Insurance reserves

As I mentioned yesterday, the quality of insurance company reserves matters a lot to state regulators.  So let’s talk a little more about reserves.

State regulators have a mission to make sure there is no chance in hell of an insurance company going bust with outstanding claims unpayable. The state regulators rely on very large cash and capital reserves to make sure that in a three or four sigma event, the insurance company is still able to pay off all claims incurred up until the drop-dead date. Mayhew Insurance routinely carries four to six months of cash or near cash as the go out of business bankruptcy reserve. The Blues and other larger carriers can get away with a little less proportional cash as their size smooths fluctuations better than a medium sized insurer. Smaller insurers whose risk pools are not too deep need more cash on hand to cover the unexpected.

Up until the Cromnibus, the risk corridor payments were seen as near cash and counted as high quality reserves. However the Cromnibus applied a large but unknown discount to those claims on Federal payments. That means the state regulators started to worry that in oh-shit scenarios, the smaller insurers could not pay off all incurred claims. And once state regulators start to worry, they shut down insurers that they worry about.

Health insurers have two sets of reserves.  The first set of reserves are the shut-down this afternoon and pay all obligation reserves.  Those reserves are calculated as a percentage of current month premiums.  The goal is for an insurer to have enough cash on hand to cover an absurdly unlikely set of claims without ever receiving another penny of revenue.  A small insurer with a shallow risk pool will need more months on hand as their ability to handle a claim from an individual with hemophilia who got bitten by a coyote after being in a BASE jumping accident is less than an insurer with a million covered lives.  The size of the risk pool helps reduce variability and lower aggregate variability leads to lower needed reserves to cover a a five or six sigma event.

These shut down and pay reserves are the reserves state regulators care about.  They must be liquid or easy turned into liquid cash, they must be accurately priced, and they must be stable.  Insurance companies are not trying to make significant money from these reserves.  Instead they need to know that a dollar in reserve today is a dollar in reserve tomorrow.  That means most of these reserves are held as cash, US Treasury debt, AAA bonds, and AAA short term commercial paper or money market accounts.  The goal is not to make money, it is to not lose money.  When the co-ops counted on the Federal government to make good on the risk corridor losses, they were marking the accounts receivable as very reliable and solid.  That assumption was destroyed by the Cromnibus.

The other type of reserves are excess reserves. Many larger non-profit insurers have significant reserves in excess of shut down and pay out everything incurred but not reported.  Some for profit companies also have large retained earning reserves.  Those reserves are utilized to make money for the insurer.  At this point the insurance company transforms itself into a hedge fund with an odd cash flow model.  Those reserves are used to buy stocks, buy other companies, invest in real estate or currency movements or derivatives or reinsurance or any other financial instrument that the insurer or its reserve investment advisors thinks can make a good return for the insurer.  In some years, gains on investments provide the entire positive financial margin for insurers.

UPDATE 1: In before the single payer advocates — yes, Medicare for All does not have any need for explicit reserve accumulation as the full faith and credit of the United States government is the explicit backer and we can safely assume the US government will not go out of business on any given afternoon, and if it does, we are in a world of far greater shit than worrying about health insurance payments.  But we don’t live in that world as is.



11 replies
  1. 1
    SRW1 says:

    At this point the insurance company transforms itself into a hedge fund with an odd cash flow model.

    A bit like car companies really.

  2. 2
    Just Some Fuckhead says:

    Skim or die.

  3. 3
    rikyrah says:

    you continue to bring the knowledge to us. Thanks to BJ for bringing you aboard.

  4. 4
    The Red Pen says:

    The mention of state regulators reminds me of a question I have:

    The ACA allows for companies to sell plans across state lines, but it requires approval from the state regulators to do so. I haven’t seen any sign that anyone is trying to do this. Too hard? Not worth the effort?

    The “sell across state lines” is a wingnut talking point; none of them aware that this is allowed by the ACA.

  5. 5
    Gin & Tonic says:

    Wow, the mention of IBNR brings back memories of a long-ago phase of my career.

  6. 6
    Thoughtful Today says:

    ” In before the single payer advocates “


    I genuinely appreciate the caveat.

  7. 7
    Richard Mayhew says:

    @The Red Pen: Aetna, Cigna, United HealthCare, some of the Big Blues already sell across state lines but the risk pools are divided at the state line. Those plans have to be approved by each state regulator.

    The ACA allows states to form interstate compacts where regulatory approval in State A is respected in State B (for instance Massachusetts might allow Rhode Island to approve a plan that can then be sold in both states without further regulatory action). No one has done that nor is there any talk of that.

    Maine and Georgia currently allow out of state insurers to sell in-state. No one has done that yet.

  8. 8
    David says:

    Off topic, but why aren’t enrollment dates harmonized. We have to elect insurance from my wife’s employer before we even receive the plan info for next year from my employer.

  9. 9
    Richard Mayhew says:

    @David: Because that would be way too easy

    I wish I was being snarky, but there is no good answer except that since most people are insured through their employers, the employers get to choose whatever dates work for them. Mandating open consistent open enrollments through out the country would be BAD because of some reason that I’ll come up with concerning equal dignitude of the states, coercian and goat fucking.

  10. 10
    The Red Pen says:

    @Richard Mayhew: Thanks!!!

  11. 11
    David says:

    Thanks for answering, Richard. And thanks for all of the information you provide for us.

Comments are closed.