Insurance Advisor Newsletter - Summer 2016

July 2016


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Table of Contents


The Affordable Care Act Six Years Later – Success or Failure? 

By John Green and Steven Shill

The Affordable Care Act (ACA or, colloquially, Obamacare) was passed into law on March 23, 2010.

To say that the ACA has generated a considerable amount of controversy over the past six years would be an understatement. The law has precipitated constant infighting between the two main political parties and generated numerous lawsuits—three of which made it to the Supreme Court, with one upholding the law as a tax. Below, we explore some of the successes and failures of the ACA. 

On March 3, 2016, the Department of Health and Human Services (HHS) announced that 20 million people gained health insurance coverage for 2016 as a result of the ACA, based on the open enrollment statistics from November and December 2015. This includes approximately 12.7 million people who signed up for coverage through the federal or state-sponsored health insurance exchanges and 7.3 million who gained coverage either through a parent’s insurance plan (18 to 26-year-olds) or through Medicaid expansion. HHS did not mention the 16.5 percent lapse rate in 2015, which translates to approximately 2 million people who won’t have coverage at some point in 2016, due to nonpayment of premiums.

While HHS cites the above statistics as a measure of the ACA’s success, the program has fallen short of its initial goals. In 2010 the Congressional Budget Office estimated there were 47 million uninsured Americans between age 18 and 64, and suggested the ACA would provide health insurance coverage for 32 million by 2019. It appears at this point the program will fall well short of these initial goals.

Further, the program is facing some challenging issues that may actually reduce the number of insured in the coming months and years. On July 5, 2016, the Connecticut Insurance Department placed HealthyCT, a cooperative that participates in the state’s health insurance exchange, under supervision and told its 40,000 policyholders they must obtain alternative coverage no later than year-end. This marks the 14th of the original 23 operational cooperatives formed under the ACA that has failed, and several others are currently on shaky footing. 

Officials at HealthyCT have attributed its demise to the Centers for Medicare and Medicaid Services (CMS), which billed the insurer $13.4 million on June 30, 2016, as part of the ACA’s risk adjustment program, intended to transfer some of the costs of less profitable or unlucky insurers to the more profitable insurers. Essentially, HealthyCT, according to CMS, actually had better results than other ACA insurers – a frightening proposition for the nine remaining cooperatives. 

Ironically, last October CMS funded only 12.6 percent of the risk corridor requests, another field-leveling initiative of the law, which was cited as the root cause of previous cooperative failures. With 14 fewer cooperatives available, many Americans have fewer, less robust and likely more expensive health insurance options. 

There are many factors that led to the shuttering of these cooperatives. Some cite the failure of the federal government to provide sufficient loans, although more than $1.2 billion of now-uncollectible loans were granted to the failed cooperatives. The risk adjustment and risk corridor programs are deemed a factor by some, as are lower than expected enrollment figures and the relative ease with which an individual can enroll in the off-enrollment period. State regulation, which can make selling products across state lines difficult, is another cause mentioned.

While all of these issues contributed to the failure of the cooperatives, the underlying cause is pricing. The cost of healthcare has outstripped the premiums charged by insurers. Many of the cooperatives, as well as some for-profit startups, gained market share on price and hoped to make up any losses down the line. Unfortunately, that never occurred for 14 (and counting) cooperatives. 

Even the largest health insurance providers have begun to realize that the individual marketplace is a risky and often unprofitable venture. In April of 2016, UnitedHealthcare announced that it would exit 26 of the 34 states where it participated in the health exchanges, leaving 795,000 members looking for replacement coverage. If UnitedHealthcare, a large and diverse health insurance company with a vast network and considerable leverage, believes it cannot make money in the individual marketplace, it suggests stormy seas ahead for many of the remaining cooperatives.

Healthcare is indeed complicated and expensive. Ideally, the ACA would have established a mechanism, such as a standing bipartisan committee, to deal with some of the unforeseen issues that have arisen since its passage in a prompt and efficient manner. But, this was unlikely to occur given the political climate at the time of its passage. 

So, where do we go from here? There are a few aspects of the ACA that make sense, including the electronic delivery of prescriptions and the ability for people with pre-existing conditions to obtain coverage. But there are also unintended consequences. The healthcare cooperatives have largely been a failure and the rapid consolidation of healthcare providers is concerning to both regulators and consumers. Doctors complain about the added administrative time; time they say takes them away from patients. While plans may be available to all, they are rapidly becoming unaffordable to those that most need coverage. Six years later, some 30 million Americans are still uninsured. As part of the backlash, insurers are increasingly taking actions to sue the federal government; a coalition of small, nonprofit health insurers met earlier this month to discuss their legal options over the risk adjustment program. One can only wonder if the money spent by the federal government on the ACA initiatives could have been put to use more efficiently.

For better or worse the ACA has changed the healthcare delivery system in the United States. While the ultimate goal of insuring every American remains elusive, healthcare providers have adapted to the changed landscape and will likely need to continue to do so. Success or failure? Probably a little of both and a great deal of uncertainty for providers, payers and consumers. The results of the November 2016 elections may bring some clarity to the future of the ACA.

NAIC 2016 Spring Meeting Top Takeaways

By Richard Bertuglia

During the National Association of Insurance Commissioners (NAIC) 2016 Spring meeting held in April, over 70 committees and task force groups met to discuss the top regulatory matters impacting the insurance industry. Here are our top takeaways from the meeting: 

A Critical Milestone in Principle-Based Reserving (PBR) Implementation Has Been Met
In 2009, the NAIC adopted a revised Model Standard Valuation Law, authorizing PBR, as well as a Valuation Manual that outlines the minimum reserve and related requirements for certain products under PBR, which could provide greater certainty around reserving and reducing requirements for some insurers. Despite protests from several states, including California and New York, the Valuation Manual was formally adopted by the NAIC three years later. However, the effective date for PBR was on hold until the amended Standard Valuation Law was adopted by the requisite 42 jurisdictions representing at least 75 percent of total U.S. life insurance premiums. During the Spring meeting, it was announced that this threshold has tentatively been reached, enabling the national adoption of the PBR Valuation Manual for life insurers on Jan. 1, 2017. Once the NAIC confirms the threshold has in fact been met, the resulting effective date will initiate a three-year transitional period where the PBR is optional. Regardless of the official implementation date, this change marks a sizable shift in the industry, allowing for a more flexible evaluation system for reserves requirements. 

Updates May Be Coming for RiskBased Capital Investments
The Investment Risk-Based Capital (RBC) Working Group is considering updates to investment RBC factors based on recommendations from the American Academy of Actuaries (AAA). The recommendations include a number of provisions: expanding the number of NAIC bond RBC factors from six to 20; using a common RBC factor for common stock for life, property and casualty (P&C), and health insurance; and increasing the RBC factor for common stock from 15 percent to 19.5 percent. However, the proposed changes to bond RBC factors should not impact residential mortgage-backed securities and commercial mortgage-backed securities that are modeled by the NAIC, as the applicable model considers assumptions which differ from those used by the AAA to update corporate bond factors. The NAIC will consider maintaining six bond factors for non-life insurers. The revised bond and common stock factors are expected to be in effect by the end of 2017.

Cybersecurity Debate Isn’t Preventing Progress
The Cybersecurity Task Force received updates on federal cybersecurity legislation and heard spirited oral comments from various industry associations on the first draft of the Insurance Data Security Model Law, which was released in late February. The Draft Insurance Data Security Model Law seeks to establish uniform standards for data security and cyber investigations, as well as breach notifications applicable to insurance licensees. Common concerns with the draft include the high cost of compliance, lack of uniformity in various provisions, broad applicability to insurers regardless of size and confusion regarding consumer rights. Despite criticism, the task force is expected to finalize the law by the end of 2016. 

Shifts in Statutory Accounting Principles on the Affordable Care Act Took Center Stage
The most significant accounting principles adopted at the Spring meeting pertained to the Affordable Care Act (ACA). The Consolidated Appropriations Act of 2016 carried with it a moratorium on the Annual Fee on Health Insurance Providers (HIPF) for 2017, creating some confusion among insurance providers, which are also subject to the fee. During the Spring meeting, the NAIC adopted an interpretation which clarifies that a reporting entity will need to accrue a liability on Jan. 1, 2016, for the HIPF to be paid in September 2016, but that monthly segregation of surplus will not be required in 2016. No liability will be recorded on Jan. 1, 2017, since no fee is required to be paid in 2017. The Section 9010 interpretation is intended to encourage standardized statutory reporting by insurance carriers for the 2017 HIPF fee moratorium. 

The SSAP Working Group also revised an accounting principle to expand the ACA risk corridors program, a risk-sharing mechanism between the federal government and issuers of Qualified Health Plans. The risk corridor roll-forward now requires disclosure of the associated asset liability balances and subsequent adjustments by program benefit year. The receivable or payable for the rollforward will reflect the prior end balance for the specified benefit year.

These new accounting and disclosure requirements became effective in the first quarter of 2016. Refer to our recent Insurance Alert for additional information.

Looking Ahead 
While we’ve outlined above some of our top takeaways from the Spring NAIC meeting, the NAIC 2016 Summer National Meeting, scheduled for late August, is just around the corner. A variety of topics including cybersecurity, group risk-based capital calculation and regulators’ use of “big data” are just some of the hot topics on the agenda. We’ll be watching and reporting back on any notable developments.

For more information, please contact Richard Bertuglia. 


BDO Spotlight: Q&A with Judy Selby, Managing Director of Technology Advisory Services

Judy Selby recently joined BDO as a managing director in the firm’s Technology Advisory Services practice, where she will help clients address cybersecurity risks and transfer of those risks through insurance. Ms. Selby brings more than 20 years of experience in insurance and technology to BDO, where she will provide guidance to organizations and their counsel on cyber insurance, cybersecurity, information governance, data privacy and complex insurance issues. Imran Makda, co-leader of the firm’s Insurance industry group, recently sat down with Judy to discuss her background, her new role at BDO and the growing field of cyber insurance.  

Why did you decide to make the leap into consulting?
The move to BDO was a natural progression. I have a background as a litigator and e-discovery practitioner, which I’ve merged with my experience in insurance and technology. In my previous role, I was still an active litigator, especially in the area of insurance, but my practice was starting to evolve into a much more consultative role. Many organizations view cybersecurity as a technology issue and treat legal and regulatory risks as a separate component. But cyber risk is much broader than a breach of technology infrastructure and needs to be viewed holistically. As a litigator, I primarily worked with clients reactively, helping them to understand their liabilities in the aftermath of a cyber incident. Now, as a consultant at BDO, I can help clients take a 360-degree view of their data and address risk at the front end. Clients can benefit from the marriage of my prior work across technology, eDiscovery, information governance and insurance—none of which should be looked at in a silo. 

What cyber risks are most often underestimated?
Reputational damage is huge. Organizations usually receive some share of the blame for the attack—from regulators, affected third parties and the broader public. In the wake of a cyber incident, the victim must deal not only with remediating the threat, but with accusations and demands from regulators, law enforcement and often their own customers and employees. How an organization responds in the immediate aftermath of a cyber incident is key, but proactive preparedness also goes a long way to mitigate any reputational fallout. The more you do on the front end, the better you look on the back end. 

What do you see as some of the largest challenges related to cyber insurance right now?
The cyber insurance market is expanding rapidly—and experiencing some growth pains along the way. Executives have a better understanding of what cyber insurance is and how it can benefit their businesses, but it hasn’t become as intuitive as other types of commercial policies. The challenge for both policyholders and insurance companies is evaluating the true value of business interruption. Not all data is created equal. The exposure of sensitive personal information may not be as debilitating as the loss of a mission-critical business function. Credit card information can be replaced, but intellectual property and medical records are immutable. Throw legal obligations and mitigating factors—such as a tested incident response plan or active defense—into the mix and that adds a whole other layer of complexity that needs to be factored into the cost of recovery. Estimating the value of data—and the liabilities associated with the loss or abuse of that data—is an imperfect and evolving science. For both insurers and policyholders, it’s critical to have a comprehensive understanding of what those risks are and how they change over time.

Insurance organizations are in a unique position in that they can play the dual role of cyber victim and cyber hero. Figuring out how to value data isn’t just something they need to do for their clients; it’s something they need to do for themselves. The underlying premise of insurance is the transfer of risk. If an insurance organization is breached, that premise may be challenged by the erosion of trust.

How do you see cyber liability insurance evolving?
In the future, cyber insurance will need to expand to complement the rise of the Internet of Things and other developing technologies, as well as the new risks that accompany them. Smart insurers are already looking for ways to build coverages around these emerging risks and partner with clients to support technology-driven growth. 


PErspective in Insurance

Private equity firms are increasingly being drawn to a variety of specialist insurers, including those focused on closed non-life business and freelance workers, as well as insurance agencies and technology companies.

The European Commission’s Solvency II directive—demanding insurance companies increase their capital buffers—went into effect in January 2016, prompting a sell off of non-core, closed non-life businesses, such as employers’ liability, medical negligence and motor policies. Closed businesses, while distracting mainstream insurers from underwriting new business, can offer specialist firms the opportunity to realize significant economies of scale, with the potential for PE acquirers to earn annual returns of over 10 percent, Reuters reports.  

Sales of closed non-life portfolios could reach $5 billion this year, up from nearly $2 billion in 2015, according to Reuters. More than half the insurers in Western Europe expect to sell at least one closed insurance business in the next three years. One such portfolio currently up for sale is U.S. insurer The Hartford’s U.K. closed non-life business. Valuations can vary greatly, but purchasers will have the upper hand when negotiating deal prices, owing to excess supply on the market and the need for buyers to ensure acquisitions enable them to cut capital costs, Reuters reports.

As part of a larger trend for PE firms acquiring technology companies of all sorts, insurance technology companies are increasingly on PE’s M&A radar. Carlyle Group acquired U.K. insurance technology firm Innovation Group in December 2015 for £500 million. Veritas Capital closed a deal to buy health data firm Verisk Analytics for $820 million in June 2016. In May 2016, Bain Capital and Vista Equity Partners agreed to buy insurance agency technology firm Vertafore from TPG Capital. According to Reuters, anonymous sources valued the deal at $2.7 billion. 

The rise of the “gig” economy has led PE firms to be increasingly interested in specialty insurers focused on this fast expanding market. PE firm Dunedin recently bought a £33m stake in Kingsbridge, a UK-based specialist insurer for freelance and shift workers, including those finding work through apps such as Uber, Airbnb, Etsy and TaskRabbit, The Telegraph reports. 

Insurance agency M&A is at an all-time high, with 109 transactions reported in North America in the first quarter of 2016. Private equity-backed buyers accounted for 50 of these deals, representing a 25 percent increase year-on-year, according to Insurance Journal. This follows two successive years of record-breaking dealmaking activity, after 451 deals in 2015 and 357 in 2014, according to Insurance Journal/investment banking and financial consulting firm Optis Partners.

Momentum in the agency space shows no sign of abating, and the fallout from the EU’s Solvency II capital requirements looks set to continue for at least the remainder of the year. Combined with the growing demand and potential for synergies offered by specialist insurers, private equity will continue to find robust opportunities in the insurance sector in the near term. 

Sources: Bloomberg, Insurance Journal, PE Hub, Private Equity Wire, Property Casualty 360, Reuters, The Telegraph, Willis Towers Watson

PErspective in Insurance is a feature examining the role of private equity in the insurance industry.

Did you know...

Insurance costs and potential losses due to uninsured liabilities remain a significant risk factor for public companies, ranking #8 among REITs, #16 among oil and gas companies and #23 among manufacturers, according to the latest BDO RiskFactor Reports.

The 2016 Atlantic hurricane season forecast released from Colorado State University calls for the number of named storms and hurricanes to be near historical averages. A total of 12 named storms, five hurricanes and two major hurricanes are expected.

In the last year, 50 percent of U.S. businesses have either increased their level of cyber insurance coverage, or purchased it for the first time, according to a survey of risk managers from The Hartford Steam Boiler Inspection and Insurance Co.

An A.M. Best survey found that industry leaders believe economic events (22.6 percent), capital markets (14.5 percent) and political events (13.4 percent) will be the leading disruptors over the next five years. Direct premiums written grew 3.8 percent in real terms in 2015, up from 3.5 percent growth in 2014, according to the latest Swiss Re sigma study.

Artemis research found that although Q2 2016 saw a decline in the outstanding catastrophe bond and insurance-linked securities market size, continued investments led to a total of 14 deals, 50 percent of which were privately placed. 

For more information on BDO USA’s service offerings to this industry, please contact one of the following regional practice leaders:
Chris Bard
Los Angeles
  Brent Horak

Richard Bertuglia
New York
  Timothy Kovel
New York

Doug Bekker
Grand Rapids
  Albert Lopez

Phil Forret 
  Imran Makda
New York

Carla Freeman
Los Angeles
  Barb Woltjer
Grand Rapids

John Green
New York