Captive Transparency

‘Shadow’ Transactions Raising More Risks

Study: The financial risks related to reinsurance are not adequately measured.
By: | February 18, 2014 • 4 min read
USA Dollar

U.S. life insurers transferred more than $360 billion worth of liabilities to unrated affiliate reinsurers in less regulated onshore and offshore jurisdictions last year to reduce their taxes and capital requirements, a new report by two leading academics revealed.

The study into reinsurance agreements for U.S. life insurers between 2002 and 2012, published by Ralph Koijen, a professor at the London Business School, and Motohiro Yogo of the Federal Reserve Bank of Minneapolis, found that insurers have been put at substantial financial risk by an “unprecedented rise” in this “shadow insurance” over the past 10 years.

The increase in shadow insurance has resulted in operating companies moving their risks to off-balance-sheet reinsurers in domiciles such as Bermuda, Barbados, Vermont and South Carolina, after regulatory changes that increased reserve requirements for life insurers were introduced a decade ago.

Koijen told Risk & Insurance®: “There has been a massive trend towards these shadow entities. For every dollar of insurance that is sold in the U.S., it used to be the case 10 years ago that two cents went to the shadow entity, but now it is more like 30 cents.

Ralph Koijen, professor, London Business School

Ralph Koijen, professor, London Business School

“This means a major trade-off for the industry. On the one hand, the system gets riskier as a result of shadow insurance, with a significant decrease in risk-based capital and greater expected losses if the reinsurer’s liabilities were to be transferred back to the operating company.

“But the flipside is that the removal of shadow insurance would result in a price increase and a decline in the quantity of insurance sold, very similar to the effect of shutting down the shadow banking system,” he said.

U.S. regulators have become increasingly concerned about the increase in shadow insurance.

The National Association of Insurance Commissioners (NAIC) has formed a Captives and Special Purpose Vehicle Use Subgroup to assess the tightening of rules for captives and special purpose vehicles used by U.S. insurers.

Separately, New York State’s Superintendent of Financial Services Ben Lawsky has called for a moratorium on future approval of shadow insurance pending further investigation.

According to figures released by the NAIC, the report found that shadow insurance increased 33-fold from $11 billion in 2002 to $363 billion in 2012.

Although the shift toward shadow insurance has enabled many U.S. life insurers to set aside less reserve for future claims, it has also left companies vulnerable to a sudden spike in claims, the study revealed.

Furthermore, the report estimated that, on average, in the absence of shadow insurance, an insurer’s risk-based capital would fall dramatically as the amount of capital required by the operating company to support the additional liabilities would significantly rise.

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Such a decline would be equivalent to a credit ratings drop of three notches and would imply an increase in additional expected losses of at least $15.7 billion for the industry, a cost ultimately borne by state taxpayers and other companies through state guaranty funds, the study said.

The report concluded: “We find that shadow insurance adds a tremendous amount of financial risk for the companies involved, which is not reflected in their ratings. When we adjust measures of financial risk for shadow insurance, risk-based capital drops by 49 percentage points for the median company, which is equivalent to three rating notches. Hence, default probabilities are likely to be higher than what may be inferred from their reported ratings.

“Our adjustments for shadow insurance implies an increase in the expected asset shortfall of $19 billion for the life insurance industry, which is a cost to the state guaranty funds (and ultimately taxpayers).”

However, the study also found that the removal of shadow insurance would result in a 1.8 percent rise in marginal costs on average for each company and a $1.4 billion decrease in the amount of annual insurance underwritten on aggregate, based on structural models.

Koijen concluded that the only “obvious rationale” for an increase in shadow insurance schemes was to “circumvent regulation.”

He said the surge in affiliated life and annuity reinsurance over the last decade pointed to capital and tax management as the main driver behind the use of shadow insurance.

American Council of Life Insurers spokesman Jack Dolan said: “Lack of transparency is a theme of this report. But it is important to recognize that captive reinsurance transactions are not only legitimate and safe but a carefully regulated means of fully satisfying required reserve requirements.

“At the same time, life insurers support added transparency and disclosure, which would dispel the notion that these transactions are ‘shadow’ arrangements. The states are currently working constructively to assure that captive transactions are appropriately disclosed and handled uniformly from state to state.”

Brad Kading, president and executive director of the Association of Bermuda Insurers and Reinsurers, concurred: “In group supervision, the impact of legal entity and affiliate transactions needs to be transparent and understood by the group supervisor and members of the regulatory college.”

Alex Wright is a U.K.-based business journalist, who previously was deputy business editor at The Royal Gazette in Bermuda. You can reach him at riskletters@lrp.com.
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Aviation Woes

Coping with Cancellations

Could a weather-related insurance solution be designed to help airlines cope with cancellation losses?
By: | April 23, 2014 • 4 min read
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Airlines typically can offset revenue losses for cancellations due to bad weather either by saving on fuel and salary costs or rerouting passengers on other flights, but this year’s revenue losses from the worst winter storm season in years might be too much for traditional measures.

At least one broker said the time may be right for airlines to consider crafting custom insurance programs to account for such devastating seasons.

For a good part of the country, including many parts of the Southeast, snow and ice storms have wreaked havoc on flight cancellations, with a mid-February storm being the worst of all. On Feb. 13, a snowstorm from Virginia to Maine caused airlines to scrub 7,561 U.S. flights, more than the 7,400 cancelled flights due to Hurricane Sandy, according to MasFlight, industry data tracker based in Bethesda, Md.

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Roughly 100,000 flights have been canceled since Dec. 1, MasFlight said.

Just United, alone, the world’s second-largest airline, reported that it had cancelled 22,500 flights in January and February, 2014, according to Bloomberg. The airline’s completed regional flights was 87.1 percent, which was “an extraordinarily low level,” and almost 9 percentage points below its mainline operations, it reported.

And another potentially heavy snowfall was forecast for last weekend, from California to New England.

The sheer amount of cancellations this winter are likely straining airlines’ bottom lines, said Katie Connell, a spokeswoman for Airlines for America, a trade group for major U.S. airline companies.

“The airline industry’s fixed costs are high, therefore the majority of operating costs will still be incurred by airlines, even for canceled flights,” Connell wrote in an email. “If a flight is canceled due to weather, the only significant cost that the airline avoids is fuel; otherwise, it must still pay ownership costs for aircraft and ground equipment, maintenance costs and overhead and most crew costs. Extended storms and other sources of irregular operations are clear reminders of the industry’s operational and financial vulnerability to factors outside its control.”

Bob Mann, an independent airline analyst and consultant who is principal of R.W. Mann & Co. Inc. in Port Washington, N.Y., said that two-thirds of costs — fuel and labor — are short-term variable costs, but that fixed charges are “unfortunately incurred.” Airlines just typically absorb those costs.

“I am not aware of any airline that has considered taking out business interruption insurance for weather-related disruptions; it is simply a part of the business,” Mann said.

Chuck Cederroth, managing director at Aon Risk Solutions’ aviation practice, said carriers would probably not want to insure airlines against cancellations because airlines have control over whether a flight will be canceled, particularly if they don’t want to risk being fined up to $27,500 for each passenger by the Federal Aviation Administration when passengers are stuck on a tarmac for hours.

“How could an insurance product work when the insured is the one who controls the trigger?” Cederroth asked. “I think it would be a product that insurance companies would probably have a hard time providing.”

But Brad Meinhardt, U.S. aviation practice leader, for Arthur J. Gallagher & Co., said now may be the best time for airlines — and insurance carriers — to think about crafting a specialized insurance program to cover fluke years like this one.

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“I would be stunned if this subject hasn’t made its way up into the C-suites of major and mid-sized airlines,” Meinhardt said. “When these events happen, people tend to look over their shoulder and ask if there is a solution for such events.”

Airlines often hedge losses from unknown variables such as varying fuel costs or interest rate fluctuations using derivatives, but those tools may not be enough for severe winters such as this year’s, he said. While products like business interruption insurance may not be used for airlines, they could look at weather-related insurance products that have very specific triggers.

For example, airlines could designate a period of time for such a “tough winter policy,” say from the period of November to March, in which they can manage cancellations due to 10 days of heavy snowfall, Meinhardt said. That amount could be designated their retention in such a policy, and anything in excess of the designated snowfall days could be a defined benefit that a carrier could pay if the policy is triggered. Possibly, the trigger would be inches of snowfall. “Custom solutions are the idea,” he said.

“Airlines are not likely buying any of these types of products now, but I think there’s probably some thinking along those lines right now as many might have to take losses as write-downs on their quarterly earnings and hope this doesn’t happen again,” he said. “There probably needs to be one airline making a trailblazing action on an insurance or derivative product — something that gets people talking about how to hedge against those losses in the future.”

Katie Kuehner-Hebert is a freelance writer based in California. She has more than two decades of journalism experience and expertise in financial writing. She can be reached at riskletters@lrp.com.
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Sponsored Content by Helios

Mitigating Fraud, Waste, and Abuse of Opioid Medications

Proactive screening for fraud, waste and abuse situations is the best way to minimize their effects on opioid management.
By: | May 8, 2015 • 5 min read
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There’s a fine line between instances of fraud, waste, and abuse. One of the key differences is intent and knowledge. Fraud is knowingly and willfully defrauding a health care benefit program for personal gain or profit. Each of the parties to a claim has opportunity and motive to commit fraud. For example, an injured worker might fill a prescription for pain medication only to sell it to a third party for profit. A prescriber might knowingly write prescriptions for certain pain medications in order to receive a “kickback” by the manufacturer.

Waste is overuse of services and misuse of resources resulting in unnecessary costs, whereas abuse is practices that are inconsistent with professional standards of care, leading to avoidable costs. In both situations, the wrongdoer may not realize the effects of their actions. Examples of waste include under-utilization of generics, either because of an injured worker’s request for brand name medication, or the prescriber writing for such. Examples of abusive behavior are an injured worker requesting refills too soon, and a prescriber billing for services that were not medically necessary.

Actions that Interfere with Opioid Management

Early intervention of potential fraud, waste, and abuse situations is the best way to mitigate its effects. By considering the total pharmacotherapy program of an injured worker, prescribing behaviors of physicians, and pharmacy dispensing patterns, opportunities to intervene, control, and correct behaviors that are counterproductive to treatment and increase costs become possible. Certain behaviors in each community are indicative of potential fraud, waste, and abuse situations. Through their identification, early intervention can begin.

Injured workers

  • Prescriber/Pharmacy Shopping – By going to different prescribers or pharmacies, an injured worker can acquire multiple prescriptions for opioids. They may be able to obtain “legitimate” prescriptions, as well as find those physicians who aren’t so diligent in their prescribing practices.
  • Utilizing Pill Mills – Pain clinics or pill mills are typically cash-only facilities that bypass physical exams, medical records, and x-rays and prescribe pain medications to anyone—no questions asked.
  • Beating the Urine Test – Injured workers can beat the urine drug test by using any of the multiple commercial products available in an attempt to mask results, or declaring religious/moral grounds as a refusal for taking the test. They may also take certain products known to deliver a false positive in order to show compliance. For example, using the over-the-counter Vicks® inhaler will show positive for amphetamines in an in-office test.
  • Renting Pills – When prescribers demand an injured worker submit to pill counts (random or not), he or she must bring in their prescription bottles. Rent-a-pill operations allow an injured worker to pay a fee to rent the pills needed for this upcoming office visit.
  • Forging or Altering Prescriptions –Today’s technology makes it easy to create and edit prescription pads. The phone number of the prescriber can be easily replaced with that of a friend for verification purposes. Injured workers can also take sheets from a prescription pad while at the physician’s office.

Physicians

  • Over-Prescribing of Controlled Substances – By prescribing high amounts and dosages of opioids, a physician quickly becomes a go-to physician for injured workers seeking opioids.
  • Physician dispensing and compounded medication – By dispensing opioids from their office, a physician may benefit from the revenue generated by these medications, and may be prone to prescribe more of these medications for that reason. Additionally, a physician who prescribes compounded medications before a commercially available product is tried may have a financial relationship with a compounding pharmacy.
  • Historical Non-Compliance – Physicians who have exhibited potentially high-risk behavior in the past (e.g., sanctions, outlier prescribing patterns compared to their peers, reluctance or refusal to engage in peer-to-peer outreach) are likely to continue aberrant behavior.
  • Unnecessary Brand Utilization – Writing prescriptions for brand medication when a generic is available may be an indicator of potential fraud, waste, or abuse.
  • Unnecessary Diagnostic Procedures or Surgeries – A physician may require or recommend tests or procedures that are not typical or necessary for the treatment of the injury, which can be wasteful.
  • Billing for Services Not Provided – Since the injured worker is not financially responsible for his or her treatment, a physician may mistakenly, or knowingly, bill a payer for services not provided.

Pharmacies

  • Compounded Medications – Compounded medications are often very costly, more so than other treatments. A pharmacy that dispenses compounded medications may have a financial arrangement with a prescriber.
  • Historical Non-Compliance – Like physicians, pharmacies with a history of non-compliance raise a red flag. In states with Prescription Drug Monitoring Programs (PDMPs), pharmacies who fail to consult this database prior to dispensing may be turning a blind eye to injured workers filling multiple prescriptions from multiple physicians.
  • Excessive Dispensing of Controlled Substances – Dispensing of a high number of controlled substances could be a sign of aberrant behavior, either on behalf of the pharmacy itself or that injured workers have found this pharmacy to be lenient in its processes.

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Clinical Tools for Opioid Management

Once identified, acting on the potential situations of fraud, waste, and abuse should leverage all key stakeholders. Intervention approaches include notifying claims professionals, sending letters to prescribing physicians, performing urine drug testing, reviewing full medical records with peer-to-peer outreach, and referring to payer special investigative unit (SIU) resources. A program that integrates clinical strategies to identify aberrant behavior, alert stakeholders of potential issues, act through intervention, and monitor progress with the injured worker, prescriber, and pharmacy communities can prevent and resolve fraud, waste, and abuse situations.

Proactive Opioid Management Mitigates Fraud, Waste, and Abuse

Opioids can be used safely when properly monitored and controlled. By taking proactive measures to reduce fraud, waste, and abuse of opioids, payers improve injured worker safety and obtain more control over medication expenses. A Pharmacy Benefit Manager (PBM) can offer payers an effective opioid utilization strategy to identify, alert, intervene upon, and monitor potential aberrant behavior, providing a path to brighter outcomes for all.

This article was produced by Helios and not the Risk & Insurance® editorial team.



Helios brings the focus of workers’ compensation and auto no-fault Pharmacy Benefit Management, Ancillary, and Settlement Solutions back to where it belongs—the injured person. This comes with a passion and intensity on delivering value beyond just the transactional savings for which we excel. To learn how our creative and innovative tools, expertise, and industry leadership can help your business shine, visit www.HeliosComp.com.
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