RETHINKING MEDICAL SCHEME RESERVING Roshan 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 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

25% Solvency Industry reserves required (2013): R billion 9 schemes underfunded – R billion underfunded 77 schemes overfunded – R billion overfunded Industry overfunded by R billion

ITAP Formula: Industry Reserves required (2013): R billion Top 9 Open and 10 Restricted Schemes: – 3 schemes underfunded – 16 schemes overfunded Industry overfunded by R billion

Stochastic Modelling Approach: Stochastically simulate one year’s claims for each scheme Calculate the probability of failure in the next year Probability 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 % chance of continued sustainability

Stochastic Modelling Approach: Claims reserves required (2014): R billion 17 schemes underfunded – R billion underfunded 69 schemes overfunded – R billion overfunded Industry overfunded by R billion

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

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