Reinsurance is an arrangement under which an insurance company (i.e., reinsurer) agrees to assume the specified risks of another insurance company (i.e., ceding company). In essence, reinsurance is insurance for insurance companies. Depending on the arrangement, the reinsurer may assume all or a portion of the insurance risks underwritten by the ceding company. In exchange, the reinsurer receives some or all of the premium and, in certain cases, investment income derived from the assets supporting the reserves of the reinsured policies.
Most actuaries susgegt that at roughly 25,000 lives, it is possible to have a stable risk pool: all other things being equal, you can reasonably predict the growth in expense year to year. With a stable risk pool, it is usually unnecessary to carry stop-loss insurance. Self-insured employers of large size typically do not carry stop-loss coverage. In a large self-insured employer pool, there are zero dollars allocated to risk charges, marketing expense, and commissions. Typically, the self-insurer “rents” a network from an insurer or third party; and pays a fee for medical management and claim services. Most large plans don’t have pre-existing condition limitations or medical underwriting but that’s not a concern because the laws of large numbers protect them: a stable, demographically mixed pool behaves predictably. A large employer pool has some “in-bred” characteristics that make it more attractive (from a risk perspective) than the small group or individual markets: all participants are actively at work (therefore less likely to be suffering from a disabling condition); the great majority are between ages 21 and 60; employee contributions are relatively minor and are tax-preferenced via a Section 125 plan (resulting in what is called a high “acceptance rate”); enrollment is typically stable with defined entrance and exit points that favor long-term enrollment (thus insuring a favorable demographic mix in the pool); and, the benefit terms can be modified to achieve a “reasonable” combination of cost/benefits (self-insured plans are not subject to state insurance coverage requirements).Many of the benefits of the large group self-insured pool are weakened in the proposed legislation: 1.Enrollment and disenrollment are not controlled. Pre-existing condition limitations and health underwriting are eliminated. These devices do help insurer profitability but they also mitigate claim volatility: wild swings in expense due to the entrance of enrollees with known, often-times expensive medical conditions. These devices also kept people in the risk pool because they knew that if they left the risk pool they could not return at all or they could only return under limited circumstances. Any risk pool depends on a balance of well and sick people. If people can leave the pool when well and return when sick, the people who are continuously insured will have to pay more to keep coverage in place. When it costs less to be uninsured, the healthy with no assets will quickly figure it out and elect to “buy” the penalty rather than the insurance. What this means practically is that those with assets (homes, retirement accounts, savings) are put at a relative disadvantage: their risk aversion will be used against them to fund the health care expense of the judgment proof (those without assets who can elect bankruptcy and use the medical system for emergency care). This is unsustainable in the mid to long term. (One version of the Baucus bill actually supports disenrollment in September because it waives the “penalty” if the time without coverage was three months or less: a tax-supported Christmas savings account?)2.Under the legislation, the plan design requires that no service can be limited on an annual or lifetime basis; no service can be denied for other than reasons of clinical effectiveness; preventive services are covered with no deductible; habilitative services are covered; and, out of pocket expense must be limited based on income. These same rules will apply to employer plans after a grandfather period. While this design is very attractive from the perspective of the consumer of health care services, it will cost more than most existing benefit designs. Wages and benefits are zero-sum companions: as the cost of health care rises wages are suppressed or take home pay is suppressed (higher co-pays and deductibles) to account for the increase in expense. We have never answered the question: Does free or near free health care make people healthy or does it free them to be sick?3.We continue to confuse risk management and medical certainty. “Medical certainty” means that a known medical condition requires significant amounts of medical services, drugs or devices or the patient will die or lose all quality of life. In these circumstances, risk management is immaterial. On the other hand, less significant disease states are subject to risk management: Patient education, best practices care management, and behavior change can reduce, prevent worsening or eliminate the disease state. Insuring all disease states through a for-profit model is absurd. If an insurer “buys” $20 million of RH factor for the treatment of hemophiliac patients, and has a medical loss ratio of 80%, then it “costs” policy holders $25 million to cover this known, non-optional expense. A $5 million transaction cost for this purchase is unconscionable. A national risk pool with consolidated purchasing for such expenses and for best practices management of care is a far better alternative than directing incremental marginal income to insurers. It would also allow us to provide a more compassionate and supportive environment for patients: If a child has hemophilia, does it really make sense that the parents pay deductibles and co-pays for those expenses? If such expenses were paid with a payroll based deduction for both employers and employees, it would avoid issues related to adverse selection (all would pay) and it would substantially reduce the cost of insurance (now a true risk management device).
Reinsurance contracts, also known as treaties, are generally written on either an automatic or facultative basis, with the former being significantly more prevalent in the market.
Bear Stearns International (European Reinsurance: Life Reinsurance Demystified)