Your medical scheme’s reserves could be costing you money

Cape Town - Your medical scheme contributions go up sharply every year, and yet the law requires that your scheme has 25% of contributions in a reserve fund. Isn’t it time this changes?

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Medical schemes are required to have a quarter of members’ contributions in reserve, according to Regulation 29 of the Medical Schemes Act of 1998. Schemes were given until 31 December 2004 to achieve this, and many schemes took several years to build their reserves up to the required level of 25%.

But this one-size-fits all approach might be outdated, and could be costing schemes and their members lots of money, as this cash sits in the reserve fund and is not earning the highest investment returns.

But do all schemes really need so much money in their reserves?

How this regulation came about

“These guidelines were established at a time when the financial soundness of the medical schemes industry was somewhat uncertain, and now almost 20 years later, the country and its socio-economic situation have evolved, and the healthcare environment has altered significantly”, says Patrick Masobe, Agility Health chief executive officer and also the founding CEO of the Council for Medical Schemes (CMS).

The CMS is a statutory body established by the Medical Schemes Act of 1998 to regulate the medical schemes industry in South Africa.

Solvency levels of schemes in SA

On average, restricted schemes tend to have higher solvency levels than open schemes. By the end of 2014, there were 83 registered medical schemes in South Africa – down from 144 in the year 2000. By 2016, 23 of these schemes are open, and the other 60 are restricted.

The difference between the two is that anyone can join an open scheme, whereas a restricted scheme is not open to members of the public, and membership is usually limited to employees/retirees of a particular company and their dependents.

Of all scheme members in SA, 58.5% belonged to open schemes by the end of 2014, and 41.5% to restricted schemes, according to the Alexander Forbes Diagnosis 2015/2016.

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Restricted schemes often have higher solvency levels than open schemes, one reason being that they have many younger and healthier members on their scheme, who are obliged to join as part of their employment contracts. But this is not always the case, as the presence of a large number of retired members can alter the claims pattern of any scheme as a whole. Young healthy people often only join open schemes when they are getting older or are starting families.

In 2014 the average solvency level for all schemes was 33.3% with open schemes standing at 30% and restricted schemes at 37.9%. By the end of 2014, according to Alexander Forbes, schemes had a total of R43.1bn in reserve.

The purpose of the 25% of contributions kept in reserve is to make sure that a scheme can pay all the claims it receives from their members, even if there were to be a sudden increase in claims, such as one would have during an epidemic. The reserves also provide security in the case of an event such as the financial failure of an external scheme administrator.

By the end of 2014, of the open schemes, Discovery had reserves of 25%, Bonitas and Momentum of just over 30%, Fedhealth of almost 40%, and Medshield of over 50%. Of the restricted schemes GEMS stood at 10% and Transmed at just over 20%.

How are scheme reserves invested?

Schemes mostly follow very conservative investment strategies when it comes to their reserves: 50.9% of open schemes held their assets in cash with only 15.4% allocated to equities and the rest in bonds and debentures. The Medical Schemes Act states that a maximum of 40% of the reserves of a scheme may be held in equities.

However, investment returns are what funds the claims of schemes that do not achieve an operating surplus (which in 2014 included 47 of the 83 registered schemes), according to Alexander Forbes.

A scheme that does not have the required amount in reserve, needs to submit a business plan to the CMS, outlining how they are going to achieve the required level of reserves. The two main ways in which this is usually achieved, are by reducing benefits, or increasing contributions. In a competitive market, both of these can lead to a loss of members.

One-size-fits all reserve requirements outdated?

“There are more practical measures of solvency requirements that could be adopted to the current context,” says Masobe. He mentions that the industry as a whole is "buckling under soaring claims costs".

He is in favour of re-looking each scheme’s obligations to its members, its member profiles, its size, and whether it is open or restricted and to determine what reserves that scheme needs.

“The most efficient and practical approach would involve each medical scheme’s Board of Trustees developing their own liquidity management strategy, which is informed by the particular scheme’s inherent risks and details the amount of liquid assets required to fulfill its obligations,” according to Masobe.

The 25% reserve requirement has a different impact on different types/sizes of schemes. As a growing and large restricted scheme, GEMS (Government Employees Medical Scheme), has been criticised for only having reserves of 10%. But if an existing scheme is growing quickly, according to the regulations, it has to come up with the required reserves immediately, whereas a new scheme is given a period of time in which to build their reserves.

Criteria for determining the size of the reserves

But according to the Alexander Forbes report, the larger the scheme, the more stable the claims experience is likely to be. For example, a claim of several million rand will have an impact on a scheme with 6 000 members, whereas a scheme with 60 000 members is less likely to be affected by it. The report recommends that the solvency requirements for larger schemes should be lower, and higher for smaller schemes.

They also recommend that the different profiles and risks of each individual medical scheme should be taken into account: a scheme where a quarter of the members are pensioners is going to need higher reserves than a scheme where only one in 10 members is a pensioner.

Masobe suggests that the trustees of each scheme put together an estimate of the necessary liquidity level, and present it to the CMS for moderation.

He argues that “the membership profiles, inherent risks and approach to medical scheme management are not uniform throughout the industry, and should not be assessed using a single, rigid standardised measure”.

A risk-based solvency measure therefore could be a more appropriate way of determining what each scheme holds in reserve.

The sustainability of a scheme should be measured by the following criteria, according to the Alexander Forbes report:

· the size of the scheme;

· membership growth;

· change in the age of beneficiaries;

· change in the operating result of the scheme relative to the industry;

· the change in the operating result per beneficiary per year;

· the change in the accumulated funds per beneficiary per year; and

· the scheme’s actual solvency.

When analysing 20 schemes according to these criteria in 2014, Alexander Forbes found that 18 schemes had more reserves than they required and that GEMS and Liberty Medical Scheme (which has since amalgamated with Bonitas) needed more.

The CMS has developed another formula for calculating the amount each scheme needs to keep in reserve, but this has not yet been implemented, and is still open for comment from the industry.

(Sources: Alexander Forbes Diagnosis 2015/2016; Council for Medical Schemes, Press release from Agility Health; The Medical Schemes Act, 1998).