Under a delivery order from the Assistant Secretary for Planning and Evaluation (ASPE) at the Department of Health and Human Services, the Lewin Group has undertaken a limited analytic study of the role of reinsurance (and similar coverages) in three insurance markets: primary health insurance coverage offered by indemnity insurance companies;1 health insurance coverage offered by health maintenance organizations; and health benefits coverage offered by employer-sponsored self-insured plans.2 The purpose of the study is to develop a better understanding of the roles that reinsurance plays in the market for health benefit coverage by looking at the amount of risk borne by reinsurance in the three primary conduits for health coverage: indemnity health insurance, HMO coverage and self-funded health plans.
The primary tasks of the study were:
- To identify and to develop a better understanding of the sources of information about the amount or level of risk borne by reinsurance in the three specified markets.
- To collect information where possible from the identified sources.
- Based upon the available information, to develop a profile of the role that reinsurance plays in the three markets.
- To develop a baseline for measuring the use of reinsurance in the three markets and to present options for obtaining more detailed information on the role of reinsurance in the markets.
Although reinsurance is widely used by the underwriters of health benefits (i.e., insured and self-funded plans), its role is little understood by policymakers. Basically, reinsurance is insurance bought by insurers,3 and is used by insurers to limit their risk exposure. Reinsurance contracts can be structured in many ways, and insurers can use reinsurance to limit their risk for an individual contract or exposure, for a group of contracts or exposures, or for a whole portion of the insurer's business.
In the health insurance and health benefits contexts, the most common forms of reinsurance coverage are individual and aggregate stoploss insurance. Insurers purchase individual stoploss insurance to limit or cap their claims exposure for any covered individual over a specified period (such as a year). For example, an insurer may purchase stoploss coverage that would reimburse the insurer for 90 percent of the claims costs incurred by a covered individual in excess of a threshold (or deductible) of $50,000 in a calendar year. Aggregate stoploss is used by insurers to limit their aggregate risk exposure over a number or group of specific risks. For example, an insurer may purchase stoploss coverage that would reimburse it for 90 percent of the claims costs in excess of a specified amount, such as 120 percent of the expected total claims costs for a group of risks (e.g., a large employer or an association of small employers). Other forms of reinsurance also may exist for health benefits. For example, a smaller insurer may reinsure a portion of the risk for an entire line (e.g., small group policies) or book (e.g., association group) of business. The reinsurer could receive a portion of the premiums and be responsible for a portion of the losses, either specifically or in aggregate. 4
Reinsurance plays important roles in these three markets. The availability of reinsurance permits primary insurers (including self-funded plans) to reduce their risk exposure in ways that can affect the availability and affordability of coverage. For example, the availability of reinsurance encourages more employers to create self-funded benefit arrangements, because through reinsurance they can protect themselves from the catastrophic costs associated with one or more very large claims. Self-funded employers also may be more reluctant to cover certain high-cost events, such as organ transplants, without the ability to reinsure. Reinsurers, by selling stoploss coverage to a number of health benefit programs, can create a relatively large pool over which to spread the risk of these catastrophic claim losses.
Reinsurance also plays an important role in protecting the financial solvency of insurance entities. Insurers generally can use bona fide reinsurance to reduce their minimum capital requirements. This can be particularly important for smaller and start-up entities. For example, a start-up HMO with $1 million in surplus could be ruined financially by one or two large claims during its early months of operations if it could not limit its claims exposure through reinsurance. Once the HMO has grown larger (e.g., 50,000 or more lives), reinsurance may be a less important aspect to its operations, because the HMO would be able to absorb the risk of catastrophic losses much more easily.
The potential role of reinsurance has been an important topic in several recent policy debates. For example:
- There have been questions about whether smaller employers who are claiming to be self-funded (to escape the effects of state insurance laws) actually are shifting a substantial portion of the risk of loss to the insurance market through reinsurance. The National Association of Insurance Commissioners (NAIC) recently developed a model regulation that attempts to define a minimum threshold for stoploss coverage (coverage with lower thresholds would be considered to be traditional health insurance), but the model has been controversial and at least one state court has found that a state law based on the model is preempted by ERISA.
- Reinsurance has been suggested to have a potentially important role in determining the appropriate minimum solvency standards for new or alternative insurance arrangements, such as provider sponsored organizations (PSOs) and multiple employer welfare arrangements.
Understanding better the roles that reinsurance currently plays in the market might assist policymakers as they address these and other important policy issues.
1 The term "indemnity health insurer" here refers to organizations that are licensed as health insurers rather than as HMOs. Organizations licensed as health insurers often offer managed care products, including PPO coverage.
2 Although it is often referred to as reinsurance, stoploss coverage purchased by self-funded employers is not reinsurance. Reinsurance technically refers to an insurance arrangement between a licensed insurance entity and another insurer. Employer stoploss coverage is more accurately referred to as excess of loss coverage.
3 Unless stated otherwise, we will consider self-funded health plans as insurers for the purposes of this discussion. We also will refer to excess of loss coverage purchased by such plans as reinsurance unless otherwise noted.
4 It should be noted that the existence of reinsurance typically does not eliminate the obligation of the primary insurer to pay a claim, even if its reinsurer fails to meet its obligations. Reinsurance generally is a contract between a primary risk taker and a reinsurer.