Changing 25% reserve limit ‘could enable schemes to put your money to better use’

Published Aug 1, 2015

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Medical schemes may be holding about R12 billion more in reserves than they need to, and, if the Medical Schemes Act was amended, this money could be put to better use, with some benefit for members’ contributions, an actuary at Alexander Forbes told the Board of Healthcare Funders conference this week.

Roshan Bhana said the requirement that schemes hold 25 percent of the contributions they receive in reserve resulted in schemes having reserves of R43.1 billion at the end of last year. But Bhana says the 25-percent requirement does not adequately reflect the risks that each scheme faces. For some schemes, the amount is too high, whereas it is too low for others.

Schemes are required to hold reserves to ensure they would be able to withstand a sudden increase in claims.

Schemes also need reserves to protect themselves against the failure of service providers, such as administrators or managed-care entities, after they have been paid. In such cases, the medical scheme might have to pay for the services of another provider.

Bhana says the requirement that schemes hold 25 percent of their contribution income in reserve penalises schemes that are growing their membership, because, for each new member, the scheme must find the required reserves immediately. Only new schemes are granted a certain period in which to accumulate the reserves.

You, as a scheme member, ultimately bear the cost – in the form of contribution increases – of your scheme having to meet the reserve requirement, he says.

The reserve requirement also applies to medical savings accounts, despite the fact that a scheme is not exposed to any risks on the amounts contributed to these accounts, because the benefits are limited to the amount you contribute.

The Council for Medical Schemes’s Industry Technical Advisory Panel has developed an alternative formula for calculating reserves, but this proposal has not been implemented yet.

Bhana says the panel’s alternative formula is based on the risk of a scheme facing unexpectedly high claims, taking into account its membership and pricing strategy, the operational risks the scheme faces and the risk to the money it invests. When this alternative formula was applied to 19 large schemes (the 10 biggest restricted schemes and the nine biggest open schemes), it was found that only two required reserves that exceed 25 percent of their contributions, and most required less than 25 percent, Bhana says.

Using data from the latest annual report of the Council for Medical Schemes, which is for 2013, the panel estimated that the R32.3 billion held by schemes at the end of that year was R10.8 billion too much. Some 77 schemes had too much money in reserve, while nine schemes had too little by this measure, Bhana says.

Alexander Forbes is of the view that the method used by the council’s technical panel has some shortcomings, because it does not take into account the profile of the members of each scheme.

Alexander Forbes has therefore created its own methodology for determining a scheme’s reserves that uses the members’ risk profiles, as determined by their ages, and what is known as stochastic modelling. This is based on a scheme’s claims history and predicts the claims that a scheme could face. It calculates the level of reserves that the scheme should hold to prevent it from financial ruin.

Bhana says Alexander Forbes’s methodology is more conservative than that used by the council’s technical panel.

On its methodology, Alexander Forbes found that schemes had R12.08 billion too much in reserve in 2013. Of the 75 schemes it analysed, 69 schemes were overfunded by R18.9 billion and six were underfunded by R6.8 billion.

Bhana says that, although schemes on the whole are overfunded, and schemes are mutual funds operated for the benefit of members, it is unlikely that schemes with surplus money in their reserves will distribute it to their members.

He says that, although medical schemes do use surplus reserves to lower contributions by planning for an operating loss, this can result in an artificial reduction in contributions, because the reduction will apply only as long as a medical scheme has excess reserves.

It would be better to use the excess funds to start an industry-wide reserve fund, where reserves from overfunded schemes could be transferred to underfunded schemes – typically those with older, less healthy members – or to extend cover to people who cannot afford to join schemes, Bhana says.

Encouraging more people to join schemes could improve the cross-subsidisation of claims risks and reduce contributions for all members.

Bhana says schemes could use their excess returns as a cushion against the short-term volatility that would occur if they took more investment risk, with the potential to deliver better returns for schemes.

Barry Childs, the joint chief executive officer of Insight Actuaries and Consultants, says transferring reserves from one scheme to another when members change schemes should be explored, because there is a massive waste of capital when a member moves and his or her new scheme is required to build up reserves from scratch.

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