Inside the Black Box Aspects of Actuarial Pricing

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Inside the Black BoxAspects of Actuarial Pricing

• AcademyHealth
• June 8, 2004
• John C. Lloyd FSA, MAAA
• Reden Anders, Ltd.

2
Overview of the Black Box

• Underlying Concepts - Commercial Insurers
• End Game
• Predictability and Adequacy for Risks Assumed
• Generation of Surplus
• Elements
• Claims Costs Estimation and Management
• Expenses
• Profit / Surplus

3
Pricing and Surplus Linkages
Benefits Expenses Taxes
Premium
Balance Sheet
Surplus Solvency Investment Viability
4
Conceptual Model Linkages
Benefits Expenses Profit

• Predictability
• Frequency Control
• Network Negotiation

Benefits 75 - 90 Expenses 8 -
15 Profits 2-10
Premium

• Recovery
• Efficiency

• Risk / Reward
• Surplus Goals

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Reasons for Surplus

• Solvency
• Minimum amounts of surplus to weather
  underwriting downturns
• Measured by RBC formula based on industry
  earnings simulations
• Investment
• Multi-year capital investments in products and
  systems
• Amortize expense over several years
• Viability
• Lower premiums for competitive positioning
• Pure RD
• Mergers, acquisitions, strategic initiatives

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Solvency Surplus Health RBC
Market/Asset Liability Management Risk
Credit Risk

• H3
• Reinsurance
• Capitation
• Receivables

• H1
• Asset Devaluation
• Asset Concentration

Operational / Business Risk
Underwriting Risk

• H4
• Admin Risk
• Rapid Growth
• ASO

• H2
• Product Specific Risk
• Managed Care Credit
• Rate Guarantees

• H0
• Interest in Affiliates

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Pricing - Framework

• One-Year Horizon
• Almost all employer group coverage focuses on a
  single year
• Prices are reset based on actual and anticipated
  cost
• Pooling Concept
• Average rate low-cost individuals cover the
  catastrophic claim
• 80 / 20 Rule bulk of the cost incurred by a
  few individuals
• Turnover
• Seldom the same individuals at risk or on claim
• Groups lapse, employees change
• Claimants recover, new accidents and illnesses
  are incurred
• Underwriting
• Used to create and maintain a broad pool of risks
• Can be used to position and entire block of
  business

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Claims Costs Pooling Concept
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Claims Costs Changes over Time
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Underwriting Maintaining the Pool

• Contractual Provisions - Eligibility
• Rate for Deviation from Pool Demographics
• Rate for Deviation from Pool Industry Factors
• Historical Claims Analysis Rx Large Claims
• Employee Medical Underwriting
• Predictive Modeling
• Balance between cost, market acceptance,
  practicality

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Pricing Approaches

• Experience Rating / Aggregate Claims Basis
• Historical Claims on Aggregate Year-of-Experience
  Basis
• Typical of Employer-Based Indemnity Group
  Insurance
• Service Component Basis
• Utilization/1000 times Cost/Unit for Types of
  Service
• Typical of MCO
• Selection-Based
• Anticipated Utilization by Group for Various
  Options
• Often Used in POS or Consumer-Driven Health Plans

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At Last Formulas

• Experience Rating Premium
• (Claims t-1 Cred) (Pool Claims (1-Cred)
  (1 Trend)
• (1 - Expense - Profit)
• Claims Historical Claims Cost
• Employer experience if available
• Pool Claims
• Manual Rates (drawn from the broad pool of risk)
• Aggregate block of business claims, often throw
  out big claims and replace with pool charge
• Credibility Blending
• Manual Rates or Prior Year Claims
• Credibility based on size of group, may be
  multiple years
• Adjustments to Resulting Claims Cost
• Benefit Changes
• Demographics

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Experience Rating Formula

• (Claims t-1 Cred) (Pool Claims (1-Cred)
  (1 Trend)
• (1 - Expense - Profit)
• Claims Historical Claims Cost
• Adjustments
• Expenses
• Recovery of cost of operations
• Can be flat or of premium often converted to
  anyway
• Profit / Surplus
• Trend Projection
• Claims Costs Estimation and Management
• The primary factor in terms of impact and
  uncertainty

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Service Component Formula

• Utilization of Services times Cost/Service
• Net Claims Cost is Trended and Expenses/Surplus
  Loaded

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Selection-Based Pricing

• POS blends In-Network and Out-of Network Versions
• CDHP blends interplay between Priced Options and
  PCA