Meteorologists state that four separate and rare events must exist for the perfect storm. Many would say that the medical insurance industry is currently witnessing its own perfect storm, where four such events would seem to coincide.
The collapse of global equity markets, over the last three years, has already pushed one life insurer to the brink and raised grave concerns about the solvency of others. For medical insurers to maintain their solvency they have to abide by the following simple equation: income growth plus medical inflation must be equal to growth in reserves. Many companies have been too often sales-led with the simple objective of growing their business. The collapse of Independent Insurance is a wreck to be avoided.
The sales drive in the late 1990s was fuelled by rising equity markets, with asset values easily keeping pace with the growth in premium revenue, engorged by medical inflation. Now that markets have turned some insurers are exiting the market, while others are becoming far more selective about the business that they write.
A low return, low inflation economy means that insurers can no longer rely upon investing their clients’ premiums to offset subeconomic premium levels and consequential net underwriting losses. The knee-jerk of most insurers is to raise premium levels. This action disenfranchises healthy customers; raises per-capita claims costs and twists the solvency spiral even tighter.
Medical inflation: there are three primary components of medical inflation: 1) the general underlying rate of inflation; 2) new medical technology; 3) the “multiplier effect” – in other words, our expectations. Our parents’ generation, and those before them, were brought up to live with pain and discomfort. Joint replacements, keyhole surgery, body scanning and state-of-the-art therapeutics were the stuff of science fiction.
Today, in a world with access to almost perfect information we expect not just a remedy, but also a cure for every condition. For those members of the public indemnified, in full, by insurance coverage there can, quite rightly, be little limit on their demand. Utilisation multiplies inflationary pressures.
Medical inflation continues to run at about five times the rate of RPI with no prospect of abatement in sight. The rapidly ageing population will exacerbate even these numbers.
The economy has turned: deflation is a new threat to the west. Major companies report significant profit reductions leading to cuts in dividends. And that’s before any of them sup from the poisoned chalice of FRS17 [the stringent new accounting standard for pension funds] and their pension liabilities.
Companies need to cut costs. Reducing the workforce has a finality that most would avoid if they could trim other costs first. Company cars and pension schemes are disappearing rapidly. The next benefit under the spotlight is medical insurance.
In the 1980s it accounted for 1% of payroll, now it accounts for as much as 7%. Can the trend be contained? The haven from the perfect storm – corporate healthcare trusts – has already been sought by one in 10 large companies in the UK. Will traditional corporate medical insurance be left all at sea?
Setting up a healthcare trust
A healthcare trust can sound impossibly exotic to a large company employee benefits buyer. Such individuals are usually concerned that they will be complicated to set up, doubtfully robust in tax law and above all, expensive. In fact, if correctly arranged with proper professional advice, they are quite straightforward and simple. It is somewhat akin to conveyancing a house sale – fraught and difficult if done yourself, simple and relatively inexpensive if carried out by professionals!
So what is a healthcare trust and what are its advantages? A healthcare trust is simply a trust into which a company pays enough money to meet the claims requirements of its members. Additionally, enough money is also paid into the trust to pay for a professional administrator to run the claims administration and give general advice on the running of the scheme. The advantage is straightforward. The bottomline cost is usually lower than an insured scheme and the employer has complete flexibility over what is and is not included within the benefits. Trusts normally work out around 10% cheaper than the equivalent insured arrangement as:
No Insurance Premium Tax (currently 5% of total premium) is levied on the claims fund or administration charge.
There is no insurance risk or use of the insurer’s solvency – hence any “risk” charges from the insurer.
The perception of the employees tends to change when making a claim from one of “claiming from a remote insurer” to one of “claiming from my own company”. Claims funds, therefore, generally reduce once in a trust.
The downside is that VAT becomes payable on the administration charge and that there is a one-off cost in setting up the healthcare trust in the first place.
Table 1: Example of cost savings available on a £1m claims fund available by setting up a healthcare trust
|Fully Insured||Healthcare Trust|
|Total Net Premium||£1,200,00||£1,130,000|
included IPT at 5% on included IPT at 5% on risk Total Net Premium charge and VAT at 17.5% on Administration Charge So what are the steps required when setting up a healthcare trust?
1. Understand your current arrangement: This first stage is to determine whether or not setting up a healthcare trust is advantageous or practical. A scheme set up for the benefit of the employees and dependants of a company is quite straightforward. Whether or not certain employees or dependants make voluntary contributions involves more careful wording of the trust deed but should cause no problem. Partnerships, as a rule, can consider a trust as long as there is a large majority of employees over partners. Groups of small companies under different ownership forming a collective trust is probably not tenable.
2. Understand the risk profile: The key decisions here are whether the company believes it can accept the risk profile of the scheme. Are the claims reasonably stable? Will the company be prepared for the upside risk as well as the potential reward? The answers to these questions are fairly easily answered if the company has more than 350 employees with a stable claims fund. However, this is more difficult for smaller companies where the claims funds can be more volatile.
Once the claims fund has been calculated, the company must decide whether it wishes to insure part of its liability at an upper limit, usually by means of an aggregate stop loss at between 120% and 150% of the notional claims fund.
3. Contracts of employment: The contractual rights of employees often lay out a contractual right to medical insurance. The key point here is that by setting up a healthcare trust there is no contract of insurance in place between the company and an insurer and no contractual right to medical insurance benefits offered by employer to employee. Most companies have many different contracts of employment with different wording. It is important that legal advice is sought for what approach to take but it usually involves communicating clearly with the employees about the change and explaining that there will be little, if any, diminution in their cover.
4. Trust deed and rules: Again, this is a job for a specialist lawyer. The trust deed lays out how the trust is constituted and its relationship with its founder – usually the employer. The trust deed can be bought “off the shelf” and rules amended to fit the trust. However, this could expose the company and the advising intermediaries to future litigation should there be loose or inappropriate wording.
One of the advantages of a trust is that the rules can be set to include or exclude whatever the employer chooses and it is not bound by the insurers in view of underwriting. However, once drafted, rules are completely non-discretionary and are usually only amended once a year. The rules are usually appended to the trust deed so that they can be changed without the necessity of amending the whole deed.
5. Corporate trustee: A trust will require trustees to ensure that the deed and rules are complied with. The drawback of having a number of trustees is that each time one retires and a replacement is appointed the trust deed must be amended, at some inconvenience and expense. The more common practice nowadays is to have a single, incorporated, corporate trustee with directors acting as quasi-trustees. Changing directors is far simpler than changing trustees.
6. Inland Revenue approval: There is a danger with any scheme which is not a recognised insurance contract that payments made to any employee will be viewed as direct remuneration to the employee, and subject to tax, including higher rate and National Insurance. It is therefore important to satisfy the IR that the scheme has been correctly set up for all of the members and that benefit-in-kind taxation will only be levied on the notional claims fund and the administration charge evenly distributed across all members receiving similar benefits.
7. Finding an administrator: Of course a company could administer a corporate healthcare trust itself. However, most choose, as with pension scheme administration, to employ a professional administration firm. These companies are usually part of one of the larger medical insurance providers and therefore can pass on the benefits of lower hospital contract prices and bulk purchasing arrangements. The administrator will normally carry out the following tasks:
Supply a dedicated telephone claims help-line service.
Pay claims and settle directly with providers or employees.
Provide management information figures on claims fund performance.
Advise on the scheme rules and their interpretation.
Assist with employee communication and extracting best value from the investment.
Advise on new legislation and give advice on claims cost containment measures.
Manage, disburse and account for the claims fund.
The seven steps discussed above may look onerous but in fact specialist firms of lawyers can assist through the whole process and will guide the unwary past the pitfalls, usually for a fee much less than the first year’s savings on a fully insured contract.
Adrian Humphreys is chief executive of WPA Protocol PLC and director of Corporate Business for Western Provident Association.