 (1987).