CIA Annual Meeting Assemblée annuelle de l’ICA June 29 & 30, 2006  Les 29 et 30 juin 2006 Ottawa, Ontario Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA From Simple to more Complex –Pooling –Traditional Retention (aka “Retrospective Experience rating” or “Unilateral Arrangements”) –Pure Self-Insurance (aka “Pure ASO”) –Partial Self-Insurance (aka “ASO/Stop-Loss” or “Minimum Premium Plan”) With Aggregate Stop-Loss With Large Amount Pooling With both Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Single Goal: Get the lowest possible cost Anatomy of Group Insurance Cost – of claims – Premium Taxes – Claims Processing Expenses – Insurer’s Administration Expenses – Insurer’s Risk Margin – Insurer’s Profit Margin – Broker’s Commission – Sales/“Special” Sales Taxes (Ont. & Quebec) Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Potential Sources of Savings in a Group Plan – Circumstancial Sources Premium lower than expected due to tight negotiation with Insurer Premium based on someone else’s risk Irrational Action by Insurer – Analytical Sources Claim cost lower than expected Actual expenses lower than expected Reduced risk and/or profit margin of Insurer Tax loophole (if any) Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Single Goal: Get the lowest possible cost Different Approaches: – Let the Insurer take the whole risk Maybe because you have no bargaining power – Your group may be too small Or you are concerned with potential bad claims experience – And you want stable / predicable costs Or you try to minimize the Insurer’s margins – In the estimation of the cost of claims and expenses – In exchange for the rewards of a potentially good experience  Fully pooled arrangement ( Try to get the lowest possible premium rates) Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Different Approaches: – Share the risk with the Insurer: Leave the insurer some margin in exchange for the possibility of an experience rating refund You have bargaining power You are more concerned with the risk that the insurer might benefit from your good experience than with the risk that the insurer would want to recover a deficit You are willing to negotiate with the Insurer over – Risk margin, Profit margin and Expenses – Reserves (IBNR, DLR)  Good old-fashioned retention Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Different Approaches: – Keep the Whole risk: Get rid of the Insurer’s insurance margins You can save the Risk margin + part of Profit margin linked to the insurance operations + maybe some taxes You have bargaining power You are financially strong enough to take the whole risk You are sophisticated enough to handle the actuarial aspects or you have a good consulting actuary You need someone to help with the administration – Can be an insurer or a TPA/TPP  Pure Self-Insurance Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Different Approaches: – Get the best of both worlds: Let the insurer take the hits - Save on recurring costs You can save part of Risk margin + part of Profit margin linked to the insurance operations + maybe some taxes You have bargaining power You do not want to get hit by large claims (ex. out-of- country medical) or by unexpected utilization – You need a cap on what you will pay You need someone to help with the administration – Can be an insurer or a TPA/TPP  Partial Self-Insurance Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Pooling – Insurer charges a pre-determined premium and takes the whole risk No retrospective premium adjustment – No experience refund – No deficit carry-over Total cost is determined at beginning of year – Assuming no change in insured population within the group Next year’s premium is based either on: – Current year’s experience without deficit recovery, or – Insurer’s rate manual, or – Experience of a pool of similar groups Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Pooling – Used for small groups on Life, AD&D, LTD, STD, Health, Travel and Dental – Experience is not credible – Little bargaining power  No need for Insurer to return any part of underwriting profit – Any other approach would be expensive to administer – Used for large groups on AD&D and Travel (often used on Life and LTD) – Experience is not credible – Risk of loss > Potential reward for good experience – Pooling of Life is often partial (e.g. excess over $50,000 / employee) Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Pooling – Can also be used on STD, Health and Dental for larger group (mostly medium-size) New groups if Insurer quotes at a loss Other groups where – E (Underwriting surplus) ≤ 0 on the long run (because of tight negotiation) – Insurer’s expenses are very tightly negotiated (cannot be lower) Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA “Old-Fashioned” Retention / Unilateral Retention – Insurer shares an underwriting surplus with client Retrospective premium adjustment – Creation of a Claims Fluctuation Reserve (CFR) – Experience refund – Any deficit is charged against the CFR; remainder is carried over to next period Maximum cost is determined at beginning of year Next year’s premium is based on: – Current year’s experience with deficit recovery Premium is higher compared with pooled group – Insurer’s risk margin is higher Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA “Old-Fashioned” Retention / Unilateral Retention – Used for medium size groups on STD, Health and Dental – Experience is relatively credible – Some bargaining power  Insurer to return part of U/W profit – Used for large groups on Life, STD, Health and Dental – Excess of Life amounts over a certain threshold may be pooled –Used for very large groups on Life, STD, Health, Dental and LTD – Excess of Life amounts over a certain threshold may be pooled – LTD in excess of 2 years may be pooled Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA “Old-Fashioned” Retention / Unilateral Retention – Client / Consultant must negotiate over: Insurer’s expenses – Claims Administration – General Administration – Risk and profit charges INBR Reserves – Level of reserves – Often a % of premiums DLR Reserves (for disabled employees) – Waiver of Premium: Basis (what modification of Krieger) – LTD (what modification of GLTD) Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA “Old-Fashioned” Retention / Unilateral Retention – Client / Consultant must negotiate over: Claims Fluctuation Reserve – % of U/W surplus that goes into CFR – Maximum level of CFR Interest – On cash flows – On IBNR Reserves – On DLR Reserves (WP and LTD) – On CFR Final Accounting Delay – To recognize run-off of IBNR reserves Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA “Old-Fashioned” Retention / Unilateral Retention – WARNING ! Do mot mix a non-taxable STD or LTD plan with anything (life, health, dental) for which the Employer pays any part of the premium – A deficit in the non-taxable STD or LTD might be offset by a surplus in a benefit partly funded by the employer  Offsetting transfer could be considered as an employer-paid premium  Tax status of STD / LTD would be jeopardized Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Bilateral Retention – Hybrid between retention and Self-insurance Same as Old-Fashioned retention except that any final deficit (at final accounting date) is repaid by the client – No need for a Claims Fluctuation Reserve (CFR) – Insurer’s risk margin is lower – Insurer’s profit margin is lower  Because MCCSR is lower – Experience refund if U/W profit – Any deficit is carried over until the contract is cancelled Other features are same as with Old-Fashioned retention Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Pure Self-Insurance – Employer keeps the whole risk OSFI tolerates self-insurance by Employer – Group Insurance is an employee benefit – Employer is expected to be solvent (What if not ?) No need for an insurer – Employer can use a TPA / TPP – TPA / TPP draws on Employer’s Account Actual Cost is known at end of year – No limit on potential cost  Can hamper Employer’s solvency – Budgeted Approach is possible (if TPP is an insurer) » Use theoretical premium as an estimate during year » Pay any shortfall or collect any surplus at year-end Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Pure Self-Insurance – Goal is to save on expenses related to insurance No insurance  No risk margin  No MCCSR  No capital locked in less productive investment  No Alternative cost of capital  Reduced profit margin  No premium tax outside Quebec, Ontario and Newfoundland – Employer may forget to hold IBNR reserves – Chap does not apply since not a post-employment or post-retirement liability – Still a liability, though – Employer must hold DLR for STD / LTD – Chap applies Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Pure Self-Insurance – Used for large groups on STD, Health and Dental – Experience is credible – Larger employers can absorb fluctuations – Used for large groups on Life (first $10,000) – Allowed by Income tax Act (but 9% Quebec tax applies !) –Used for very large groups on LTD Remember Eaton’s: not as safe as an insured plan Employer must hold reserves for claimants Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Pure Self-Insurance – Client / Consultant must negotiate over: TPA / TPP’s expenses – Claims Administration – General Administration – Profit charge – Client need help from consultant to set up: INBR Reserves DLR Reserves (for disabled employees) – STD – LTD (what modification of GLTD) – CICA 3461 Valuation Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Pure Self-Insurance – Client Incurs Additional (External) Costs Increased Audit Costs – Reserves – Benefit payments Taxable benefits (in Quebec): more complex to calculate – Calculation generally done by Consultant Legal Costs – Employees who are not satisfied with benefit payments will sue the Employer Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Pure Self-Insurance – Tax considerations GST applies on TPA / TPP’s charges Quebec Sales Tax (7.5%) applies on TPA/TPP’s charges Ontario Sales Tax and Quebec’s 9% Tax apply to claims paid Premium taxes apply in Ontario, Quebec and Newfoundland (2% in ON and QC; 4% in NF) on claims + expenses Quebec’s Compensatory tax (0.35%) also applies on claims + expenses Non taxable self-insured STD or LTD is impossible Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Partial Self-Insurance – Employer wants the best of both worlds Keep the “non-risky” part of the risk – Self-insure up to X% of Expected Cost » If X ≤ 100%  sometimes called “Minimum Premium Plan” » If X ≥ 100%  usually called “ASO / Stop-loss” – Employer theoretically saves » Part of Insurer’s Profit Margin » Part of Insurer’s risk margin Maximum Cost is known at beginning of year – Potential cost is limited to Attachment Point + Stop-Loss premium Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Partial Self-Insurance Insurer takes the risk of fluctuations – Charges a Stop-Loss premium – Needs a higher Risk margin (as % of Stop-Loss premium) » If Insurer takes the same risk as with an insured plan, then the risk charge should be the same (as % of theoretical premium  higher % of Stop-Loss Premium) » unless Attachment Point > Theoretical Premium  Attachment Point ↑  $ Risk Margin ↓ – Needs a higher Profit margin (as % of premium) Attachment Point must be defined – Often as % of theoretical premium Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Partial Self-Insurance – Who handles IBNR Reserves ? Employer – IBNR reserves can be excluded from calculation to determine whether attachment point is reached or not » Need lower attachment point in 1 st year if IBNR are not considered – Who handles DLR for STD / LTD ? – DLR may be split between insurer and Employer if the first “N” years of LTD are self-insured – More difficult to have annual Stop-Loss » DLR vary with recoveries Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Partial Self-Insurance – Used for not-so-large groups on STD, Health and Dental – Experience must be reasonably stable – Or Employer must be willing to live with high attachment point » And greater fluctuations –Used for large groups on LTD More complex than pure self insurance – Equivalent to longer STD followed by LTD with longer elimination period Employer must hold reserves for claimants Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Partial Self-Insurance – Client / Consultant must negotiate over: Expenses on self-insured portion of plan – Claims Administration – General Administration – Profit charge Attachment point – What % of theoretical premiums ? Stop-Loss Premium – Level of premium in relation with Attachment point – Risk and Profit charges included in Stop-Loss premiums may or may not be disclosed Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Partial Self-Insurance –Client need help from consultant to set up: INBR Reserves DLR Reserves (for disabled employees) – STD – LTD (what modification of GLTD ?) – CICA 3461 Valuation on LTD Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Partial Self-Insurance – Tax considerations GST does not apply Quebec Sales Tax (7.5%) does not apply Ontario Sales Tax and Quebec’s 9% Tax apply to claims + expenses Premium taxes apply in Ontario, Quebec and Newfoundland (2% in ON and QC; 4% in NF) on claims + expenses Quebec’s Compensatory tax (0.35%) also applies on claims + expenses Non taxable self-insured STD or LTD is impossible Session GRP-5 : Financial Arrangements 101

CIA Annual Meeting  Assemblée annuelle de l’ICA Partial Self-Insurance – Client Incurs Additional (External) Costs Increased Audit Costs – Reserves – Benefit payments Taxable benefits (in Quebec): more complex to calculate – Calculation generally done by Consultant Legal Costs – Employees who are not satisfied with benefit payments will sue the Employer Session GRP-5 : Financial Arrangements 101