At a Glance
A healthcare finance leader can guarantee recognition of his or her organization’s insurance program and better manage the program’s liability by discussing changes in the following areas with an actuary:
- Claims management
- Coverage or retention
- Financial reporting of losses
- Management goals
- Other insurance and operational matters
Many hospitals and health systems use actuaries to determine unpaid self-insured claims liability for financial reporting and to project losses. (Self-insured unpaid claims are recorded on financial statements as a liability and reviewed during the audit process.) It’s important for healthcare finance leaders to know the full range of key topics that should be discussed with the actuary to guarantee recognition of an insurance program and to better manage its liability
As shown in the exhibit below, hospitals should communicate with their actuaries when they make changes in any of the following areas:
- Reserving, paying, or reporting claims
- Coverage or retention
- Financial reporting of losses
- Management goals
- Other insurance and operational matters
Change in Reserving, Paying, or Reporting Claims
Actuarial estimates are based on the theory that the past is indicative of the future. Estimations of loss development are made on the premise that claims handling, loss reporting, case reserves, and claims payment are handled consistently from year to year. Future loss development, as estimated by the actuary, determines the incurred-but-not-reported (IBNR) losses, which are recorded as a liability on the financial statements.
Case reserves. Case reserves on known, reported claims are commonly established by general counsel and risk management. If the policy for setting these reserves changes, the actuary should be informed. For example, if case reserves are valued at the ultimate, or best, estimate of what the claims will settle for after previously being “stair-stepped” (i.e., incrementally increased), it will be difficult for the actuary to determine the reason for the increase in loss reserves, whether it be a change in management policy or adverse loss experience. This problem may be compounded when higher development is applied to higher losses, resulting in a redundant liability. The actuary may need to rely on alternative methods when management changes case reserves
Claims payment and reporting. If a new initiative is implemented to pay claims faster to get them off the books, the actuary should be informed. Otherwise, the actuary may perceive this change as an indicator of increasing claim severity and overestimate IBNR based on the assumption that this pattern will continue, thereby increasing IBNR. Actuaries also rely on consistent reporting and definition of claims. For example, if a health system’s leaders begin reporting claims that were previously excluded, such as those related to incidents reported or 90-day letters, the actuary might misinterpret the increase in claims as an increase in frequency.
Change in Exposure
Exposure is used to measure an insurance program’s change in risk. Theoretically, the more exposure, the greater the losses and claims expected.
Definitions of metrics. For medical malpractice purposes, exposure is measured in terms of “bed equivalents”—occupied beds, outpatient surgeries, emergency department (ED) visits, and physicians, for example. Actuaries assume that reported statistics are measured on a consistent basis each year. For example, the assumption is that the metrics that define and constitute an outpatient procedure (whether by number of patients or number of procedures) remain the same. If the organization’s leaders change the definition of these metrics, it is important to inform the actuary.
Mergers and acquisitions. When a hospital or health system acquires or sells a division or acquires new members, its leaders should report the transaction to the actuary, as this activity may significantly change loss projections and unpaid claim liability. In another scenario, the healthcare organization may decide to limit risk by discontinuing risky procedures such as deliveries. Although a change in risk exposure should be apparent in the statistics reported to the actuary, communicating the exact driver helps ensure full understanding. When organizations that include self-insured physicians change the physician mix—by hiring more neurosurgeons or acquiring a physician group, for example—this change should be communicated to the actuary. When exposure is evaluated in terms of bed equivalents, an organization could easily double its exposure by acquiring physicians, considering that one ED physician is generally accepted to be equivalent to five or more occupied beds.
Change to Coverage or Retention
The discussion with the actuary should address changes in components of self-insured malpractice retention as well as in other self-insured lines of coverage.
Malpractice retention changes. Hospitals and health systems that self-insure malpractice losses commonly purchase excess insurance on a claims-made basis but record the self-insured liability on an occurrence basis. Self-insured retentions are typically selected based on the loss experience of the organization, marketplace availability, and the price of excess insurance. Although the main retention (which is usually on a per-occurrence basis) is fairly stable, components such as an inner aggregate corridor, deductible, annual aggregate, and excess limits change more frequently. Small community hospitals also may change coverage from self-insurance to ground-up commercial insurance (that is, coverage from the first dollar of loss) during a soft market. Moreover, each location within a system or specialty may have different retentions. Health system leaders should confirm that the actuary has a full understanding of retentions by year and by entity or group within the system.
Other self-insured lines. The healthcare organization also may have other self-insured lines of coverage, such as workers’ compensation or auto liability. Because these liabilities may be viewed as insignificant on the financials in comparison with medical
malpractice, the organization’s leaders may consider them a lower priority. In fact, workers’ compensation exposure for a healthcare entity can lead to significant IBNR losses and is best estimated by an actuary. Some states require a statement of actuarial opinion for self-insured workers’ compensation exposure. As of 2012, in California, self-insured workers’ compensation losses must be evaluated by a qualified actuary for the purpose of collateral, as stated in California Senate Bill 863, with the first actuarial report due in May 2013.
Change in Financial Reporting of Losses
The actuary also should be aware of changes in loss reserves and financial reporting requirements.
Loss reserves. Senior leaders often determine the structure of their organization’s self-insurance program and make key decisions regarding the program, among the most important being to decide whether to discount loss reserves (i.e., unpaid claim liability) and, if applicable, to identify which discount rate to use. If the decision is made to discount reserves, the organization’s leaders should be able to support the discount and provide the rationale for the discount rate to both the auditor and the actuary. The discount rate is inversely related to loss reserves; if the discount rate is lowered, loss reserves will increase.
Senior leaders also must decide whether to book loss reserves at actuarial central estimates—formerly known as the mean—or at designated percentiles. (Medical malpractice is among the few lines of insurance coverage in which booking above the mean is permissible and not uncommon.) The actuary should be informed of any changes, especially because the discount rate may change with each evaluation.
Other reporting changes. Information about periodic updates in financial reporting requirements should be disseminated to all parties. An example of such a change is Financial Accounting Standards Board Accounting Standards Update 2010-24, requiring all healthcare entities to present reserves on a gross-of-excess basis as well as a net-of-excess basis.
Actuaries also should know about changes in internal treatment of program expenses, such as the treatment of unallocated loss adjustment expenses. For example, if a previously excluded provision is included in the reserves, the actuary should be informed.
The healthcare organization’s leaders also should discuss with the actuary any tail liability that may need to be recorded on the financial statements. For example, a program that purchases commercial insurance for a physician group may need to record a tail liability if the hospital or health system offers occurrence coverage to the physicians. An acquired physician group also may be offered prior acts coverage, increasing the liability to the hospital or health system. It is helpful to give the actuary a complete physician roster that includes detailed information about physicians and coverage.
Change in Management Goals
When management goals change, the healthcare organization’s leaders should inform the actuary to avoid misinterpretations of intentional changes and to help ensure the actuary fully credits the organization for its incentives to improve safety and control total losses.
Intentional changes. When the organization’s leaders discuss the status of the organization’s self-insurance program and potential changes, they may focus on improving safety to prevent claims and control loss experience. Alternatively, priority may be given to improved claims handling through actions such as reporting losses more quickly and maintaining adequate reserves. To gain insight into the potential impact of any future large losses, leaders should talk with the actuary about the level of conservatism in the actuarial projections. It is important for the actuary and an organization’s leaders to be on the same page, understanding each other’s perspectives on stability versus responsiveness in the estimations, because intentional changes can affect an organization’s financial statements.
Allocations and benchmarking reports. When system leaders use an allocation or a benchmarking analysis, the goals should be communicated clearly to the actuary. Allocations or benchmarking reports should be tailored to management goals such as ease of understanding, ease of communication, ease of administration, or stability over time. Leaders should decide how much to rely on exposure, losses, or a blend of the two, and whether any loss caps should be imposed. When benchmarking a program, leaders should compare the program with others on an “apples to apples” basis, meaning with those that have an equivalent exposure and risk profile. The actuary can assist leaders with this exercise. As goals and priorities change over time, the actuary can help modify the allocation or benchmark to align with the new goals.
Loss experience, exposures, and retentions may come to mind as discussion points between hospital or health system leaders and the actuary, but all insurance and operational matters should be discussed, even if not initially thought to affect actuarial estimations. Any change or expected change in tort reform may affect reserves and funding. The actuary can provide leaders with a financial impact assessment. In addition, large losses in the pipeline, new loss trends, or accounts payable for settled-but-unpaid claims should be noted. Even changes in a service provider, such as a third-party administrator or auditor, or internal personnel or management changes, are important for the actuary to know. If leaders expect an increase in hiring or future layoffs, that information also should be conveyed to the actuary because it may affect the frequency of losses in workers’ compensation. Finally, any change to company culture or operational goals that makes the past less predictive of the future, such as the introduction of a safety program, should be discussed.
Getting to the Right Number
Healthcare leaders understand their organization’s insurance program better than anyone else does. The challenge lies in effectively communicating a comprehensive description of the program to all parties, including the actuary, auditor, and broker.
Actuarial estimates are relied upon not only by healthcare finance leaders for financial reporting, but also by the broker for securing reasonable excess premiums and limits. To achieve optimal results, an organization’s leaders should value the actuary as a partner who can provide insight into the insurance program. Through communication and in-person meetings, leaders can open a window into the “black box” of the actuarial process. Leaders should not be afraid to challenge the actuary, as discussions with the actuary often bring to light valuable information that may not have been previously communicated or even considered. The actuary’s role is to provide independent estimates; with productive communication, those estimates will more accurately reflect the true exposure of the insurance program.
Richard C. Frese, FCAS, MAAA, is a consulting actuary, Milliman, Chicago.
Publication Date: Wednesday, May 01, 2013