Patient Protection and Affordable Care Act

That’s an interesting title, isn’t it?

After living with this bill for three months since it’s passage in March 2010, I’m certain that it doesn’t protect many patients and it certainly has nothing to do with affordable care. The bill merely expands federal regulation of medical insurance, usurping a role that has been performed by the states since the industry began. It also establihes a new set of entitlements with woefully inadequate provisions to pay for them. Finally, it establishes a new set of rules for private medical insurers that will drive many carriers out of the business, significantly increasing the likelihood of a federal take-over of the industry.

Despite all of these problems, it is the law of the land, and we must find ways to deal with it. My clients and I are nearly over the shock that the bill was passed in the first place, and we are now beginning to develop strategies. I will share thoughts on these strategies over the coming weeks.

Jeff Miller
Consulting Actuary

Healthcare Reform

I can’t resist offering a few thoughts about the healthcare reform discussions in Washington. As I write this, the House bill has passed and the Senate leadership is meeting behind closed doors. I’ll focus these comments on several aspects of the House bill.

First, I’m not sure what problem the Congress is currently trying to solve. Some possible candidates are:

1. Accelerating healthcare costs
2. Uninsured individuals
3. High unemployment
4. Federal deficits increased by existing programs (Medicare,

As I read the House bill, it is projected to make only a dent in the uninsured problem, and do so at a very high cost. Furhter, those are the projections, and the Congress is famous for overly optimistic projections. More importantly, the House bill seems certain to increase untemployment by imposing higher payroll taxes or additional costs through mandated benefits. Employers are not going to be encouraged to hire more people.

I’ve heard one Congressman state that the House bill will give everybode access to a plan similar to that available to federal employees. Federal employees represent perhaps the largest and most stable group in the world. We have learned many times that one can’t combine many small and unstable groups and get the same experience as a large and stable group. I guess the federal government is now going to learn this lesson again based on its own mistakes.

In order to control risk in a medical insurance program, one must achieve a mix of at least 80% “healthy” people and at most 20% “sick” people. The sick people are quite happy to buy medical coverage, but the healthy people resist. The House bill encourages the healthy people to by coverage by putting them in jail for five years if they don’t! Why didn’t we think about that in the health insurancce business?

The politics of healthcare are truly challenging. However, we can solve most of the problems listed above by establishing a base plan for everyone that is financed through a payroll tax or (my preference) a federal sales tax. This base plan might be a leaner version of the Medicare benefits. In fact, Medicare Advantage would be a great platform to start from. That would allow employers and individuals the opportunity to “upgrage” their benefits through private plans. Such a plan was designed my Milton Friedman for Chile, and has been copied throughout Latin America. However, someone would need to define the basic plan, and then we would need a tax on the “middle class” to pay for it. Thus, this idea is not likely to go very far.

We’ll see what happens!

Jeff Miller.

Start-Up Insurance Companies

Some might view it as a strange time to think about starting a new insurance company. However, contrarians might suggest that this is the perfect time. I have been involved with a number of start-up companies over the years, and I would like to share some lessons that I have learned.

The most important first step is to identify a market. Start-up companies depend on a significant volume of sales that generate value. Thus, the company needs to focus on a market and products with significant demand. Further, the market price for this product needs to exceed the marginal costs by a significant percentage. In other words, the product needs to be highly profitable when only marginal expenses are considered.

The second topic to address is distribution. If the market is significant and the margin available for expenses and profit is large, then distribution should not be a problem. However, distribution costs are always difficult to control. In fact, all aspects of the distribution function are difficult to manage. Start-up companies must address these issues immediately and continuously throughout their operations.

The third topic to address is people. The company won’t be started in the first place without a committed entrepreneur. That person needs to consider himself or herself as chief executive officer and chief marketing officer. During the start-up phase, neither of these two functions can be delegated. The secong person to add is a consulting actuary. That certainly sounds self-serving, but I believe it is true. An experienced consulting actuary can help with product design and financial management. He or she can also help with administrative issues. However, more importantly, an experience consulting actuary can help the new company deal with regulators, investors, and agents. The third and final key hire is an administrative manager. This person deals with day-to-day challenges, particularly cash flow. These functions will get out of hand without strong daily management.

The next thing to address is money. A start-up company’s first need is operating capital. I have seen too many companies started with inadequate operating capital. Starting an insurance company is going to be expensive. Operating expenses are likely to be at least $2 million in the first year, with very little cash flow from premiums. Money is also needed for risk capital. Risk capital can often be obtained through reinsurance, but that source is expensive. Risk capital is going to cost at least 15% per year for a start-up, and there is no way to get around it. If, however, the company controls its own risk capital, then this capital can be managed and invested effectively.

The final ingredients for a start-up company is regulatory authority and a financial security rating (AM Best, S&P, etc.). Regulatory authority is needed to issue insurance products. Start-up companies in the US face the challenge of obtaining licenses in several states, and that takes time. As a practical matter, security ratings are also necessary in order to sell insurance products. However, they take even more time. Most start-up companies decide to “rent” regulatory authority and security ratings through fronting arrangements. However, such arrangements can be problematic. I don’t really see any way to avoid fronting arrangements, but I always encourage start-up companies to begin building their own companies, with licenses and ratings, as soon as possible.

These are some of my experiences with start-up companies. Your thoughts would be greatly appreciated.

Jeff Miller.

Small Group Medical Insurance

I recently met with a prospective new client to discuss small-group medical insurance. He was a very bright financial executive who had little experience with small-group medical insurance. He found some of my assertions about the market to be counter-intuitive. Small group medical is a very large market that can look attractive. However, the following facts, learned from bitter experience, must be kept in mind.

First, and most importantly, you can’t combine a number of small groups and treat the whole like a large group. This strategy has led to too many financial disasters for the risk takers who have tried it. The reason is too many decision makers. When a number of small employers band together to form a risk pool, each one still has the option of leaving the pool at some point in the future. They also have the option of not joining the pool in the first place. Over time some of the insured lives will develop chronic conditions. Thus, premium rates will begin to increase in order to cover those claims. Those small employers without any chronic conditions will be able to find cheaper coverage elsewhere, and they will leave the pool. As a result, premium income will drop, but claims will not drop as much, and premium rates will spiral upwards. Premium rates of small-group programs must always be kept as close as possible to rates available to each group in the open market. Otherwise, the sick groups will stay and the healthy groups will leave.

Second, premium rates must always be kept as low as possible. Most small employers can not afford to pay more for medical insurance than is absolutely necessary. The three keys to marketing success have always been price, price, and price. Low prices are driven by restrictive networks, lean benefits, tight underwriting, and aggressive administration. You can’t just choose one of these strategies. You must employ all of them. The most healthy groups are always the most price sensitive. Thus, a successful program nearly always has the lowest price.

Finally, no exceptions to the rules can be allowed. There is always pressure for underwriting and claims concessions, particularly when powerful agents are involved. Underwriting and claims administration for small-group medical insurance are nasty, but exceptions frequently lead to failure for a program.

I consider small-group medical to be one of my specialties. However, it is not a game for the faint at heart, and basic priniciples must always be kept in mind.

Jeff Miller.

International Healthcare

Healthcare expands to consume the available money.

I’ve had two opportunities to learn this basic lesson. I’m determined not to require a third.

The first opportunity was in Bogota, Colombia. Colombia had established a system of socialized medicine very similar to the system established in Chile. The system in Chile was designed by Milton Friedman and it made a great deal of sense. The government collected money for a mandatory basic health plan through payroll taxes. That money was then funneled back to local health plans (similar to HMO’s in the US) as directed by the employer. Local health plans were required to buy reinsurance for “catastrophic events” (those costing more than about $US 4,000). The system looked sound, theoretically.

The problem came with the reinsurance arrangements. Many international reinsurers entered the market, bringing new money into the system. Healthcare expands to consume the available money. Thus, healthcare for catastrophic events expanded to take advantage of the new reinsurers. Pricing based on historic experience proved to be inadequate, and a number of reinsurers lost money. A good bit of fraud didn’t help the situation much either.

My second opportunity occurred recently in Brazil. Once again, a new insurer, sponsored by a US company, enters the market. This time fraud played a bigger role. The healthcare providers combined forces with a few brokers and a few internal employees to significantly inflate claim expense. The problem was discovered only after extensive and detailed audits. Once the fraud was eliminated, it appears that claim costs are returning to expected levels.

These international experiences have taught me that the first step in establishing a new health plan is to build systems for reducing healthcare costs. Then, and only then, can you begin signing up customers. United Healthcare has used this approach in the US. Hopefully, I won’t need to learn the lesson a third time.

Jeff Miller.

Healthcare Financing

I have the privilege of serving on a committe of the American Academy of Actuaries that develops thoughts on the issues of small-group medical insurance. We are hopeful that our thoughts are considered useful by Members of Congress, their staff, and officials in the Obama Administration. Healthcare financing is an extremely complex topic, and yet we strive to simplify the issues and discuss the likely consequences of alternative policies.

Through all of this discussion, it is clear to me that some elements of healthcare must be considered a right, and not a privilege, by a civilized society. It is also clear that some elements of healthcare must be considered a privilege, and not a right. Someone must draw the line between these two. Further, placement of that line depends to a large degree on cost. Cost depends to a large degree on where the line is drawn. Thus, design and management of healthcare financing systems will be a challenge for many, including actuaries, for some time to come.

Healthcare financing interests many different parties, including patients, insureds (who are not yet patients), healthcare providers, payors, and governments. As actuaries, we can assist each of these parties. We must focus on their interests and their inter-relationships with the other parties.

I believe we can improve the system currently existing in the US. However, I don’t believe that systems that work in the US will necessarily be similar to systems that work in other countries. Any system in the US must recognize the entrepreneurial nature that has driven nearly all innovation since the beginning of this country. As health actuaries, I believe we will contribute to the effort to find better solutions. I also believe that those efforts will continue for many years to come, with a number of interim solutions implemented in the meantime.

Thank you.

Jeff Miller.

Actuarial Management in a Recession

This is a commercial for small actuarial consulting firms — mine and others.

If you are responsible for the actuarial work in a risk-assuming organization, I’m sure you are striving to get the most from a limited budget. However, you can’t afford to let anything slip in the current market. Your organization can lose much more money from an actuarial mistake than it can save from reducing the actuarial budget. On the other hand, many organizations are limiting new hires in this environment. Also, large consulting firms cartainly have their place, but they can be very expensive.

Consider working with a smaller consulting firm. Smaller firms can offer the following advantages:

1. You are generally working directly with the firm’s principal. That person is usually a highly experienced actuary who is fully committed to his or her practice and clients.
2. Actuaries in small firms are usually very well connected in the industry, so if they need help from others, they can obtain that help in a very cost-effective manner.
3. Small firms, by definition, can’t serve very many clients. Thus, you will be very important to the principal and his or her firm.
4. Small firms don’t have the same level of overhead of large firms. Billing rates are often substantially lower.

Sure, I’m a small firm (a firm of 1), and I will benefit if risk-assuming organizations look favorably on small actuarial consulting firms. However, I believe that those responsible for actuarial management can significantly enhance the effectiveness and efficiency of their department if they consider using small consulting firms as one of their resources.

Thank you.

Jeff Miller
March 26, 2009

Excellence in Actuarial Work

There are only two things more expensive than good actuarial work - Bad actuarial work and no actuarial work at all.

This statement certainly holds true for organizations that assume, spread, or manage risk. However, defining good actuarial work is not that easy. That’s why I’m asking you to share your thoughts on excellence in actuarial work through this blog.

Maybe the most important tool an actuary can have is a crystal ball. Our projections would be much more accurate if we could see into the future. However, that’s like saying that the most important resource that a gambler can take into a casino is luck. Unfortunately, we don’t have a crystal ball. Like the old joke says, we give directions to the driver of a car by looking out the rear window.

However, excellent actuarial work can, potentially, do the following:

1. Identify trends and project the meaning of continuation of those trends.
2. Find opportunities for financial transactions to create value for all parties involved. Value, of course, is in the eye of the beholder.
3. Identify financial arrangements that are not sustainable.
4. Quantify the impact of adverse or favorable experience and the risk or probability that such experience will develop.
5. Design programs that will achieve the objectives of those who participate.

Allow me to offer some examples of situations that must have involved excellent actuarial work at some time, and probably are benefiting from such work today:

1. Northwestern Mutual Life
2. State Farm
3. United Healthcare
4. Some of the most solid private pension plans (I would love to hear of some examples)
5. Chile’s public pension system (designed by Milton Friedman)

I hope you will share some examples of excellent actuarial work that you have encountered. Please tell us the following:

1. What problem or need was the program trying to address?
2. How has the program been a success?
3. How did actuarial work contribute to that success?

Thank you for your participation.

Jeffrey D. Miller, FSA
Consulting Actuary