Insurance reserves

As I mentioned yesterday, the quality of insurance company reserves matters a lot to state regulators.  So let’s talk a little more about reserves.

State regulators have a mission to make sure there is no chance in hell of an insurance company going bust with outstanding claims unpayable. The state regulators rely on very large cash and capital reserves to make sure that in a three or four sigma event, the insurance company is still able to pay off all claims incurred up until the drop-dead date. Mayhew Insurance routinely carries four to six months of cash or near cash as the go out of business bankruptcy reserve. The Blues and other larger carriers can get away with a little less proportional cash as their size smooths fluctuations better than a medium sized insurer. Smaller insurers whose risk pools are not too deep need more cash on hand to cover the unexpected.

Up until the Cromnibus, the risk corridor payments were seen as near cash and counted as high quality reserves. However the Cromnibus applied a large but unknown discount to those claims on Federal payments. That means the state regulators started to worry that in oh-shit scenarios, the smaller insurers could not pay off all incurred claims. And once state regulators start to worry, they shut down insurers that they worry about.

Health insurers have two sets of reserves.  The first set of reserves are the shut-down this afternoon and pay all obligation reserves.  Those reserves are calculated as a percentage of current month premiums.  The goal is for an insurer to have enough cash on hand to cover an absurdly unlikely set of claims without ever receiving another penny of revenue.  A small insurer with a shallow risk pool will need more months on hand as their ability to handle a claim from an individual with hemophilia who got bitten by a coyote after being in a BASE jumping accident is less than an insurer with a million covered lives.  The size of the risk pool helps reduce variability and lower aggregate variability leads to lower needed reserves to cover a a five or six sigma event.

These shut down and pay reserves are the reserves state regulators care about.  They must be liquid or easy turned into liquid cash, they must be accurately priced, and they must be stable.  Insurance companies are not trying to make significant money from these reserves.  Instead they need to know that a dollar in reserve today is a dollar in reserve tomorrow.  That means most of these reserves are held as cash, US Treasury debt, AAA bonds, and AAA short term commercial paper or money market accounts.  The goal is not to make money, it is to not lose money.  When the co-ops counted on the Federal government to make good on the risk corridor losses, they were marking the accounts receivable as very reliable and solid.  That assumption was destroyed by the Cromnibus.

The other type of reserves are excess reserves. Many larger non-profit insurers have significant reserves in excess of shut down and pay out everything incurred but not reported.  Some for profit companies also have large retained earning reserves.  Those reserves are utilized to make money for the insurer.  At this point the insurance company transforms itself into a hedge fund with an odd cash flow model.  Those reserves are used to buy stocks, buy other companies, invest in real estate or currency movements or derivatives or reinsurance or any other financial instrument that the insurer or its reserve investment advisors thinks can make a good return for the insurer.  In some years, gains on investments provide the entire positive financial margin for insurers.

UPDATE 1: In before the single payer advocates — yes, Medicare for All does not have any need for explicit reserve accumulation as the full faith and credit of the United States government is the explicit backer and we can safely assume the US government will not go out of business on any given afternoon, and if it does, we are in a world of far greater shit than worrying about health insurance payments.  But we don’t live in that world as is.