RETHINKING MEDICAL SCHEME RESERVINGRoshan Bhana

Why do schemes need to hold reserves?• Reserves buffer against adverse experience

– Absorb unexpected claims volatility– Used to fund unexpected claims– Catastrophic events

• Reserves should reflect the level of risk faced by the scheme– Not all schemes are equally risky– Consider all sources of risk

• Claims• Credit• Operational• Investment

What events do schemes need protection against?

• High cost claims– Single events with low frequency but significant cost

• Variability of claims• High volume, low cost claims• Failure of scheme service providers

– If service providers could not continue doing business, would the scheme be able to continue to operate?

• Asset risks– Risk of investments losing value

Current reserving requirements• Regulation 29 to the Medical Schemes Act 131 of 1998

– Accumulated funds may not be less than 25% of gross contributions for the accounting period under review

• Shortcomings of current requirements– Fixed 25% is not reflective of the risks faced by each scheme

• 25% will be too much for some schemes, but too little for others– Penalises growth which improves the stability of the scheme– Members ultimately bear the cost through additional contribution increases– Requires reserves to be held for MSA

• 2013 reserves held: R 43.194 billion

Possible measures of solvency• Status quo: 25%

• ITAP formula:

– LR: Liability Risk, dependent on scheme size and pricing strategy– OR: Operational Risk, dependent on impairment losses and level of NHE– AR: Asset Risk, dependent on investment strategy

• Stochastic modelling approach – Risk of Ruin:– Each scheme should hold reserves sufficient to prevent failure with reasonable levels of certainty

• Liability measures – not considered for this presentation

222 ARORLR

25% Solvency• Industry reserves required (2013): R 32.382 billion

• 9 schemes underfunded– R 3.851 billion underfunded

• 77 schemes overfunded– R 14.662 billion overfunded

• Industry overfunded by R 10.812 billion

ITAP Formula:• Industry Reserves required (2013): R 15.797 billion

• Top 9 Open and 10 Restricted Schemes:– 3 schemes underfunded– 16 schemes overfunded

• Industry overfunded by R 27.397 billion

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Stochastic Modelling Approach:• Stochastically simulate one year’s claims for each scheme

• Calculate the probability of failure in the next yearProbability of failure of 0.5% - risk of failure once in the next 200 years

• Reserves calculation:– Worst-case claims in the next year minus 85% of risk contributions– High level of conservatism built into calculation– Prevent a 1 in 200 year event - 99.5% chance of continued sustainability

Stochastic Modelling Approach:• Claims reserves required (2014): R 31.151 billion

• 17 schemes underfunded– R 6.896 billion underfunded

• 69 schemes overfunded– R 18.939 billion overfunded

• Industry overfunded by R 12.043 billion

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Implications of an alternative statutory solvency requirement• Distribute excess reserves to members

– Unlikely given that members cannot be called upon in cases of under-capitalisation– Won’t be allowed by Regulator in current environment

• Potential for lower future contribution increases– Certain schemes would have an extreme advantage in the short-term, especially

larger schemes– Need to consider regulation to prevent advantage– Schemes may be able to adopt alternate pricing philosophies– Current practice for some schemes above the 25% statutory solvency requirement– Regulation may be required to remove artificial advantages

Implications of an alternative statutory solvency requirement• Transfer of assets from over-funded schemes to under-funded

– Form of reserve equalisation– Alterative to risk equalisation

• Increase medical aid access (LCBOs) – Schemes with reserves in excess of RBC measures or alternate measures may actively pursue extended coverage for current uncovered members– May be easier to implement for sector or industry funds

• Transferred to industry fund– Would still be used as a buffer for extreme events– May be met with high level of resistance– Likely to be extremely unpopular

Implications of an alternative statutory solvency requirement• Removal of barriers to entry and exit

– Current potential new entrants may be discouraged from entering environment due to onerous solvency requirements

– Current schemes over the 25% statutory requirement may be lulled into a false sense of security when considering the current requirements in the absence of a purely risk based measure

• Schemes could pursue a more aggressive Investment Strategy – the very basis of the source of this discussion.

Acknowledgements

• Alison Counihan• Stefan Bekker• Cecilia Augustine• Roshan Bhana

THANK YOU