How providers calculate costs, payments
The financial and rating aspects of employee benefits can be a mystery to anyone outside the insurance industry. Thousands of dollars of life insurance can cost pennies a month, while dental coverage seems to cost about the same as one visit to the dentist.
Setting premiums
In group insurance programs, premiums are based on a combination of the chosen plan design, past utilization and the characteristics of the plan sponsor’s workforce (such as age, occupational risk). For life insurance coverage or for employers with a small workforce, the insurer may use the results of its entire block or “pool” of business in the analysis because of the relatively low incidence, and therefore the unpredictability of these claims. Life insurance premiums do not therefore necessarily equate to the paid claims from one plan.
With the greater frequency of health and dental claims, the “law of large numbers” allows insurers to predict future trends. The predictability or credibility of past results will increase as the size of the workforce, and therefore the number of claims, increases. As a result, annual health and dental premiums usually bear a resemblance to the total annual claims paid out for a plan, plus administration costs. This is particularly true for large employers.
Setting premiums for long-term disability (LTD) coverage falls somewhere along the spectrum between the pooled and the experience-rated approaches to insurance underwriting. LTD premiums are based on a combination of the results of the insurer’s entire block of business and the sponsor’s plan utilization patterns. The weight that is given to the plan sponsor’s own past results is usually higher for employers with a larger workforce. LTD premiums are probably somewhere in between health and dental premiums, and life insurance premiums in their relationship to paid claims.
Adjusting for claims
When health and dental claims are submitted to the insurer they are adjudicated and benefit payments are made. At the end of the policy year, the carrier reviews the claims experience and makes corrective adjustments to the premiums for the upcoming year. The underwriter’s objective is to consider past claims trends and attempt to predict the future so that the new premiums equal the payment of claims plus expenses, in the coming year.
Rick Holinshead, managing partner, Ontario group practice at Morneau Sobeco, says, “You might think of it as steering your car by looking primarily in the rear view mirror — a larger workforce simply means a larger mirror, more information and better navigation.”
In recent years, health and dental premiums have steadily increased. This is a result of higher-cost drugs, new treatments, an aging population and higher utilization rates per capita. “At present these factors combine to yield annual claims cost increases of 15 to 20 per cent for health benefits and seven to 10 per cent for dental care,” Holinshead says.
Although LTD insurance is funded through the payment of monthly premiums, when the insurance carrier approves a claim, it must calculate the costs and establish a reserve, based on a present value calculation, to finance the monthly benefit payments for the duration of the disability. This may, in the case of a total and permanent disability, continue until the claimant is 65.
Within the present value calculation, assumptions are made based on prevailing rates of return in the financial markets. During periods of low rates of return, larger amounts must be set aside for the future claims liability. This has the effect of increasing the insurer’s premium requirements to establish these “disabled life reserves.” High interest rates generally translate into lower disabled life reserve requirements, and therefore lower LTD monthly unit rates.
“In today’s investment environment,” says Holinshead, “many LTD rate adjustments are in the double digits, after a period in the 1990s of relatively stable LTD costs.”
Managing risks
If the benefits program is structured on either a retention/refund or budgeted ASO (administrative services only) basis, the plan sponsor assumes ownership of year-end results. A surplus or deficit is calculated annually, in arrears. ASO balances are often discharged immediately at the end of each policy year. Surpluses generated under retention/refund arrangements are generally accumulated and carried forward in the form of contingency reserves, premium holidays or a refundable surplus, while deficits may be amortized over two or more years to be discharged by future plan results.
Health and dental claims, because of their higher incidence and therefore higher predictability, are the most commonly considered components of a benefits plan for retention/refund or ASO arrangements.
Plan sponsors with health or dental programs can protect themselves against adverse fluctuations by purchasing high amount pooling insurance. In return for a pooling charge, the insurer agrees to take full financial responsibility for any amounts above a pre-determined threshold (for example, $10,000 or $20,000 of claims per plan participant). This insures the program’s financial results against the unexpected occurrence of very high claims by one or a few participants in the plan.
Since life insurance and disability claims are less predictable, these coverages are often provided on a fully insured, non-refund basis under which the insurer combines the year-end financial results of all its policy holders. No refunds are made to the plan sponsors, but similarly no deficits are allocated for recovery from plan sponsors.
“The bottom line for plan sponsors,” says Mariola Andrusky, senior director, group insurance underwriting at Desjardins Financial Security, “is that the average cost of group insurance plans is between four and five per cent of the employee’s salary, and rising.”
What does that mean?
•Fully insured: The carrier guarantees the financial backing and cash requirements to fund all eligible claims incurred while the contract is in force, even if claims’ liabilities run on past the plan’s lifetime (for example, long-term disability claims may be paid to the insured person to age 65.)
•Hold harmless: Under certain circumstances, in exchange for the carrier agreeing to waive its reserve requirements, the plan sponsor and the carrier enter into a “Hold harmless agreement.” If the plan sponsor terminates the program with the carrier, and a final accounting determines that a deficit exists on the books, then the plan sponsor agrees to reimburse the carrier for the full amount of the deficit.
•Pooling: Every experience-rated plan sponsor has its own maximum capacity for the acceptance of financial responsibility for incurred claims under its plan. To mitigate risk associated with unusually high levels of claims in a given year, the sponsor can negotiate a “pooling” arrangement whereby the carrier assumes the unwanted risk in exchange for a non-recoverable premium charge (the pool charge). If claims exceed the pre-determined pooling “trigger point,” the carrier absorbs the excess loss. If the pool charge is not sufficient to cover the pooled claims, the carrier accepts this as a cost of doing business. If the pool charges exceed the pooled claims, the carrier keeps the surplus.
•High-amount pooling: Normally offered for health insurance, this pools benefits claims in excess of a pre-determined dollar limit per claimant per year. In exchange for this protection, the carrier levies a charge against the policy. This form of pooling allows the plan sponsor to share in profits, while limiting potential losses from a small number of high amount claims.
•Stop-loss pooling: This form of pooling is offered for life insurance. It pools claims in excess of a pre-determined percentage of the premium, usually between 110 per cent and 150 per cent. The plan sponsor pays a pooling charge in exchange for the insurer’s acceptance of claims in excess of the predetermined percentage of the premium. This allows the plan sponsor to share in profits, and at the same time limit the negative consequences of a very high volume of paid claims, a small number of high amount claims, or both.
•Refund accounting: Refund accounting is the method of calculating in-year surpluses and deficits. Plan sponsors that are prepared to share the risk associated with a group insurance program also want to share in the profits that arise in those years where claims are low. The carrier provides a year-end financial report outlining the financial position of the program and the allocation of any surplus or deficit.
Source: Aon Consulting.
Setting premiums
In group insurance programs, premiums are based on a combination of the chosen plan design, past utilization and the characteristics of the plan sponsor’s workforce (such as age, occupational risk). For life insurance coverage or for employers with a small workforce, the insurer may use the results of its entire block or “pool” of business in the analysis because of the relatively low incidence, and therefore the unpredictability of these claims. Life insurance premiums do not therefore necessarily equate to the paid claims from one plan.
With the greater frequency of health and dental claims, the “law of large numbers” allows insurers to predict future trends. The predictability or credibility of past results will increase as the size of the workforce, and therefore the number of claims, increases. As a result, annual health and dental premiums usually bear a resemblance to the total annual claims paid out for a plan, plus administration costs. This is particularly true for large employers.
Setting premiums for long-term disability (LTD) coverage falls somewhere along the spectrum between the pooled and the experience-rated approaches to insurance underwriting. LTD premiums are based on a combination of the results of the insurer’s entire block of business and the sponsor’s plan utilization patterns. The weight that is given to the plan sponsor’s own past results is usually higher for employers with a larger workforce. LTD premiums are probably somewhere in between health and dental premiums, and life insurance premiums in their relationship to paid claims.
Adjusting for claims
When health and dental claims are submitted to the insurer they are adjudicated and benefit payments are made. At the end of the policy year, the carrier reviews the claims experience and makes corrective adjustments to the premiums for the upcoming year. The underwriter’s objective is to consider past claims trends and attempt to predict the future so that the new premiums equal the payment of claims plus expenses, in the coming year.
Rick Holinshead, managing partner, Ontario group practice at Morneau Sobeco, says, “You might think of it as steering your car by looking primarily in the rear view mirror — a larger workforce simply means a larger mirror, more information and better navigation.”
In recent years, health and dental premiums have steadily increased. This is a result of higher-cost drugs, new treatments, an aging population and higher utilization rates per capita. “At present these factors combine to yield annual claims cost increases of 15 to 20 per cent for health benefits and seven to 10 per cent for dental care,” Holinshead says.
Although LTD insurance is funded through the payment of monthly premiums, when the insurance carrier approves a claim, it must calculate the costs and establish a reserve, based on a present value calculation, to finance the monthly benefit payments for the duration of the disability. This may, in the case of a total and permanent disability, continue until the claimant is 65.
Within the present value calculation, assumptions are made based on prevailing rates of return in the financial markets. During periods of low rates of return, larger amounts must be set aside for the future claims liability. This has the effect of increasing the insurer’s premium requirements to establish these “disabled life reserves.” High interest rates generally translate into lower disabled life reserve requirements, and therefore lower LTD monthly unit rates.
“In today’s investment environment,” says Holinshead, “many LTD rate adjustments are in the double digits, after a period in the 1990s of relatively stable LTD costs.”
Managing risks
If the benefits program is structured on either a retention/refund or budgeted ASO (administrative services only) basis, the plan sponsor assumes ownership of year-end results. A surplus or deficit is calculated annually, in arrears. ASO balances are often discharged immediately at the end of each policy year. Surpluses generated under retention/refund arrangements are generally accumulated and carried forward in the form of contingency reserves, premium holidays or a refundable surplus, while deficits may be amortized over two or more years to be discharged by future plan results.
Health and dental claims, because of their higher incidence and therefore higher predictability, are the most commonly considered components of a benefits plan for retention/refund or ASO arrangements.
Plan sponsors with health or dental programs can protect themselves against adverse fluctuations by purchasing high amount pooling insurance. In return for a pooling charge, the insurer agrees to take full financial responsibility for any amounts above a pre-determined threshold (for example, $10,000 or $20,000 of claims per plan participant). This insures the program’s financial results against the unexpected occurrence of very high claims by one or a few participants in the plan.
Since life insurance and disability claims are less predictable, these coverages are often provided on a fully insured, non-refund basis under which the insurer combines the year-end financial results of all its policy holders. No refunds are made to the plan sponsors, but similarly no deficits are allocated for recovery from plan sponsors.
“The bottom line for plan sponsors,” says Mariola Andrusky, senior director, group insurance underwriting at Desjardins Financial Security, “is that the average cost of group insurance plans is between four and five per cent of the employee’s salary, and rising.”
What does that mean?
•Fully insured: The carrier guarantees the financial backing and cash requirements to fund all eligible claims incurred while the contract is in force, even if claims’ liabilities run on past the plan’s lifetime (for example, long-term disability claims may be paid to the insured person to age 65.)
•Hold harmless: Under certain circumstances, in exchange for the carrier agreeing to waive its reserve requirements, the plan sponsor and the carrier enter into a “Hold harmless agreement.” If the plan sponsor terminates the program with the carrier, and a final accounting determines that a deficit exists on the books, then the plan sponsor agrees to reimburse the carrier for the full amount of the deficit.
•Pooling: Every experience-rated plan sponsor has its own maximum capacity for the acceptance of financial responsibility for incurred claims under its plan. To mitigate risk associated with unusually high levels of claims in a given year, the sponsor can negotiate a “pooling” arrangement whereby the carrier assumes the unwanted risk in exchange for a non-recoverable premium charge (the pool charge). If claims exceed the pre-determined pooling “trigger point,” the carrier absorbs the excess loss. If the pool charge is not sufficient to cover the pooled claims, the carrier accepts this as a cost of doing business. If the pool charges exceed the pooled claims, the carrier keeps the surplus.
•High-amount pooling: Normally offered for health insurance, this pools benefits claims in excess of a pre-determined dollar limit per claimant per year. In exchange for this protection, the carrier levies a charge against the policy. This form of pooling allows the plan sponsor to share in profits, while limiting potential losses from a small number of high amount claims.
•Stop-loss pooling: This form of pooling is offered for life insurance. It pools claims in excess of a pre-determined percentage of the premium, usually between 110 per cent and 150 per cent. The plan sponsor pays a pooling charge in exchange for the insurer’s acceptance of claims in excess of the predetermined percentage of the premium. This allows the plan sponsor to share in profits, and at the same time limit the negative consequences of a very high volume of paid claims, a small number of high amount claims, or both.
•Refund accounting: Refund accounting is the method of calculating in-year surpluses and deficits. Plan sponsors that are prepared to share the risk associated with a group insurance program also want to share in the profits that arise in those years where claims are low. The carrier provides a year-end financial report outlining the financial position of the program and the allocation of any surplus or deficit.
Source: Aon Consulting.
