In the past decade, the employee benefits market has undergone some significant changes. These changes have been brought about by Clients and Brokers, Governments, Insurers, and Self Insurance, Each transfers an element of risk to benefit plan sponsors.
Clients and Brokers
When asked why they have benefits; clients usually state that they offer benefits to “be competitive, attract quality employees, retain and motivate staff by showing interest in their well being”. Usually, there is no formal method in place to evaluate if these objectives are being met; nor to decide what benefits design is necessary to achieve these goals. Because benefits have an annual renewal, clients typically pay closer attention to plan management at renewal, to avoid rate increases.
The goal is to reproduce the existing plan; with no reduction in benefits, at a reduced price. The reduced premiums, which result from marketing the plan, validate this way of thinking. At renewal, clients are using these extremely low quotes to leverage their negotiations with their current carrier. This bidding mentality does not factor in the long term effects of increased risk. Clients are taking on additional risk either voluntarily as when accepting promotional discounts or involuntarily as when the benefits environment is changed by external forces, such as changed legislation.
Some examples of hidden risks to benefit plans:
- U.S. television pharmaceutical commercials marketing direct to the public (Urging employees to “Ask your doctor…”)
- Aging population coupled with new legislation disallowing mandatory retirement age
- Improved dentistry
- Increased long-term disability claims
- The Consumer price index during this last decade has averaged about 3%/yr. The Health Care combined inflation and trend factors have been about 13%-15%. Dental trend and fee guide increases have averaged about 5%.
First, through a gradual downloading of risk to private plans. The two examples of this trend are the removal of Chiropractic coverage and eye exams from O.H.I.P.. This has meant that benefit plans now have increased costs for covering these items from first dollar.
And Second, is the introduction of significant initiatives which the government believes will be valued by their electorate.
- Bill C-91 extension of patent protection for proprietary drugs – has led to increased costs due to significant new drug breakthroughs and also the repackaging of old drugs.
- Privacy Legislation has led to increased administration costs
- In an effort to lower the cost of car insurance premiums, the government introduced No Fault Auto Insurance. One of the ways in which this controlled the cost of purchasing car insurance was that private benefits plans were made first payor for the costs of caring for an employee who is injured in a car accident.
Insurers have been competing ferociously with one another for bigger market share. As a consequence, they are quoting rates which, in some instances, are even insufficient to pay claims. If they are awarded the business at these discounted rates, they face the hurdle of the first renewal. Rather than writing the client a cheque for the amount of the marketing discount, Insurers reduce the unit rates for both Health and Dental. When the claims experience is analyzed at the first renewal, the required increases look disproportionately high because this discounted premium starting point was artificially low. (see table below)
Triggered by this seemingly large increase in the first year, clients will often ask for another marketing. This second plan marketing will show large premium reductions available from the new business discounts from other carriers. To keep their client, the insurer may apply a marketing discount again. Typically, insurers find themselves in a cycle of unprofitable renewals till they can no longer lose money and the case moves to a new provider, where the cycle begins again.
Although there are variations on the theme, the typical renewal calculation is based on; more or less complex versions of the following formula:
The insurer establishes a rate for your group based on the actual claims ratio generated by your employees. At renewal, any losses are absorbed by the insurer as are any excess premiums. The following year’s rates are then adjusted to reflect the previous year’s utilization.
The lower the starting premium, the higher the percentage adjustment that is required at the first renewal. However, the total required premium is the same. The insurer is not trying to recapture their losses but rather, forecasting the premium that will be required next year.
In a Self Insured or A.S.O. (Administrative Services Only) program, a third party (can be an insurer or T.P.A.( Third Party Administrator)), is employed to adjudicate and pay claims, and to administer the plan. The administrator takes no risks and acts only as a clearing center for claims. The insurer or TPA charges a fixed percentage of paid claims, or a flat rate per claim, to cover their costs for adjudication expenses. The client company is responsible for all health and dental eligible claims, plus expenses, up to the pre-defined individual or group pooling level (Stop-Loss).
For a plan which is self-insured, the typical premium calculation formula looks something like this:
Paid Claims + Inflation + Admin Expenses + Stop Loss Pooling + Premium + Taxes – Cash-flow interest
All these components of cost exist in traditional insured plans as well. Self Insurance produces the lowest administrative costs because the risk belongs entirely to the client. If the claims are higher than anticipated in the preceding year, the administrator will not only calculate a higher premium for next year, but also recapture any deficits incurred in the previous year.
It is important to note that changing to ASO will not eliminate the need to consider inflation/trend factor assumptions or even the need to reserve. (Under A.S.O. the client can hold a notional reserve on their own balance sheet) We may debate over the exact reserving that would be prudent or the actual inflation rate (ranging from 10%-15%) but, on average, 80%-85% of the premiums are used to pay claims. The savings then; are on the remaining 15%-20% which are the expenses. Therefore, the offer of extravagant savings, to be realized through self insurance, may not materialize because we are still only saving on the administrative portion of the plan.
Do Your Homework Before Shopping for a Benefits Plan
- Select a broker – Establish performance criteria for Broker
- Establish Value proposition (philosophical drivers) for the benefits
- Discuss risk tolerance
- Establish a budget
- Discuss plan changes or improvements based on #2 above
- Establish costing for Pooled Benefits (Life, AD&D & L.T.D)
- Before shopping, evaluate the risks posed by each funding method, select the most appropriate
- Determine catastrophic claims pooling level
- Establish performance criteria for carrier and specific renewal methodology
- Create a formal written policy for how long the company will keep an absent (from any cause) employee on the benefit plan
- Check to see if the General Liability insurance policy of the company has an “Administrative Error” Rider, if not, obtain costing
- Review Internal Administrative practices to assure compliance with Labour Standards, Privacy, and Human rights legislation
Now you are ready to shop the plan.