"Effects of Leveraged Trend"
By Jeff Wright The stop-loss market has been extremely soft for the past several years. Due to this, renewal increases have been almost non-existent. However, during this time, medical trend (inflation) did not cease to exist. Claim cost continued to increase while stop-loss premiums remained flat, or decreased. The result, losses across the industry are at the highest levels in our history. For stop-loss to be a viable product in the future, we must take corrective action in the form of rate increases. Since employers have been accustomed to renewal rate passes, or even decreases, this rate action will be met with some resistance. One way to defend the rate action is to explain the effects of leveraged trend. Following are a few examples: Example #1 Assume a $20,000 Specific. Claimant John Doe has $35,000 claim for policy year 1997. So, there is a $15,000 reimbursement. ($35,000 - $20,000 specific). Assume trend for the 1997 policy year is 8%. Now, the same claim occurring in policy year 1998 would be $37,800 (= $35,000 x 1.08). This would make the stop loss claim increase to $17,800 ($37,800 - $20,000 specific), or a 19% increase. In this example, an 8% trend in first dollar claims leverages into a 19% trend in stop loss claim cost. Example #2 Assume a $100,000 specific deductible. Claimant Jane Doe has a $120,000 claim for policy year 1997. So, there is a $20,000 reimbursement. ($120,000 - $100,000 specific). Again, assume trend for the 1997 policy year is 8%. Now, the same claim occurring in policy year 1998 would be $129,600 ($120,000 X 1.08). This would make the stop loss claim increase to $29,600 ($129,600 - $100,000 specific), or a 48% increase. In this example, an 8% trend in first dollar claims leverages into a 48% trend in stop loss claim cost. Conclusion: Medical inflation trends can have a huge leverage effect on stop loss claim cost. In fact, as the stop loss deductible increases, the leverage effect increases also. As you can see, assuming as little as 8% annual trend in medical claims has a dramatic impact on the ultimate claim to the reinsurer. This is largely due to the fact that the employer is keeping his/her liability static or constant. Renewal rate action can be lessened if the employer is willing to assume additional liability (absorb the trend) in the specific deductible. The following are same examples as above, but with the employer assuming increases in the specific deductible. Example #1 From above, the 1997 reimbursement was $15,000. With no change to the specific deductible, the stop loss claim reimbursement grew to $17,800 for 1998 (+19%). If employer increases the specific deductible to $22,500, the stop loss claim reimbursement is $15,300 ($37,800 - $22,500), only a 2% increase versus the 19% increase. Example #2 In the second above above, the 1997 reimbursement was $20,000. With no change to specific deductible, the stop loss claim reimbursement grew to $29,600 for 1998 (+48%). If employer increases the specific deductible to $110,000, the stop loss claim reimbursement is $19,600 ($129,600 - $110,000 specific), actually a 2% decrease versus a 48% increase. Another Conclusion As you can see, if the employer assumes additional liability, the effect of trend on the reinsurance is substantially reduced and the stop loss rates should reduce also. Leveraged trend is only one component in renewal calculations. However, these examples help what's going on behind renewal rate increases. |
