Hurricanes and healthcare—how can reinsurance help us?
This post was actually conceived in late July, long before Harvey, Irma, and Maria were drops of moisture over the Atlantic. Willow had recently conducted an exploration of the reinsurance industry for one of our clients, and we thought this niche of the financial world might be relatively unknown and potentially interesting to our readers.
Then hurricanes pounded the Atlantic and the Gulf, and the subject of reinsurance suddenly became extremely relevant. Insurance companies are prepared to pay out claims on a single restaurant destroyed by a fire, or three flooded homes. But how do they have the resources to make good on billions of dollars in claims filed all at once?
The answer: They don’t.
This is where reinsurance comes in, preventing insurers from defaulting in the face of massively destructive events like Harvey, Irma, or Maria.
Perhaps you’re already familiar with reinsurance, but if you’re not, it’s basically an insurance policy for insurance policies—hence the name “reinsurance.” In a nutshell: a primary insurance company purchases coverage on its own policies from a reinsurance company. Then, in the event of a catastrophe, the reinsurer is responsible for covering an agreed-upon portion of the loss, preventing the primary insurer from defaulting.
This isn’t a perfect metaphor, but it’s a little like parents co-signing a loan for their adult child, which distributes the risk. If all goes well, the child stays solvent and makes the payments, and the parents never have to step in and pay the debt. But if a personal disaster occurs, the bank still gets paid what it’s owed and the child is protected from bankruptcy.
This is how, when an Irma-level natural disaster strikes, the people of an entire region are able to rebuild their homes and businesses, because their insurance companies have “parents” to step in and help pay out the claims.
That is a very high-level overview, and if you would like more details, we’ve included a short section at the end that outlines the primary ways reinsurance is utilized.
But we’re going to move on now to our battered and befuddled healthcare industry. Because the same notions being used for property are being applied in innovative ways by State and Federal governments to help steady health insurance premiums.
Reinsurance in Healthcare
A recent push in several States (and also in Congress) is using government-sponsored reinsurance policies to alleviate the sharp rise of health insurance premiums being seen in areas across the country.
The premium increase seems to be driven by three main factors:
- Dramatic increase in pharmaceutical costs, particularly for highly innovative drugs that treat relatively rare diseases
- Rise in patients with chronic illness (such as diabetes), which must be covered under the Affordable Care Act (ACA) but which also come with tremendous cost implications for insurers
- Uncertainty among insurers about whether they will receive the promised cost-sharing subsidies from the Federal government that were designed to offset the costs listed above
Several States (most notably Minnesota) saw sharp increases on the horizon for their citizens and decided to act on their own, brokering deals with private insurers to help pay for the highest-cost patients—the ones who need special drugs, frequent treatments, or both. Under the Minnesota plan, the State government would pay 80% of claims ranging between $50,000 and $250,000, mitigating the insurer burden from all three factors above in one piece of legislation.
The Minnesota program is still awaiting approval from the Federal government (which would help fund the reinsurance), but the mere prospect has stabilized premiums within the state. Increases scheduled for 2018 have been reduced, and in some cases, premiums have actually fallen.
In 2016, the Alaska Legislature created a similar, more narrowly-focused program and received a Federal waiver in July. Before the program, 2017 premiums for the individual market were projected to jump 42%; after the law was passed, they increased only 7% and are projected to decrease by 20% in 2018.
Meanwhile, on the Congressional level, the fierce healthcare debate has at least one point that Republicans and Democrats agree on: that governmental reinsurance of some kind is a necessary tool to support and subsidize the health insurance industry.
How and who will pay for it are points of contention between the two parties, whether at the State or Federal level. In the private sector, the premiums charged by reinsurers are usually large enough to cover their claims (at least, that’s the bet that private reinsurers are making). However, the government is not charging premiums to health insurance companies, so the funding must be redirected from other programs or raised in some manner. In Minnesota, the funding question proved divisive between the parties, even with bipartisan support for the program itself.
But the idea in itself is sound and, if it continues to work, we may see more States following the examples of Alaska and Minnesota.
Curious to know a few more details about private (non-government) reinsurance? Read on.
There are two basic types of reinsurance policies.
Treaty: Covers a set of policies. Assume a fictional insurer called Florida Property Protection Group insures a group of property policies in southern Florida. FPPG knows that this area is occasionally struck by hurricanes and that the company does not have the resources to pay out if all of its policies have to be paid out at once (for example, an Irma-sized event).
Because FPPG knows that this is a possibility, it purchases a treaty policy from Reinsurance Inc. (also fictional) that will cover the entire set of southern Florida policies. After a catastrophic event, Reinsurance Inc. is responsible for a share of the claim burden, easing the financial strain on FPPG. Because of this arrangement, claims will get paid out to the property owners and FPPG will stay solvent.
Facultative: Covers ONE extremely large policy. Perhaps FPPG covers one building that is valued at $500 million. Even though it’s just one property, it is worth so much that if the building is destroyed, FPPG might not be able to pay out that massive single claim. But if they take out a facultative reinsurance policy with Reinsurance, Inc., both insurers would be responsible for a share of that $500 million, making it feasible to pay out.
Of interest: facultative policies are also occasionally taken out to cover the life insurance of a celebrity or other public figure. This is rare, though, as few people have life insurance policies so large that paying out would bankrupt an insurer.
Sometimes both of these types of reinsurance policies work together.
Using the above example, FPPG might take out a treaty policy to cover its set of Florida properties and a facultative policy to cover the Twelfth National Bank skyscraper, specifically.
We hope you found our quick look at reinsurance informative and interesting. And if you like what you’re reading in these posts, please take a moment to subscribe to our blog.