With mergers and acquisitions (M&As), it is critical that the medical professional liability insurance program be properly accounted for. Unpaid losses and loss adjustment expenses associated with the program can be a significant item on a balance sheet. There can be both substantial benefits and dangers associated with M&As that are important for management to consider in the preliminary stages of the M&A process. Milliman’s Richard Frese and Andy Hoffman provide perspective in this article.
This article was published in the February 2017 issue of Inside Medical Liability.
In this article, Milliman’s Richard Frese and Andy Hoffman offer organizations perspective concerning critical topics they should discuss with an actuary to enhance their insurance program, better manage liabilities, and maintain appropriate actuarial analysis for the needs of their program. The authors also discuss best practices when working with an actuary.
This article was published in The Risk Management Quarterly.
A captive insurance program can offer healthcare organizations several benefits such as broader coverage, improved cash flow, and direct access to reinsurance markets. However, not every organization is suited for a captive. Its management must assess the benefits and drawbacks before creating one. Milliman’s Richard Frese provides perspective in his article “Captive insurance: Is it the right choice for your insurance exposures?” He also discusses the background of captives, how organizations should choose a domicile, selecting coverage policies, actuarial analysis for loss projections, and considerations when shutting down a captive.
A well-designed allocation structure can help hospitals lower self-insurance costs by distributing costs at a departmental or employee level more effectively. This article, authored by Milliman consultant Richard Frese, highlights some features that hospitals should consider when designing and implementing an allocation structure.
When implementing an allocation, it is first necessary to achieve buy-in from members or departments and to define the goals. Allocations often apportion expected future insurance costs, historical unpaid claim liabilities, and tail liabilities (claims that have occurred but have not yet been reported). The finance managers should establish the goals of the allocation process to ensure program needs are met.
These goals should include ensuring that the allocation system encompasses five key features:
• A loss-control incentive that encourages safety among members
• Stability, with no significant fluctuation in annual contributions and liabilities
• Equity, as reflected in the fair treatment of all members (which does not mean that they all pay the same amount or rate)
• Intelligibility, ensuring the allocation is easily understood and readily accepted by members
• Ease of administration, allowing managers to carry out the allocation without difficulty….
Designing a Basic Structure
Allocations commonly are built on exposure, losses, or a blend of the two. Exposure often is defined as “bed equivalents” for professional liability and as payroll for workers’ compensation. Proper weights (i.e., conversion factors) translate – for example – occupied beds, outpatient surgeries, emergency department visits, and physicians into bed – equivalents. Different risk classes in payroll, such as nurses and clerical workers, also should be adjusted for. An allocation based purely on exposure is easily administered and may help keep the allocation amounts smoother over time.
An allocation using losses will encourage members to minimize losses, but may be more of a challenge to administer and design for several reasons.
Healthcare organizations pursuing a merger and acquisition (M&A) transaction should seek an actuarial analysis to estimate their medical malpractice (medmal) exposure. When seeking guidance from an actuary, executives need to consider several details that go into estimates, such as loss-development assessments, frequency and severity trends, and the accuracy of utilization data. Milliman actuary Richard Frese discusses these three details in his recent HFM magazine article entitled “Actuarial considerations of medical malpractice evaluations in M&As.” Here’s an excerpt:
A Loss-Development Assessment
An actuary applies mathematical models to estimate unknown losses or future losses based on prior history. Unknown losses are referred to as incurred but not reported (IBNR) losses. IBNR losses include claims that have not yet been reported, further loss development on known claims, claims that will reopen, and claims that may be in the pipeline but have not yet reached the status of a full suit. The sum of the known case reserves and the IBNR equals the liability on the balance sheet. The actuary tries to use as much of the hospital’s or health system’s history as is credible in developing a loss-development analysis. When there is not full credibility, an actuary blends in an industry standard or may use only this standard. When assessing future loss development, the actuary makes judgments. Even a slight variation in one of the actuary’s selections can have a significant impact on a loss estimate, particularly the tail factor, which explains the longer development of a tail factor in medical malpractice. Loss development will vary significantly between jurisdictions. Healthcare leaders should try to understand the actuaries’ thought processes and challenge the actuaries when the analysis does not line up with their assumptions. In an M&A transaction, it may be appropriate for an acquiring organization to assume the loss development of the acquired entity will follow the loss development of the acquirer. In this instance, leaders for the entity being acquired should be asked to value the reserves and payments so that the methodologies are consistent. Management may also request a scenario that assumes loss development of the acquired entity follows its own historical pattern. Loss control also becomes a question during an M&A transaction. The acquired organization may lose the motivation to engage in safe practice and defend claims. If the acquired entity has claims-made coverage, the acquirer may require that all claims be reported to the current insurance program.
Frequency and Severity Trends
The costs of claims usually rise over time, but the rate at which they occur can vary. When forecasting losses, actuaries examine both frequency and severity trends. Trends may be estimated based on the hospital’s or health system’s own data, if credible, or may need to be supplemented with industry information. A change in trends will affect future loss estimates. Considering that pro forma financial statements may require a projection of the next three years, it is important that the trends examined be appropriate so that the funding is adequate, not deficient or excessive. An actuary also may apply a trend for exposure when projecting future losses (commonly measured in occupied-bed equivalents), but such a projection often is based exclusively on the hospital’s or health system’s own growth or decrease in utilization and/or physicians.
Accuracy of Utilization Data
An actuary assumes that losses are proportional to the hospital’s or health system’s utilization—as measured by the number of inpatients beds, procedures, and physicians, for example. An organization’s leaders should ensure that metrics are detailed and accurately represent the operations of the hospital or health system. Some data may reflect increases over time, while other data may illustrate reductions that have occurred, so it is important to capture all available statistics. The definition of utilization metrics may vary by hospital. An organization’s leaders should discuss with the actuary what constitutes a record of each metric. This conversation is critical because an actuary will convert the statistics into occupied-bed equivalents and will need to ensure the proper weight or conversion factor is applied. In addition, some actuaries apply an industry cost per occupied bed to the number of occupied beds to arrive at an estimate of losses. This estimation will be skewed if the bed conversion factors that are applied are incorrect.
The long-tail nature of professional liabilities and workers’ compensation claims make it difficult to gauge the effect that healthcare reform will have on self-insurance. A plan of action is needed though to help organizations value their self-insurance programs. Milliman’s Richard Frese recently authored an article in HFM magazine offering five strategies for lessening the impact of the Patient Protection and Affordable Care Act (ACA) on self-insureds.
Here is an excerpt:
Healthcare leaders will be better prepared to ensure that actuarial estimates will meet loss accruals and forecast needs by implementing these strategies.
Inform all parties of legislation updates and implementation. Although the components of the ACA have been determined, implementation has hit a few snags. Even with a strong effort to explain the proposed changes to the public, there have been multiple interpretations. Further clarification and revisions—and even repeal—are possible. Healthcare leaders should focus on keeping all parties—including the broker, actuary, auditor, third-party administrator, outside defense counsel, and captive management—involved in the self-insurance program apprised of any changes. In return, these parties also should communicate any changes with each other and with the organization’s senior leaders.
Gather opinions from various sources. Senior leaders of each provider organization may not share the same views as leaders of other organizations regarding how the ACA may affect their organization’s role and function. The leaders of each organization will want to ensure the organization’s service providers are on the same page and are working toward its goals and directions, particularly if strategic goals and directions have been revised because of the ACA. During these conversations, leaders also should share their interpretation of what is occurring in the industry.
Monitor loss activity. Healthcare leaders should work closely with risk managers, third-party administrators, and other claims personnel to track any changes in frequency and severity of reported claims. Service providers should be alerted immediately about any noticeable changes. It should be noted whether such changes are believed to be due to the ACA or a different cause, such as a change in claims handling. It will be critical to determine whether any loss change reflects an actual trend and is expected to continue or whether the change is related to a one-time event. Internal meetings also might be held more frequently to better monitor activity.