Do current solvency levels limit a medical scheme’s growth and inhibit expansion into low-income markets? Principal Officer of Bonitas Medical Fund, Gerhard van Emmenis, explains how there’s been a shift in global opinion about pre-determining the solvency ratios for private medical schemes, and how South Africa is no different.
Chapter 7 of the Medical Schemes Act 131 of 1998 requires that a medical scheme ‘shall at all times maintain its business in a financially sound condition.’ The Act defines financial soundness to mean that a medical scheme has sufficient assets to generally conduct its business, provide for its liabilities at all times and for meeting prescribed solvency requirements of 25%. But is it an accurate method?
Dr Anton de Villiers of the Council of Medical Schemes (CMS) says they’d like to see a solvency framework that will promote growth in the industry while ensuring healthy competition amongst the schemes.
While financial stability should be maintained, there is no one size fits all and individual circumstances of each scheme should be taken into account. We believe the current requirements: Don’t take into account the size of the scheme; the differences between restricted and open schemes; limits a scheme’s growth and inhibits expansion into low- income markets.
The current thinking both locally and internationally is that a risk-based approach is a healthier overall risk management of the industry.
Some of the key issues:
- Larger schemes tend to have less claims volatility and therefore could hold less capital in this regard
- Open schemes are more prone to members joining for a specific benefit and leaving soon after receiving treatment, which affects reserves for open schemes
- With the solvency requirement based on 25% of gross contribution income, inadequate pricing – or under-pricing – is incorrectly rewarded by holding lower capital
- Savings contributions are treated the same way as risk contributions although the risk differs
- Doesn’t consider the asset profile of the scheme
- A good solvency regime protects the interests of the scheme’s members. An early warning system could enable the regulator to detect problems earlier and take corrective action.
Using risk profiles to determine solvency ratios
The CMS conducted research on various risk-based solvency frameworks and presented their findings and a proposed framework in November 2016. It was a simplified risk-based capital model that allows for the following components:
- Business Risk (day to day capital requirements for a scheme)
- Assets Risk (fall in market values in extreme events)
- Operational Risks (failures in people, systems and processes)
International changes that SA could adopt
Economic and financial theory suggests the efficient use of capital is an important element in a cost effective financial system in any insurance market, including healthcare. Significant regulatory advancement is being undertaken in South Africa under the Financial Services Board (FSB), as well as internationally under ‘Solvency II’ regulations. In summary, these regulations aim to determine the amount of reserves required based on the risks underlying the product and market, referred to as ‘risk-based capital’ techniques.
One clear indicator of risk is the size of the pool of lives being covered. Smaller pools of lives experience more volatile claims. All else being equal, a smaller medical scheme would need to hold a larger reserve.
The transition to a risk-based approach would need to ensure that the competitive environment between schemes, both large and small, remains unchanged and is fair for all schemes.
Large schemes get a bigger competitive advantage (in the short-to-medium term at least) since these schemes are likely to reduce their 25% of contribution solvency requirements significantly. This will leave them with excess reserves.
The more robust risk-based framework will require a complex infrastructure in order for it to be implemented – closer monitoring and more comprehensive reporting. Strict regulation of the solvency requirement means several consultative processes are required before presenting amendments to the Department of Health and the Legislature for consideration.
Is there a better use for extra reserves?
Reserves are typically set to cover 1 in 200 year events and take into account risks such as uncertainty in claims experience, liquidity constraints, investment market uncertainty, operational risks and so on.
Efficiency in the use of member funds is vital if schemes are to provide beneficiaries with the greatest benefit. Excess member funds could then be placed elsewhere for better use such as; lowering the cost of healthcare; better risk management by schemes; investment of reserves to help limit contribution increases and providing richer benefits to members.
The road forward?
Trustees struggle to marry solvency requirements in terms of growing membership. Growing schemes are less competitive than shrinking schemes so other proposals include a lower solvency requirement of between 12.5 to 15% for large schemes, a ratio closer to 25% for medium and small schemes while some smaller schemes could require more than 25%.
There is no doubt that medical schemes need to maintain financial stability and sustainability and must have sufficient assets to conduct business. However, the greater the growth, the higher the required solvency levels which does not encourage expansion, particularly where it’s needed most, in the low-income market.