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Chapter 9: Risk Management

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This document should not be carried outside the physical and virtual boundaries of TCS and
its client work locations. Sharing of this document with any person other than a TCSer will
tantamount to violation of the confidentiality agreement signed when joining TCS.

Notice
The information given in this course material is merely for reference. Certain third party
terminologies or matter that may be appearing in the course are used only for contextual
identification and explanation, without an intention to infringe.
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Contents

Chapter - 9 Risk Management .......................................................................................... 4
Introduction ...................................................................................................................... 4
9.1 Health Insurance and Risk ...................................................................................... 5
9.2 Categorization of Health Insurance Risks ............................................................... 5
9.2.1 Environmental risk ......................................................................................... 5
9.2.2 Financial Risk .................................................................................................6
9.2.3 Operational Risk ............................................................................................ 7
9.2.4 Pricing Risk .................................................................................................... 8
9.2.5 Reputation risk ............................................................................................. 10
9.2.6 Strategic Risk ............................................................................................... 10
9.3 Risk Assessment .................................................................................................. 11
9.4 Risk Assessment Tools ......................................................................................... 11
9.4.1 Quality of Risk Assessment Tools ................................................................. 11
9.4.2 Criteria for Assessing Risk Assessment Tools ............................................... 11
9.4.3 Classification of Risk Assessment Tools ....................................................... 12
9.5 Risk Adjustment .................................................................................................. 13
9.6 Risk Assessment Models ...................................................................................... 13
9.6.1 Applications of Risk Assessment Models ...................................................... 13
Summary ........................................................................................................................ 14
References ...................................................................................................................... 16

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Chapter - 9 Risk Management

Introduction
Offering health insurance itself is acceptance/transfer of risk of the insured to the insurer.
Hence such risks are underwritten by sound actuarial principles. Health insurer is subjected
to various types of risks like environmental risk, financial risk, operational risk, pricing risk,
reputational risk, and strategic risk. All these risks are to be assessed using various risk
assessment tools before underwriting them. Data used by the risk assessment tools might
vary from demographic information, self reported health status and administrative data.
Based the assessment, the risk is adjusted accordingly (generally premium adjusted). This
chapter brings insight into various types of risks faced by the health insurer and tools for
assessing them and how they are adjusted.

Learning Objectives
On completion of this chapter, you will understand the:
Various types of risks faced by the health insurer
Definition of risk assessment
Measuring the performance of risk assessment tools
Various risk assessment models
Applications of risk assessment models

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9.1 Health Insurance and Risk

The purpose of health insurance is to transfer an individuals financial risk of meeting the
expenses of healthcare services to a third party, generally an insurer by the way of a
healthcare plan or an insurance policy. In return to accepting risk, insurer gets the premium
from insured. The collected premium may or may not be sufficient to meet the cost of
services. Hence, the premium is calculated based on the anticipated cost of healthcare
services of those of insured.

Risk selection comes into picture when individuals have option to choose among various
plans. And adverse selection happens for many reasons like:
People belonging to high medical risk enroll to one particular healthcare plan
Might happen randomly
Differences in benefit package and empanelled provider network strategies
Healthcare plans luring healthier enrollees
9.2 Categorization of Health Insurance Risks

There are a lot of risks associated with health insurance that is going to impact both the
insurer as well as insured. Those risks can be categorized into:
Environmental risk
Financial risk
Operational risk
Pricing risk
Reputation risk
Strategic risk

9.2.1 Environmental risk
It includes risk factors which come from external elements like economy, completion, fraud
etc,
Buyer Environment: It is the risk that the target market or buyers bring a positive
or a negative impact on the product.
Ex: Formation of buyer groups

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Competition: It is the risk, that a competitor either entering or leaving the market
brings a significant impact because of changes in market shares (possibly through
mergers and acquisitions) or that substitutes health insurance like self-funding or
price wars to increase market shares (low) to cover fixed costs.
Economy: It includes the risk consequence of adverse economic conditions whose
effects might include: increased LTD (Long Term Disability) claims due to
unemployment in case of downturn, and stress claims in an upturn. In case of
positive economic outlook there will be more people with insurance, which might
increase burden on provider network which is not manageable.
Fraud (External): There are different types of fraud which was discussed in detail in
the next chapter. General types of fraud include: provider fraud and subscriber
fraud.
Legal/ Regulatory: There will be a lot of legislative and regulatory changes
happening corresponding to health insurance which can have a positive or a
negative impact on them. Positive effects include making product attractive by the
way of tax deductions, premium subsidies etc.., or might bring negative impact by
completely eliminating private market by introducing national healthcare.
Supplier environment: It is the risk associated with the suppliers of the insurance
market. For instance cost shifting of medical equipment to insurers employed by
providers or an exit/entry of a large provider firm from/into the market or medical
malpractices or provider alliances.
9.2.2 Financial Risk
It is the risk associated with the financial status of the insurer which might range from
capital adequacy to liquidity. Moreover the premium collected by the insurance company is
invested into various asset classes, which as well are subjected to various risks.
Asset default: This kind of risk comes into picture when the investment assets are
subjected to credit risk that is, the company which issued the security is unable to
make payments.

Financial Viability: It is the risk that the company will not be able to meet its
current obligations.

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Interest rate: Fluctuation in the interest rates affects the cost of healthcare services
and the valuation of assets. Healthcare costs include provider bills, cost of business
venture, utilization etc..,

Liquidity: When the assets are not able to be immediately converted to cash at a
fair market value then the company will become illiquid

Re-investment risk: It is the risk that the future cash flows when reinvested might
not be able to generate similar returns

Reserve adequacy: There are set norms by the regulator to the insurance industry
with respect to adequate reserves that the company should maintain in order to
remain solvent even under uncertain circumstances. So if the reserves are
inadequate then the insurer will not be able to meet the obligations and if they are
in excess then it is considered to be conservative and will be subjected to negative
pricing, tax and reputational implications.
9.2.3 Operational Risk
Health insurance involves a lot of operational activities like premium collection, claims
handling, bills processing, reinsurance, sales force management, and provider network
management etc, Hence there is a scope of risk with all the activities.

Billing and Collections: It is the risk encountered when the cash inflows do not
happen as expected because of poor billing and collection practices.
Ex: Cash flow problems inefficient customer accounts receivables,

Claims processing: It includes risk associated with handling lawsuits and disputes
related to claims administration (management & adjustment). It also includes risk
associated with billing issues with provider network.


Fraud (Internal): The risk arising out of dire financial consequences because of
internal fraud or inadequate internal controls that are placed to detect and combat
fraud.
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Re-insurance: Inability to obtain reinsurance at a desired level or lack of reliability
and improper timing of cash flows from reinsurer to the ceding company is a
hindrance.

Sales force: Risk arising out of ineffective and improper techniques used by sales
force to achieve desired results.

Training: Inadequately trained employees make mistakes that lead to adverse legal
and financial consequences for the insurer.

Vendor relations: TPAs (Third Party Administrators) perform most of the
administrative work of the insurer, if they are not complying to the insurers
standards it results in violation of contractual terms, which further is going to have a
direct or an indirect impact on the insurer.
9.2.4 Pricing Risk
Premium pricing is the toughest task in case of health insurance inspite of using several
actuarial and statistical methods because of the complexity arising out of competition,
data, products, regulations and legislations. Hence there are a lot of risks associated with
health insurance pricing.
Anti-selection: If the pricing and the benefit structure of the company is not aligned
to the anticipated prices and better risks then it would not attract much of people.

Bargaining power: Group insurance premiums are generally at a discounted price
of the normal premiums. And if it differs with the normal pricing policy then insurer
might be subjected to pricing risk.

Competition: Pricing risk in terms of competition will be in the way of lower
premiums which are not adequate enough to cover the claims, other administrative
expenses, taxes and estimated profits.

Data: If insurers are provided with inefficient and inadequate data it results in
improper pricing of the product or a wrong product.
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Model: If the model used in pricing an insurance product cannot reflect the scope of
pricing risk associated with the product adequately, then it might not deliver
anticipated results.

Regulatory/ Legislative: It is the risk insurer faces when,
not allowed to price the product at an adequate rate,
not permitted to use sound actuarial principles in premium pricing,
price revision is not allowed when essential

Underwriting: If an insurers underwriting policy accepts following risks into
underwriting classification then it is definitely subjected to risk:
A risk which is heterogeneous with the risk pool
A risk that increases the average cost of expected claims

Re-insurance: The risks arising out of reinsurance include:
Unavailability of reinsurance
Extent and form of reinsurance selected
Cost of reinsurance
Reliability and timeliness of the reimbursements from the reinsurer

Trend: If the insurer fails to keep up with the trends in the following aspects then it
is subjected to risk:
Inflation risk arises when the actual cost of expenses exceeds the
anticipated cost of expense
Technology risk arises when the insurer is not able to anticipate the claims
cost of technologies that will be available in the future or the ones that are
going to be cover or used by the insurer
Utilization risk arises when the actual frequency of claims and services differ
from the expected ones.

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9.2.5 Reputation risk
It is the risk that the reputation of the insurer might be damaged because of several external
and internal factors.
External factors: It covers risk factors that are external to the company (insurer)
Rating agencys rating of the insurer changes with the companys/ industrys
actions which if downgraded is a risk to the company
Stock analysts interpret the corporate information of medium & long term
corporate strategies which results in the volatility of the stock prices of the
insurance company
Disgruntled policyholders creates negative publicity to the company

Internal factors: It covers risk factors that are internal to the company (insurer)
Corporate governance is one of the primary view points of the public on the
insurance company
Claims adjustments are to be in line with the expectations of the policy
holders and the providers of healthcare
Fraud results in the loss of companys reputation, which will happen when
proper controls are not put in place to detect and prevent it.
Sales through unethical, misleading and forceful tactics lead to changes in
future regulations/ legislations and expectations of future policyholder
9.2.6 Strategic Risk
It is the risk arising out of unrealistic and inefficient strategies employed by the insurance
companies.
Capital management: It is the risk when the corporate strategy is not supported by
adequate capital that is necessary to run the normal business.
Growth: The risk that there are insufficient resources to sustain the growth
witnessed.
Management failure: Risk resulting out of unsuccessful management strategies
putting companys future at risk.
Network management: The risk when the insurer has not paneled with the
providers that supports the corporate strategy, which can be by the way of:
Insufficient provider network
Inability to attract because of fee structure and contract terms
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Mergers & Acquisitions: It is the risk when a proper due diligence is not performed
which identifies problems that hinder strategic fit.

9.3 Risk Assessment

Now that various types and sources of risk are identified, the magnitude of the risk has to be
assessed so as to determine the cost of insurance accordingly. Risk assessment
methodology is used to calculate the estimated overall healthcare cost of each member
under the pool. Risk assessment is often referred to as risk adjuster because risk
assessment tools are used to identify high risk individuals and their premium income is
reallocated to accurately reflect the homogeneity in distribution of health risk among plans.

9.4 Risk Assessment Tools

The mechanism by which the data is analyzed termed as risk assessment tool. These tools
are designed to measure the risk either on a historic or on the current period basis.
9.4.1 Quality of Risk Assessment Tools
Risk assessment tool can be measured on its ability to accurately predict the expenditure
variation of an individual or a group. The statistical measure of its predictive power is
represented by R
2
. Closer the R
2
value to 1 it is considered more predictive.
Another method of determining the adequacy of risk assessment tools is the predictive
ratio. It is the ratio of total predicted cost to the actual cost for a given set of population
under consideration. An accurate tool gives a predictive ratio of 1. Any ratio less than 1
implies that the tool is under-predicting the cost of the given group and a ratio greater than
1 implies that the tool is over-predicting the cost.
9.4.2 Criteria for Assessing Risk Assessment Tools
Since each risk assessment tool has got its own predictability there has to be criteria for
assessing them like:
Predictive power: Ability of the tool to explain the variation in expenses of given
individual or a group
Incentives: Impact on the behavior among providers and healthcare plans in the
short and long term.
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Availability of data: Data required for the functioning of the tools should be
complete, timely and of quality
Transparency: All the stakeholders must be able to understand the functioning of
the tool
Simplicity: It must be easy to implement and use
Reliability: Consistency in the performance of the tool over a period of time
Cost: Efforts (time & money) spent on the tool and acquiring data
9.4.3 Classification of Risk Assessment Tools
Risk assessment tools can be classified based on the data used for assessment like:
Demographic Information: It is one of the traditional risk assessment tools where
the risk premiums are calculated based on the demographic factors like age,
gender, marital status, location of residence etc.., Demographic data becomes the
base for other mechanisms of measurement. Though its predictive powers are too
low, because of ease in the nature of calculation and inexpensive administration it is
used in most of the risk assessment models. Moreover it is transparent, reliable and
easy to verify, audit and comprehend.

Self Reported Health Status: In this case, risk adjusted premium varies for each
individual (or a group) based on their health status measured either by surveying
enrollees or a pre-contract health check-up for each of them. It is more predictive
than demographic information but is relatively costlier to implement. The reason
for higher cost is the significant amount of time and money has to be spent
gathering such data.

Administrative Data: There is a lot of administrative data that can be used to
measure medical risk which includes medical expenditure history, diagnostic data
(like inpatient/ outpatient claims data, encounter data), and data on usage of
prescription drugs. Research suggests that administrative data has got higher
predictive powers when compared to the demographic data alone. Diagnosis based
models are not transparent.



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9.5 Risk Adjustment

It is the method by which the premiums to insurers and payments to providers and other
healthcare professionals are adjusted reflecting the risk assessment scores. If predictive
models are used they estimate the future costs while the risk adjustment models determine
the health status.

9.6 Risk Assessment Models

There are two types of risk assessment models:
Prospective/ Predictive models: They take past data into consideration for
predicting the future cost estimates of the members and arrive at the health
insurance premiums. Generally they are used to adjust payments.
Concurrent models: They take current data into consideration for estimating the
expenses of the same period. They generally are used to calculate the actual
utilization for the current period.
9.6.1 Applications of Risk Assessment Models
Risk assessment tools has got innovative uses which include:
Managing patient care, for instance high-cost case identification
Adjusting payments from plans to providers
Profiling physicians based on their quality & productivity
Physician payments based on specific quality measures
Predictive modeling to assist healthcare plans in their routine business functions
like underwriting and renewal rating
Evaluating managed care programs
Setting budget and premium rates for payers

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Summary
The purpose of health insurance is to transfer an individuals financial risk of
meeting the expenses of healthcare services to a third party, generally an insurer by
the way of a healthcare plan or an insurance policy.
Health insurance risks can be categorized into:-
Environmental risk
Financial risk
Operational risk
Pricing risk
Reputation risk
Strategic risk
Sources of environmental risk are:-
Buyer Environment
Competition
Economy
Fraud (External)
Legal/ Regulatory
Supplier environment
Sources of financial risk are:-
Asset default
Financial Viability
Interest rate
Liquidity
Re-investment risk
Reserve adequacy
Sources of operational risk are:-
Billing and Collections
Claims processing
Fraud (Internal)
Re-insurance
Sales force
Training
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Vendor relations
Sources of pricing risk are:-
Anti-selection
Bargaining power
Competition
Data
Model
Regulatory/ Legislative
Underwriting
Re-insurance
Trends with respect to technology, inflation and utilization
Sources of reputational risk are:-
External factors like rating agencys rating, stock analysts interpretations,
disgruntled policyholders
Internal factors like Corporate governance, Claims adjustments, Fraud
results in the loss of companys reputation, Sales through unethical
practices
Sources of strategic risk are:-
Capital management
Growth
Management failure
Network management
Mergers & Acquisitions
Risk assessment tool can be measured on its ability to accurately predict the
expenditure variation of an individual or a group.
Risk assessment tools are classified based on the date they use like:-
Demographic Information
Self Reported Health Status
Administrative Data
Types of risk assessment models are:-
Prospective/ Predictive models
Concurrent models

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References
Kathryn E. Martin, Deborah L. Rogal, and Sharon B. Arnold, Health-Based Risk
Assessment: Risk-Adjusted Payments and Beyond, Health Care and Financing Organization
January 2004
An Introduction to Risk Assessment and Risk Adjustment Models, American Medical
Association
Winkleman R, A Comparative analysis of Claims-based Tools for Health Risk Assessment,
Society of Actuaries, April 20, 2007

Notice
The information given in this course material is merely for reference. Certain third party
terminologies or matter that maybe appearing in the course are used only for contextual
identification and explanation, without an intention to infringe.


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