Claim costs produce a loss ratio but fixed costs never do.
All health plans, whether self-funded or fully-insured, maintain an accounting of every dollar earned and expensed. Each dollar is split between one of two accounting buckets: (1) Fixed Costs and (2) Claims.
Pre-renewal accounting is important in rate setting. Since claims drive costs a group’s historical loss ratio lays the foundation for predicting future costs. It must be determined if allocated claim dollars (Bucket #2) have been enough to sustain past year’s risk and will it continue to do so for another plan year?
There are two methods in determining a loss ratio, the Wrong Way and the Right Way. The difference between the two is Bucket #1. Fixed costs have nothing to do with claim costs.
Let’s review a self-funded 100 life case to illustrate both methods:
- $645,560 Total Annual Plan Contribution
- $176,485 Total Annual Fixed Cost (27% of Total Contributions)
- $469,075 Total Annual Claim Fund
- $492,117 Total Plan Paid Expense (Bucket 1 + Bucket 2)
- $315,632 Total Paid Claims Less Rx Rebates/Stop Loss Recoveries
The Wrong Way
Loss Ratio = $492,117/$645,560 = 76%
The Right Way
Loss Ratio = ($645,560 – $176,485) / $315,632 = 67%
The PEPM cost breakdown under both methods = $147 to Bucket #1 and $391 to Bucket #2. Since $147 is static the “loss ratio” is 100% with all monies expended, nothing more and nothing less. The $391 claim allocation expenditure fluctuates producing a “profit & loss” ledger entry, or loss ratio.
Unfortunately there are games to be played with numbers when it comes to health insurance reporting. For example, there can be fixed costs hidden on the claim side of the ledger. An experience advisor can ferret those out but usually missed by most plan sponsors. Credibility factors can be skewed or even (conveniently) overlooked in the renewal calculation. Experienced advisors won’t let this pass but clueless plan sponsors miss it almost every time.
If you looking at a rate increase again this year our best advice is to look hard at the numbers and underwriting rationale. A 9% loss ratio differential as in the example above can translate to a rate reduction.
Claim costs produce a loss ratio but fixed costs never do.
