Why should you use an actuary for self-funded groups?

How often nowadays do your self-funded clients express concern about their health plan budgets? Seems like every day, doesn’t it? With medical inflation rates hovering around 9%, pharmacy trend in double digits and stop loss renewal rates in the mid-teens to 20s, not to mention ongoing health care reform requirements, it’s no wonder CFOs and HR professionals need you more than ever.

How are you helping your self-funded clients with their IBNR and budget setting? I’ve heard of a few situations lately where the broker tells me that the client just handles this on their own. Your client may think they know best but what they are doing is gambling with potentially a multi-million dollar budget. What if they are wrong? Do you think they will want to take the blame? Not likely, when they can blame their broker who gave them bad, I mean no, advice. Enter new broker who uses an actuary and points out that not doing so could lead to mistakes like the one they just suffered. Say “sayonara” to that client.

I’ve also had a few brokers tell me that they basically do for their clients what an actuary does. Brokers are great at their jobs, but an actuary is not a broker who can only do one part of the job. I can’t do what you do, and you can’t do what an actuary can do. How can an actuary help? An actuary is trained to perform complicated claims analysis. What we do complements each other and helps the client make informed decisions.

So when the CFOs and HR professionals look to you and say, “Now what?” That’s when you smile and reply, “Now we bring in our actuary.”

The bare minimum involvement that I recommend for an actuary in self-funded cases is a year-end IBNR reserve and rate development/budget setting because the plan sponsor needs an IBNR appropriate to its own claim experience and adequate rates to avoid an operating loss in the plan. Relying on the administrator to provide these recommendations causes a host of issues.

C’mon, you say, I review the administrator’s workup and it looks pretty involved. Hold up. So are you telling me that when it comes to fully insured renewals, you’re just paying what the carrier asks for? Of course not, that would be leaving money on the table. So why, then, would you take the administrator’s word for it regarding your self-funded groups when it comes to IBNR and claim projections when the administrator is typically just processing claims and isn’t taking any risk except for perhaps stop loss on large claims?

If the administrator isn’t taking any substantial risk, what motivation does it have to go to any extra lengths to customize an estimate specifically for your self-funded client? Not much. The administrator’s figures are typically based on its book of business averages, and it will typically use its trend to make projections. What it gives you and your client amounts to an accommodation in the absence of a better alternative, and it’s hardly what I would call “negotiated” despite any back and forth that may occur between the broker and the administrator. Some analyst is probably blindly handing you whatever the administrator’s black box spits out. Is that really how your self-funded client wants to set its budget and IBNR?

I hope not, because the black box may give you an answer based on experience that includes only 11, not 12, months of claims. I’ve seen that. Or perhaps the answer will be exclusive of pharmacy claims because, oh that’s right, it was carved out last year. Seen that as well. And what’s this god-awful maturity factor in here trying to make up for missing the run-out from the recently terminated prior administrator? The administrator knows what the administrator knows and sometimes doesn’t know it that well, while your job and an actuary's job is to know our client’s plan as well or better than the client knows it, at least certain aspects of it like the drivers of claims.  

Relying on the administrator to set the IBNR reserve is a mistake because it doesn’t typically look at the client's own run-out experience; it (again) relies on averages which may not be accurate for each self-funded group. Relying on a rule of thumb to set IBNR reserves is risky as well. Let’s say you eschew the administrator and look to a staff member with an underwriting background, and he/she suggests the client holds such and such as a reserve. You might be OK in a normal year, but you're taking a gamble that you won't need a big adjustment if the nature of the plan changes due to, say, overutilization or irregularities in payment patterns.

Ever had a year when you underfunded the IBNR reserve? Ever been nervous about having to come up with money at year end, praying that experience gets better? Have any self-funded clients who are OK with end of year surprises and ending at a loss because of an IBNR adjustment? You have to be careful that your client isn't holding too much money in reserve which keeps it from being used elsewhere, and more importantly, isn't holding too little money which would then drain resources from other areas or raise red flags upon audit.

Case in point. A self-funded prospect (now client) had been maintaining a lower IBNR reserve due to a perceived high fund balance. Upon a change in external auditor, the reserve level came under scrutiny. My actuarial analysis of the plan’s true run-out experience demonstrated that a more natural reserve level was $92,000 higher than what they were holding. While the reserve strengthening amounted to an additional expense, it was strategically timed to a period in which the plan experienced an operating gain that would more than finance the change in IBNR. The client was happy to raise the strength of its balance sheet and relieve itself of auditor pressure so that it could focus on running its business.

In another case, the administrator for a self-funded group was using an 11% trend, which you might say is the general market trend. This group had low utilization and was actually trending closer to 6% on a sustained per employee per month basis. We conservatively added 3% margin and used 9% overall, and in doing so saved the client millions of dollars on its budget over what the administrator had suggested.

In another situation, I was brought in to work with a self-funded client following a year in which it had relied on the administrator’s claim projection rather than that of an actuary and ended up $250,000 in the hole on a claim spend of $2.0 million. What’s worse, the news of the deficit ended up in the public eye and caused all sorts of political issues. Sound familiar? I bet you are glad this isn’t your client. I discovered that there was a gap in the experience that remained unfilled by the administrator, and that the administrator was about to perpetrate the same mistake again! So I fixed it using an actuarial technique, giving the client a more realistic projection for the next budget cycle so it could set its premium rates to a more appropriate level. While the change meant higher rates, the client’s CFO was pleased to have an explanation for the prior shortfall and happy at the prospect of being more on target in the coming year.

And what is being assumed by the administrator for the self-funded large claim incidence? Does anyone have any idea what’s normal for this particular group, and not just the “average” for like-sized groups? An actuary does, and that is crucial to budget setting, to negotiating stop loss contracts and to identifying opportunities for your client. I have developed an actuarial buying tool that helps you understand the true cost/benefit analysis of the stop loss decision and whether it makes sense to raise or lower an attachment point given the reinsurer’s quotes and the self-funded employer’s expected large claim experience. Knowing what’s normal for them, we can then scenario test for bad and good years to take advantage of kinks in reinsurance pricing. Knowing the true cost/benefit as determined by an actuary gives you facts to negotiate with and can save your client money on the one real thing to negotiate for self-funded groups.

How might that work, you’re dying to ask? Using a large claim expectation model, I helped a self-funded client better understand its large claim experience and what it should expect from year to year given its single/family mix. The actuarial cost/benefit analysis revealed an opportunity, given the reinsurer pricing for several attachment points. I recommended a minor increase in the specific stop loss threshold, moving up from $175,000 to $200,000. The client realized annual savings of $630,000 in lower fixed costs, with only the moderate increase in its expected large claim exposure. This was a client under enormous pressure to cut costs, and the savings gained through this analysis helped save the jobs of 16 employees.

So once we’ve gotten beyond the basic actuarial needs, we can focus on the fun stuff like an actuarial accrual accounting model that is unlike other self-funded plan management reports because it is on an incurred claim rather than just paid claim basis. This difference means a self-funded client can assess the true adequacy of its premium rates and whether its accruals are correct, i.e. will it make its budget or not. It includes detail showing the gain/loss position and IBNR on a monthly basis, and scalars so it can easily be coordinated with and calibrated to the client’s own internal accounting. I’m sure you’re conducting a mid-year review with your clients, but the pricing for the current year is at least eight months old, maybe ten. How many CFOs or benefit managers do you know who would like an updated clue about how the year is expected to turn out so they can plan ahead? How happy do you think your self-funded client would be if you demonstrated a dynamic actuarial accrual model that re-casts the rest of the year as new data comes in to provide early warning of rate inadequacy or good news of lower than expected utilization? Do you think your client would love you for the heads up? Add another month or two of experience and it’s a great basis for next year’s budget development.

Then, prepare to dazzle your self-funded client with a time-saving contribution strategy model that incorporates eight different scenarios to help allocate a renewal change between the employer and its employees’ payroll deductions. It can be useful to explore different philosophies, should they be brought on by economic pressures, benchmarking, multi-site considerations, union contracts or mergers and acquisitions. The output includes detail showing rates for all plans and all scenarios so a client can make decisions faster.

Self-funded groups are the ones that are the more heavily prospected of your clients than any other, by regional brokers who use an actuary in the service of their clients, and national players with an actuary (or several) on staff. Don’t get left on the sidelines of the game by relying on a disinterested third party administrator. Instead, level the playing field. For self-funded groups of any size, having an actuary on your team is the only alternative.