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The Actuary The magazine of the Institute & Faculty of Actuaries

Excess reinsurance treaty considerations

The most important consideration in
the reinsurance purchasing decision
is determining the risk objectives of
the organisation. This article
addresses the issues faced when purchasing
medical excess reinsurance on a medical portfolio.
The proper risk analysis performed by the
insurer, or in conjunction with its reinsurer, will
address the following considerations:
? What is predictable risk versus unpredictable
? Is coverage purchased just for the rare catastrophic
claim or for more frequent types of
large claims?
? What is the appropriate reinsurance
deductible for the health insurer, and how is
it stated?
? How is the maximum reinsurance benefit
? Is coverage purchased for losses occurring
during a 12-month calendar period or for
policies/risks that attach during a 12-month
? How do any special deductibles impact the
reinsurance layer?
? Does the insurer want risk fully transferred on
a non-participating basis, or does the insurer
want to retain a portion of the risk through
a participating or other type of basis?
? How are costs for claims management shared?
Medical excess normally covers all claim
charges from an individual that exceed an
annual excess deductible. The reinsurer’s liability
mirrors the claim liability of the insurer. In
other words, the liability of the reinsurer shall
begin and end with the liability of the company.
As a result, the reinsurer will be very interested
in how the insurer and its third-party
administrators manage large claims and the
networks that they utilise. A poorly managed
claim can result in a large claim liability for the
reinsurer. The following discusses the considerations
in designing a reinsurance agreement.
Reinsurance design considerations
? Predictable risk versus unpredictable risk.
Predictable risk arises from claims that can be
expected to occur each year within a range of
deviation. Unpredictable risk, which usually is
not fully considered, refers to claims that may arise once every five, 10 or more years. Examples
of unpredictable risk include a medical
claim that exceeds £2 million or more during a
year; a jumbo claim from a procedure that borders
on being experimental but is deemed as
covered under a plan; claims from a catastrophic
event; or claims arising from extracontractual
? Working layer coverage versus catastrophic
coverage. A working layer is defined as an
excess deductible level for which the insurer,
with relative certainty, will have at least several
claims exceed that deductible each year. Claims
in a working layer can have some volatility, but
the volatility as a percentage of premium is usually
lower. By purchasing reinsurance at a working
layer, the insurer has more predictable
experience for a product than just purchasing
coverage for claims at a catastrophic level. The
downside is that the insurer will pay more in
reinsurance premiums and possibly margins to
the reinsurer for this lower deductible layer.
A catastrophic coverage layer is one where the
insurer expects, at most, to have just a few
excess claims a year, and in some years will have
no claims that exceed the deductible. The cost
of such coverage is much less than at a working
layer, and the reinsurance recovery received
when a claim exceeds that high layer is reduced
by the high deductible. Therefore the cost to the
insurer is less, but it is important to note that
the potential recovery is less as well.
? Reinsurance deductible. A reinsurance excess
deductible is established based on a review of
insurer goals and risk tolerance. The setting of
the deductible is a blend of quantitative risk features
and qualitative risk tolerance. In many
cases a lower reinsurance deductible may be
desired from a subjective risk tolerance level,
though quantitatively a higher level could be
purchased. Defining the deductible is also important
when purchasing excess medical reinsurance
to cover claims arising from an employer
stop-loss plan. One approach is to purchase an
excess deductible that includes claims paid both
by the plan up to the specific deductible, and
the insurer above the specific deductible. The
other option is to include only claims paid by
the insurer in excess of the specific deductible.
? Reinsurance maximum. The maximum benefit
reinsured can be different from that covered
under the medical plan. Frequently, the medical
plan provides a lifetime benefit. The reinsurance
treaty will provide a maximum benefit
that is the lesser of an annual maximum or the
insured’s available lifetime maximum.
? Loss occurring or risk attaching. The
deductible can be determined on a calendaryear
basis for losses occurring during a period
or for risks that attach during a calendar year.
The decision depends on the type of risks
covered. For insured medical risks, where an
incurred date for each claim is clearly established,
the medical excess coverage can be on a
12-month loss-occurring period, such as a calendar
year. A risk attaching coverage period is
used frequently for group coverage. During the
12-month agreement period for the reinsurance,
each underlying group is covered beginning
on its next anniversary date or the
effective date for a 12-month period.
? Impact of special deductibles. Special deductibles
arise in several ways:
? For employer stop loss, a higher specific
deductible may be set for an individual as a
way to underwrite known or projected
claims in lieu of higher premiums. This practice
is called lasering. The excess medical
treaty should define how the excess medical
reinsurance deductible is impacted by lasering.
One such approach is to have the
reinsurance deductible increase by the same
monetary amount that the laser exceeds the
employer group’s specific deductible.
? Another option under an employer stop-loss
policy is offering an aggregating specific
deductible. An aggregating specific deductible
requires the employer’s plan to not only
pay claims up to the specific deductible on
each person, but also to self-insure claims in
excess of the specific deductible until the
aggregating specific deductible is met. the
following is an example of such a situation:
(i) An insurer sells a stop-loss policy with a
£200,000 specific deductible.
(ii) The stop-loss policy has an aggregating
specific of £500,000.
(iii) The insurer purchases excess medical
reinsurance for claims of more than
£500,000 (on a first pound basis).
(iv) If one person has a £650,000 claim, the
self-insured plan is responsible for the first
£200,000 as part of the specific deductible.
In addition, £450,000 of claims in excess of
the deductible satisfy a portion of the
£500,000 aggregating specific deductible.
In such a case, assuming no other claims from that employer group, neither the stoploss
insurer nor the reinsurer would have a
claim liability.
If this example were changed so that one
person had a £650,000 claim and two people
each had £300,000 in claims, the stop-loss
insurer would have a £150,000 claim. The
reimbursement under the excess medical reinsurance
could be handled in one of several
ways. The reinsurance could be designed to:
? pay the £150,000, since this is the
amount in excess of the £500,000 deductible
and is not in excess of the insurer’s
? have no claim liability for this particular
? pay a percentage of claims determined
by dividing the excess claim liability
(£150,000) by the amount of claims
exceeding the £200,000 deductible (ie
£150,000 divided by £650,000).
? Risk transfer options. An insurer can decide
whether a non-participating or a participating
arrangement is desired.
A non-participating arrangement is desired
when the insurer wants to lock in the cost and
not have future earnings positively or negatively
impacted by the excess reinsurance
experience. With a non-participating arrangement,
the insurer does not realise positive
experience results in a year directly; rather the
impact of any positive results would be potentially
recognised in current and future renewal
premiums. From an accounting perspective, a
non-participating arrangement is easier since
future experience refunds need not be
accounted for or projected. For a participating
arrangement, there is a risk of prematurely
accounting for a refund, which increases
reported earnings in a quarter. Subsequently,
this releases the accrued refund asset when a
large claim is reported, thereby creating a charge
to earnings.
A participating arrangement is selected by an
insurer that desires to reduce its costs when
experience is favourable. Participation can arise
in several forms:
? Profit commission. A traditional way is that
a percentage of the experience gain is paid
back to the insurer, after providing for the
reinsurer’s risk margin and expenses.
? Swing rate. In such a case the insurer pays a
‘minimum premium rate’ until claims
exceed a defined percentage of that rate. At
this point the premium rate ‘swings up’ proportionately
to claims, but does not exceed
a ceiling ‘maximum rate’. A swing rate allows
the insurer to have reinsurance costs that are
proportional to normal claims fluctuations,
but also locks in the cost in case of an unusually
high claim level.
? Aggregating specific deductible. Another
common way for an insurer to have a participating
arrangement is to have a second
deductible for claims in excess of the
deductible over which the reinsurance begins
to pay. The coverage is frequently nonparticipating
once claims exceed this deductible
and become the liability of the reinsurer.
? Lower deductibles for defined conditions. In
some cases, a lower excess deductible is offered
by the reinsurer or requested by the insurer for
certain conditions: eg an organ transplant where
a network is established with preferred pricing.
? Claim management expenses. Many times
on large medical claims, a third-party auditor or
vendor will be utilised to review the hospital
charges and to further negotiate a reduction on
charges. The manner in which these expenses
are shared needs to be defined in the reinsurance
agreement. Following are two approaches:
? Claims management expenses are shared
proportionately based on the amount of the
billed claims.
? Claims management expenses are covered in
the same manner as any other claims cost.
Therefore, if the final amount of claims
exceeds the excess layer, the reinsurer pays
all of the claims management expenses. If
the final claims amount is below the excess
deductible, the insurer pays the expenses in
addition to the underlying claims up to, but
not exceeding, the excess deductible.
? Contested claims. The insurer should notify
the reinsurer of its intention to contest a claim
that might exceed the excess deductible. If the
reinsurer chooses not to participate in a contested
claim, the reinsurer shall pay its full
amount of reinsurance liability on such claim
and shall thereby be relieved of all future liability
with respect to such contested claim. If
the reinsurer joins the insurer in a contest or a
compromise, the reinsurer shall participate in
the same proportion that the amount at risk
reinsured with the reinsurer bears to the total
amount at risk to the insurer on the claim, and
shall share in the reduction in liability in the
same proportion.
Insurer decision process
In selecting excess deductible and reinsurance
options, the reinsurance decision maker may
consider the following:
? Frequency and severity of claims at various
deductible levels. What has been the insurer’s
recent experience with excess claims?
? Risk profile of insurer’s membership.
? Risk tolerance and budget considerations.
How will management respond to a claim
reported in a quarter that is in excess of
£500,000? £1 million? £2 million or more?
? Insurer size and coverage type. Is the standard
insured maximum benefit £1 million or
is it £5 million?
? Underwriting margin and results. If the plan
is marginally profitable, one large claim may
result in a loss for the year. If the plan is very
profitable, the insurer may want to retain risk
rather than pay potential reinsurance margins.
? Insurer’s financial strength and parental support.
? Capital requirement of product. Excess products
such as employer stop loss require more
capital than first pound products.
? Relative size of medical block within a company
compared to other insurance products.
? Reinsurer’s expertise and market knowledge.
Renewal process
Most agreements are one year long and must be
amended each year as part of the renewal activity.
To change rates, the parties must mutually
agree to amend the terms of the treaty, for
which notice must be given 90 days in advance
by either party. One way to provide a shorter
notice of rate change and to allow for proper
time to evaluate experience is for the reinsurer
each year to send to the insurer a preliminary
notice of termination more than 90 days before
the treaty anniversary. The reinsurer will then
prepare renewal terms and normally present to
the insurer 3045 days prior to anniversary. If
the offer is accepted, the reinsurer will send a
treaty amendment to the insurer that reflects
the renewal terms and rates.