Solvency ratios can make or break medical schemes

The irony

One of the perverse results is that under the current framework, if a scheme gets rapid membership growth with a good profile, which is advantageous for the scheme, it will dilute the reserves and can drive the solvency to under 25 percent. Conversely, a scheme losing members who have a good profile, which is bad for the scheme, will experience a release in reserves thereby increasing the levels. This means, schemes that are growing may be less competitive because of the need to build and maintain required solvency levels.

New global thinking

However, it has been recognised globally, and by the CMS in South Africa, that the existing system of determining solvency ratios needs to be revisited. De Villiers says the CMS would like to introduce a solvency framework that will promote growth in the industry while ensuring healthy competition among the schemes.

According to Dr Bobby Ramasia, the principal officer of Bonitas Medical Fund, “locally and internationally, the healthcare system is regulated just as any other business. However, significant reserving regulatory advancement is being undertaken in South Africa under the Financial Services Board (FSB), as well as internationally under so-called Solvency II regulations. These initiatives are major global initiatives aimed at ensuring consistency and latest best practice in setting prudent reserves for insurance products.

“The regulations, in summary, aim to determine the amount of reserves required based on the risks underlying the product and market, referred to as ‘riskbased capital’ techniques. Thus, a company (or medical scheme) with more risk would need to hold a higher reserve than a company with less risk.”

After submissions from local stakeholders, the CMS too found that the most popular option is a risk-based solvency.

Greatest risks to solvency

“Reserves are typically set to cover one in 200 year events and take into account such risks as uncertainty in claims experience, liquidity constraints, investment market uncertainty, operational risks, etc,” Ramasia said. “The two greatest risks in the health-care environment are higher than expected claims followed by investment market risk if the scheme is invested in the equity market.”

Size matters

One clear indicator of risk is the size of the pool of lives being covered. Smaller pools of lives experience more volatile claims, while larger pools experience less volatile claims. All else being equal, a smaller medical scheme will need to hold a larger reserve as a percentage of contributions, than a larger scheme.

What is an equitable solvency ratio?

The CMS is exploring risk-based capital techniques as an alternative to the current solvency calculation framework. The Industry Technical Advisory Panel (Itap) – a body set up by the CMS with collaborative work being done between the CMS, medical schemes, health-care actuaries, administrators and managed care organisations – conducted some research on riskbased techniques in 2012 and presented the findings in March 2013.

The Itap developed a simplified riskbased capital model that allows for three components:

– setting contributions too low results in a risk of operating losses, jeopardising short- and long-term sustainability.

Pricing risk Claims volatility risk

– future claim levels are unknown and volatile, thus a scheme must hold sufficient reserves to beable to meet its obligations. Typically smaller schemes have more volatile experience, which needs to be taken into account.

Liquidity and other risks

– a scheme needs reserves to fund claims and expenses in months where the contributions are insufficient, for expenses in a winddown scenario, for operational risks, etc.

The model assigns a risk category per scheme based on the capital adequacy ratio (CAR) index, with risk category one implying a scheme with more than adequate reserves, whereas a category four implies the scheme is at significant risk of financial ruin. The CAR index is calculated by expressing the actual scheme reserves as a percentage of the required reserves under this model.

The formula developed by the Itap is now publicly available and it appears that risk-based solvency measures for the medical scheme industry may be introduced within the foreseeable future.

The risk-based framework is not without requirements. It must be:

Simple to implement – a complex framework will only increase regulatory costs in an environment already grappling with rising costs.

Identify the most significant risks relevant to the schemes and determine appropriate levels of capital to mitigate these.

Respond fairly quickly to the changing environment and the risks faced by medical schemes.

The methodology must not unfairly advantage some schemes while disadvantaging others.

Analysis of the industry results, based on the 2011 CMS report, identified that the medical scheme industry has been holding almost twice the required reserves that risk-based techniques suggest are necessary to cover 1 in 200 year extreme events.

To build up unnecessarily high reserves is inefficient. To build reserves requires additional contributions from members.

With rising health costs and unavoidable premium increases the bugbear of the industry, and the low growth in the number of people that are joining medical schemes due to affordability, this can only be seen as a positive step forward.

To build up unnecessarily high reserves is inefficient. To build reserves requires additional contributions from its members.