Reading the recent Parliament discussion on our Medishield reserves and its loss ratio got me thinking…and writing.
From an insurance point of view, a loss ratio is defined as the ratio of what an insurance company pays in benefits and associated expenses (such as adjustments) to what is collected in premiums, expressed as a percentage.
It was highlighted in Parliament that the loss ratio of Medishield last year was around 44%. Meaning for every $1 of premiums collected, 44 cents was paid out.
Solely based on this figure, the premiums would appear high. It could easily be halved from current levels and the Medishield scheme would still be very healthy with a loss ratio of less than 90%.
Health Minister Gan Kim Yong explained that the 44% was not the correct figure to look at. A better comparison would be with the incurred loss ratio as it also took into account future liabilities (of incurred claims).
The example given was that someone with kidney failure will need to make dialysis claims not only in the first year, but for the rest of his life.
If you factor in all these potential future claims, the incurred loss ratio for Medishield over the last five years was actually 96%.
I did a mental thought experiment and was not very convinced with the use of this incurred loss ratio.
Before I share my thought experiment, just a small disclaimer. While I’m fairly well versed with health insurance, I’m no actuary. Hopefully, someone more qualified can help to expand on these ideas and correct me if I’m wrong.
Let’s look at an extreme case where Medishield only covers one person and every year, this person pays $1000 in premiums.
His kidney fails and he needs regular dialysis, of which Medishield pays $900 every year. The means that the loss ratio is 90%.
If the premiums and Medishield claim for the dialysis does not change for the rest of this person’s life, the Medishield scheme would still be completely solvent as it only pays out 90% of premiums collected.
This is no need to factor in for any future losses as the system basically takes care of itself year after year.
Now let us look at the incurred loss ratio for the same example.
First of all, we need to estimate what is the potential future liability of this kidney dialysis patient.
Say we use 9 years of future claims.
The total incurred losses (current + potential) now becomes 900 + (900 x 9) = $9000 and the incurred loss ratio works out to be a staggering 900%.
To keep the incurred loss ratio at 90%, the annual premiums for this person will have to be increased to $10,000!
My calculation of the incurred losses did not take into account the present and future value of money. If I did, the losses and premiums will be lower.
With regards to the use of incurred loss ratio to determine the level of premiums, I don’t like it for a few reasons:
Personally, I think Medishield premiums are priced too conservatively in accumulating reserves. The Medishield Life Review Committee has recommended greater transparency on their reserve requirements. That, together with its premiums pricing principles, will help the public to understand and appreciate the scheme better.