05 August 2014

Understanding MediShield Reserves

During the recent Parliament debate, several Members spoke on the future capital adequacy of MediShield Life.

Since MediShield Life's reserves are derived from (i) MediShield's reserves, which will be transferred to MediShield Life; and (ii) annual surpluses, overly high reserves mean that premiums are excessive.

So how much is enough?

Incurred Loss Ratio, Not Claims Ratio
Using MediShield as an example, Mr Gerald Giam compared annual claims to annual premiums (the claims ratio), and concluded that premiums were excessive.

As Dr Janil Puthucheary pointed out, we have to consider the change in MediShield's liabilities in addition to the annual claims versus the premiums collected (the incurred loss ratio).

According to him, MediShield Fund's incurred loss ratio was 119 per cent, 111 per cent and 91 per cent in 2011, 2012 and 2013, respectively. It averaged 96 per cent in the past five years.

Furthermore, also according to him, for not-for-profit scheme such as MediShield, the ideal incurred loss ratio should approximate 100 per cent. However, this is not quite correct, as we shall see later.

What Is Incurred Loss Ratio?
The incurred loss ratio is:

current claims + change in liabilities for claims
current premiums collected

Current claims are straightforward, and need no explanation.

Liabilities for claims are actuarial estimates of future claims.

MediShield Fund's insurance contract liabilities of $1,700 million as at 31 December 2013 comprised $125 million due within one year, $822 million due in 2015-2018 and $753 million due after five years.

Similarly, its insurance contract liabilities of $1,334 million as at 31 December 2012 comprised $101 million due within one year, $550 million due in 2014-2017 and $682 million due after five years. (The sharp rise in insurance contract liabilities in 2013 probably resulted from MediShield's enhanced coverage in 2013.)

When valuing insurance contract liabilities, actuaries need to be conservative to ensure that they are adequately provided for.

However, conservatism impacts short-term profitability.

But what if the insurer is a not-for-profit insurer such as MediShield Fund and there is no real need for a surplus (equivalent to profit at for-profit insurers) once capital is considered to be sufficient?

MediShield Fund's insurance contract liabilities are valued using the methodology prescribed by the Monetary Authority of Singapore. Even so, certain assumptions are needed.

These assumptions affect the size of its insurance contract liabilities, as shown by the following sensitivity analysis of its insurance contract liabilities in 2013 to changes in the assumptions:
Over the past seven years, changes in valuation basis by MediShield Fund resulted in its insurance contract liabilities falling as much as $210 million (in 2008) and increasing as much as $209 million (in 2013):

Capital Adequacy Ratio
Insurers are required to maintain a capital adequacy ratio ("CAR") of at least 120 per cent. The CAR is determined by the nature and value of the assets and liabilities.

MediShield Fund's CAR was 157 per cent as at 31 December 2013.

MediShield Life will target a CAR of 200 per cent.

MediShield Fund's CAR fell to 148 per cent in 2008, and if the economic crisis had worsened, its CAR could have breached the minimum requirement, according to Minister for Health Gan Kim Yong. This situation arose, not from a sharp increase in claims or insurance contract liabilities, but to a sharp $205 million net fair value loss, or almost 19 per cent, in MediShield Fund's investments.

The net fair value gain or loss of MediShield Fund's investments over the past six years is shown in the following figure:

MediShield Fund's investments are held in debt and equity securities, in Singapore dollars and foreign currencies. The position as at 31 December 2013 is as follows:

Currency Denomination
of Securities
$ million
Debt securities    
‒ Singapore dollars
‒ Other currencies
Equity securities 
‒ Singapore dollars
‒ Other currencies

As MediShield Fund's liabilities are denominated in Singapore dollars, it hedges "where necessary" its interest rate and currency exposure with forward contracts, futures, options and swaps.

CPF Board's sensitivity analysis shows that the value of MediShield Fund's investment portfolio as at 31 December 2013 would change $75 million for every 10 per cent change in equity prices. Is it worth taking the risk?
Premium Rebates
Mr Gan said:
"MediShield and MediShield Life as long-term health insurance schemes ensure sustainability by setting aside sufficient reserves. The reserves enable MediShield to honour [inter alia] ... premium rebates for the older age groups. It would not be responsible ... if yearly premiums for MediShield just exactly balanced yearly payouts, for this would mean that it cannot meet [inter alia] ... premium rebates."
Premium rebates are not acts of charity or generosity by MediShield Fund or the Government, nor are they ad hoc events. Premium rebates are scheduled to be given to policyholders who are aged 71 and above, provided they had pre-funded their MediShield premiums when they were younger.

MediShield Fund should account for the pre-funded premiums when received as a liability because the premium rebate constitutes an amount owing to the policyholders.

If, as Mr Gan argues, MediShield Fund needs to give premium rebates from its reserves, it would appear that it had treated the pre-funded premiums when received as surpluses, which were then taken to MediShield Fund reserves. This treatment is incorrect.

Alternatively, Mr Gan apparently misunderstood MediShield Fund accounts and accounting principles.

Whatever the case, MediShield Fund (or its successor, MediShield Life Fund, in the future) does not need to build up its reserves for premium rebates because premium rebates are or should be given from its insurance contract liabilities, not its reserves.

1. The data in this article are taken from Central Provident Fund Board's annual reports 2008 to 2013 and the Parliament debate on the MediShield Life Review Committee Report on 8 and 9 July 2014.

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