-0-

Pandemics, Catastrophic Trends and Capital Issues

John P. Cookson, F.S.A. Milliman, Inc.

-1-

Tail Risk

Pandemic is the prime example Other risks could combine to reach this level Pandemic combines with other risks and can occur at same time

as other unfavorable risks

1572

-2-

Measurement of Healthcare Risk

Typically related to increases in Loss Ratio (LR) above target Always expect some random fluctuation LR a function of premiums and claims Both driven by claim cost trend

– Claim trends determine future claims when applied to past claims– Past claim trends, inaccurate forecasts of past claim trends and

forecast of future claim trends determine premium

So claim trend is a primary driver of LR fluctuations Claim cost trend is primary driver of healthcare underwriting risk

1572

-3-

Types of Risk in Healthcare Insurance

Management Risk– Bad decisions

Other (non-controllable)– Political--Obamacare, mandated benefits, rate regulation, exchange

risk corridors, rebates, risk adjustment

Random Risks– Catastrophic claims, epidemic, catastrophes

Economic Risks– Unanticipated changes in the economy affecting trends– Economic growth, inflation

All can affect perceived trends

1572

-4-

Risk Affects Capital Needs

Capital needed reflects the risks taken Size and geographic spread affects risk Access to capital affects risk Reinsurance or other risk transfers can control risk Does reinsurance or risk control necessarily reduce the capital

you need since if it reduces risk?– Counterparty Risk– Regulator RBC Credit?– Rating Agency RBC Credit?

1572

-5-

Impact of Trends on Rating Lag

1572

-6-1572

-5%

0%

5%

10%

15%

20%

25%

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Adjusted HCI and S&P Claims Indices vs. CPI-W (1-Year Trend, 12-Month Lag) +

Personal Income (3-Year Trend, 18-Month Lag)

Trend Composite CPI-W 1-Year Trend 1-Year Lag + PI 3-Year Trend 18-Month Lag

Historical Trend Fluctuations

-7-

Impact of Trends on Underwriting Cycle

1572

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Blue Cross/Blue Shield Underwriting Gain/Lossvs. Change In Healthcare Trends

Blue Cross / Blue Shield Underwriting Change in Health Cost Index

-8-

Modelling for Pandemic Risk

Pandemic Risk Development– Potential Impact of Pandemic Influenza On the U.S. Health

Insurance Industry report, Jim Toole with input from panel of actuaries

– Estimates cost impact of 1957 and 1918 level pandemics– Potential cost impact

Two point estimate not enough Need chance of occurrence

– Rely on Life cat bond work

Trend history has epidemics since early 1970s and 1960 for NHE

1572

-9-

Develop Loss Ratio Model

First build model of other risks Driven by claim trend fluctuations plus other factors Then add in pandemic risks on top of other risks as simulation Flow trends thru rating system model

– Historic trends flow thru to rates along with forecasts– Future trends simulate claims

Rating model should be for homogenous classes rated on same basis– Prospective, contingent premium, refunds, etc.– Don’t mix Medicare Advantage with Commercial– Homogeneous risk characteristics

1572

-10-

Develop Loss Ratio Model--Premiums

Bring in other premium variables– Lag between experience and renewal data– How rates are developed– Impact of past trend estimates– Predictability of trends and methods– Target LR– Healthcare Reform impacts– Expenses and margins, lapses and sales– Pandemic rating effects

1572

-11-

Develop Loss Ratio Model--Claims

Model of historic trend fluctuations Impact on different carriers Size of block effects Starting cost estimate fluctuations Healthcare reform effects Correlations of trends Pandemic model impacts

1572

-12-

Develop Loss Ratio--Composite

Divide simulated claims by simulated premiums Distribution of Loss Ratios Develop probabilities of attachment at various LRs Develop expected costs at various LRs

1572

-13-

In Event of Severe Pandemic with no Protection

What happens to RBC How do you recover? Impact of ACA Loss Ratio rebate requirements

1572

-14-

Cat Bond Development

Use Loss Ratio Model as base for bonds Bond proceeds at risk of loss if attachment LR exceeded

– Proceeds held in trust

Risk premium over short-term investment rates– Represents payment for risk– Bond Rating Valuations

Provides capital relief for proceeds held in trust Long-term must continue reissuing or

– Raise other capital to replace

Rating agencies limit on how much credit provided in their ratings

1572

-15-

Alternative Methods

Use forecast of trend methods with simulations– Good forecasts can reduce variability and costs

Use swaps or reinsurance on trends– Can limit to pandemic with two triggers

• High trends plus flu pandemic

S&P Healthcare Claims Indices – Futures and Options?– Swaps– Traditional Reinsurance– Issue of capital credit for risk

Some need tighter protection than just pandemic (ACOs)– Better modelling, trend prediction, etc. can tighten the ranges

1572

-16-

Control of Trend Risk

Until recently no clear database S&P Claims Based Indices introduced in October 2013

– History back to early 2008

Insurers and ACOs beginning to explore links to S&P– How do you increase future payment levels?– How do you measure performance?– How do you share risk?

ASO groups looking for trend protection in future costs as a way to measure and guarantee performance

1572

-17-

S&P Trend Detail

National, Regional, most States, some Metro areas Several medical service breakdowns

– IP, OP, Practitioner, Rx

Individual, Small Group, Large Group, ASO

1572

-18-

S&P Total Cost Trends

1570

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

Feb-

10A

pr-1

0Ju

n-10

Aug

-10

Oct

-10

Dec

-10

Feb-

11A

pr-1

1Ju

n-11

Aug

-11

Oct

-11

Dec

-11

Feb-

12A

pr-1

2Ju

n-12

Aug

-12

Oct

-12

Dec

-12

Feb-

13A

pr-1

3Ju

n-13

Aug

-13

Oct

-13

Dec

-13

Feb-

14A

pr-1

4Ju

n-14

Aug

-14

Oct

-14

Total Cost - 12 Month Trends

National ASO Total Cost National Individual Total Cost

National Large Group Total Cost National Small Group Total Cost

-19-1572

Impact of Individual on Total Healthcare Costs

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

May

-09

Jul-0

9S

ep-0

9N

ov-0

9Ja

n-10

Mar

-10

May

-10

Jul-1

0S

ep-1

0N

ov-1

0Ja

n-11

Mar

-11

May

-11

Jul-1

1S

ep-1

1N

ov-1

1Ja

n-12

Mar

-12

May

-12

Jul-1

2S

ep-1

2N

ov-1

2Ja

n-13

Mar

-13

May

-13

Jul-1

3S

ep-1

3N

ov-1

3Ja

n-14

Mar

-14

May

-14

Jul-1

4S

ep-1

4

Total - 3 Month Trends

Total Total Excluding Individual Differential

-20-1570

S&P All Business Trends

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

Feb-

10A

pr-1

0Ju

n-10

Aug

-10

Oct

-10

Dec

-10

Feb-

11A

pr-1

1Ju

n-11

Aug

-11

Oct

-11

Dec

-11

Feb-

12A

pr-1

2Ju

n-12

Aug

-12

Oct

-12

Dec

-12

Feb-

13A

pr-1

3Ju

n-13

Aug

-13

Oct

-13

Dec

-13

Feb-

14A

pr-1

4Ju

n-14

Aug

-14

Oct

-14

All Business - 12 Month Trends

National All Business Facility Cost National All Business Professional Services Cost

National All Business Rx Cost National All Business Total Cost

-21-

S&P Healthcare Claims Indices

Standard & Poor’s and S&P are registered trademarks of Standard & Poor’s Financial Services LLC, a part of McGraw Hill Financial. Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”).

1572

-22-

Disclaimer

This presentation is a general outline of certain issues related to Health Insurance Risk. This is not to be relied upon for any applications by any user, since the particular circumstances may differ from the general discussion here. Actuarial estimates are based upon sets of assumptions and to the extent the future results differ from these assumptions, the estimates will differ from actual results. Furthermore, there is significant variability in health insurance which makes results subject to considerable uncertainty.

1572