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The Actuarial Standards Board (“ASB”) made changes to ASOP 6, which is the Actuarial Standard of Practice (“ASOP”) related to Measuring Retiree Group Benefit Obligations and Determining Retiree Group Benefits Program Periodic Costs or Actuarially Determined Contributions. One of these changes is the requirement that Per Capita Benefit Costs must be age-graded if the benefits program is fully community rated. The narrative that follows is an explanation as to why this change is in error and must be repealed before it goes into effect.
ASOP 6 defines the principles to be used in the valuation of employer liabilities and costs of retiree benefits that are guaranteed to current or future retirees. One retiree benefit discussed in this ASOP is health care. Generally, costs and liabilities for postretirement health care benefits are valued using a seriatim method which uses an estimated Per Capita Benefit Cost as the annual estimated cost for the base year and trend assumptions for use in trending these base year costs into subsequent years. Since, on average, health care costs increase as an individual ages, health Per Capita Benefit Costs are generally age-graded. The actuary uses premium rates or incurred claims estimates to develop a table that has an average annual claim costs for each year of attained age, beginning with the earliest year of possible retirement and ending at some point where the assumption can be made that the last entry can be used for the defined age (say 90) and all succeeding ages (91 and older retirees).
One current exception to the use of age-grading is when the benefit plan through which the retiree health benefits are purchased is fully community-rated. A plan that is fully community rated has rates that vary based only on benefit and family tier (single, family, etc.). This implies that the premium would be the same if a group had two enrollees aged 64 or if it had enrollees aged 22. The fact that the rates are community rated means that the rates for any group is based on all groups in the pool and not on the experience of that single group. Under this type of rating arrangement, a group would pay the same rate regardless of the ages of its retirees that it places in the community-rated pool. Using this logic, the community rates are currently used as the Per Capita Benefit Costs since this represents the total cost to the group regardless of the experience and the ages of its retirees.
The ASB has changed its requirement in the case of a fully community rated group. It does not dispute the logic of the previous paragraph but it does say that a group may change benefit plans to a lower cost experience-rated plan in the future and that necessitates using age-graded costs in the current valuation even though there may be no intent on the part of the group to change plans in the near future.
Reasons That New Methodology is Not Appropriate
There are multiple problems with requiring fully community-rated health benefit plans to be valued using age-graded Per Capita Benefit Costs:
Generally accepted actuarial principles for valuations under ASOP 6 are that these valuations use information known as of the valuation date. Valuations are not allowed to assume any “estimated” future changes in plan design, either an increase or decrease. “Estimated” changes in costs due to a possible change in pension fund administrator or retiree health plan administrator is not allowed. Requiring an assumption that at some point in the future an employer will change to a new administrator that is experience-rated is contrary to the logic preventing a change in benefits or administrator assumptions. If change in administrator assumptions are not allowed in any other situation, why would it be required here, especially in situations where employers have no intent to change funding arrangement.
Age-grading would result in a substantial overstatement in liability each year since the rates are actually community-rated in the base year and no imminent change would be expected in the near term. Using age-graded costs in Year 1 of the valuation would dramatically increase estimated Year 1 cost over what would actually be paid in premium for that year. Likewise, Year 2 would probably be overstated unless the unlikely scenario of a switch, unknown at the time of valuation, to an experience-rated program is realized in Year 2. The use of Actuarial Present Value in valuations implies that Year 1 and Year 2 (etc.) have a much bigger impact on the total liability than Year 10 and Year 11 (etc.). When performing a January 1, 2016 valuation, for example, the fact that an employer may change to an experience-rated plan 5, 10, or some subsequent year down the road would not affect the January 1, 2016 liability nearly as much as the known overstatement in the earlier years in the valuation. So, even if it is possible that a program might become experience-rated at some point down the road in some future year that has a lesser impact on this year’s valuation, changing Per Capita Benefit Costs in Year 1 would have an immediate substantial increase in liability for that year that is artificial and that would result in gains in valuations performed in future years as the erroneous assumption for prior years is replaced by actual historical paid premium. For example, If the community rates times number of estimated retirees in 2016 for a January 1, 2016 valuation is $1,000,000 and the age-graded costs times the retirees by age gives $1,500,000, then the January 1, 2016 valuation has an overstatement of $500,000 just for 2016 costs as the $1,000,000 is the total cost to the employer since it IS currently community-rated during that year. Likewise, 2017 will be substantially overstated unless the employer converts to an experience-rated program in 2017. So, even in a situation where an employer ends up converting to an experience-rated program in 2020, the January 1, 2016 liability is overstated by the present value of the difference in costs for the flat community-rated premium and age-graded premium methods for the four years that it actually remains fully community-rated, 2016 through 2019. The net result is the actual overstatement using this method substantially exceeds the understatement, even in cases where the employer does switch to an experience-rated plan in the future.
Some states do not allow certain sized employers to be experience-rated. For example, in 2016 New York State (along with other states due to ACA) will require all employers with 100 or less employees to be community-rated. For ASOP 6 to require a change in assumptions to a scenario that is actually illegal is not appropriate. Also, Medicare advantage plans are community-rated from the employer-group perspective.
In certain regions, a payor may have a dominant market share and a switch to a new arrangement that is experience-rated may not be feasible. A requirement to use an assumption is not practical in this situation.
A “switch to an experience-rated plan that is cheaper” inherently means that age-grading the community rates would overstate any year in the valuation. The valuation would need to determine an estimated year of switch and the percent savings that the employer would achieve as a result of switching to the experience-rated plan. For example, if the assumption is that the employer would see a 20% reduction by going experience-rated then the community rates would be age-graded and these age-graded rates would then be reduced by 20%. Theoretically this table would be assumed to come into place at some point in the future as it is obvious for a period of time that the community rates are the actual cost to the employer, even if it is just the first year. At such point in time where the valuation assumes the switch to take place then the flat community rates would be replaced by the age-graded table. There is no guidance on when to assume the switch occurs and to assume that it occurs in year one is not appropriate.
Use of this ASOP as is would result in a substantial loss for employers who are affected by this change, a substantial loss that is due to an incorrect assumption that the plan is no longer fully community-rated, as signaled by the use of age-graded Per Capita Benefit Costs for Year 1 of a valuation. There will be much confusion and anger, and less accurate liability calculations.
The ASB should repeal the portion of the ASOP 6 changes that require age-grading for fully community-rated groups. Failure to do this will result in overstated, erroneous liabilities and substantial confusion and anger in the marketplace. It is undertandable that the Actuarial Standards Board is trying to prevent huge losses due to switches from community-rated to experience-rated coverage but a a more appropriate and less disruptive method of accomplishing this is to require a person with fiscal responsibility of the employer-group to sign off that they understand that a switch from community-rated to experience-rated may result in a substantial increase in postretirement liability.