Category Investments

Is self-insurance an option for group risk schemes?

06 December 2004 Steven Rosenberg

Most employers make use of the group insurance market to underwrite the benefits promised to employees on death or disability. Over the last few years, however, developments in the market have widened the range of options available to employers for the f

The actuarial research and development team at Momentum Collective Benefits used data from a number of clients to undertake a full analysis of the various group risk insurance options available to determine appropriateness of different options for different schemes.  There are essentially three alternatives to full straight-forward insurance that are available to companies, namely full self-insurance, self-insurance with reinsurance cover and insurance with a profit-share attached to the cover. The research examined the viability of all three options for a number of companies and it shows that there are some cases where self-insurance could be a better option than full insurance for companies, but these are limited to the very large schemes and are applicable only in certain circumstances.

What is clear from the research is that the size and membership profile of the scheme will have a significant effect on the self-insurance decision. As a scheme increases in size, the expected saving from self-insuring increases, although this is influenced by the assumption in the underlying model that full insurance premiums include a constant profit margin, which may be inappropriate given the greater competition in the market for large schemes.

Another area where self-insurance is a viable option for very large schemes is for employers who have instituted mechanisms to improve their claims experience, but have not been compensated by the insurance market in the form of reduced premiums. For example, if a company with a large scheme that has experienced an increase in the number of death claims has instituted a comprehensive HIV/AIDS management programme, especially one involving the provision of antiretroviral medication to HIV-positive employees, insurers should reflect the expected benefits of the programme in their premium rates. In the event that the insurer is not willing to offer a premium reduction in advance of the improvement of experience, the company would do well to implement a self-insurance strategy to benefit from the anticipated reduction in claims.

By comparison, smaller schemes are in every case better off being fully insured. The claims in small schemes are extremely volatile and therefore the risk that the company would assume in order to self-insure would be difficult to justify. The company would be saving on the insurance profit margin, but would be trading that for uncertainty regarding potential claims.  The volatility of claims experience is such that a particularly poor year of experience could be enough to threaten the financial viability of the company.

The analysis showed that in most cases, the self-insurance with reinsurance option was also less favourable than full insurance except for some very large schemes. Self-insurance requires a scheme to put aside large amounts of funds upfront to provide some protection against the wide variation of claims experience. Using self-insurance with reinsurance, this variation can be reduced to a large extent and hence the initial funds required for protection are less, but at the same time it reduces the profit saving and still requires some initial fund to be set up.

In the case of very large schemes, the variability of the claims experience is not that great. Using self-insurance with reinsurance will not add much value to the pure self-insurance scenario – in fact it could result in a higher expected cost to the scheme than in the case of using full insurance.  The reason for this is that the additional funds needed to protect the risk, is proportionately greater than the funds needed by an insurance company to protect its own very large and diverse portfolio. These funds would be better freed up for use by the employer in other aspects of their core business. Again the extent to which it is more favourable to fully insurance depends on the competitiveness in the market, since that determines the extent to which an insurer can charge a profit margin.

When analysing the profit share scenario, the analysis concluded that a profit-share may be a good option for many companies since they stood to benefit from any profits over that period without taking on any risk. This has not always been popular in practice because of the margin on premiums charged by insurers for putting such arrangements in place.  However, for schemes of a certain minimum size (at least 1,000 members) where profit-share arrangements are provided for over a suitable period (often three years, although this can be less for larger schemes) to allow for some stability of expected profits, the required margin may be small enough to make the profit-share arrangement very attractive.

By Steven Rosenberg, Head of Actuarial Research and Development at Momentum Collective Benefits

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