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Comparison of IBNR Methodologiesshould the material be construed to do so. It is the product of a research effort commissioned by theSociety of Actuaries Health Section to add to the library of resource information for the estimation ofIBNR reserves and further knowledge in that area. The material is neither intended to preclude the use ofother methodologies for estimation of IBNR reserves for any purpose nor provide an official statement orposition on the use, application or preferability of other methodologies as compared to the methodologiesdescribed herein.Defining IBNR“IBNR” is an acronym, short for “incurred but not reported,” that is probably used the most by actuariesand non-actuaries alike to refer to a certain balance sheet liability of an insurer or HMO. Anothercommon proxy for this acronym is “claim reserves,” which we will also use in this report. However,“IBNR” has a more formal definition (see below) in which it is merely one part of an insurer’s claimliabilities. For the purpose of this report we are not going to use the formal narrow definition of “IBNR.”In this report we will broadly consider “IBNR” or “claim reserves” to represent a broad collection ofinsurer or HMO balance sheet entries technically representing a more formal definition of “liabilities” butnot the formal definition of “reserves.” Whereas “liabilities” formally relate to events that have alreadyoccurred, but for which a payment has not yet been made and thus costs have already accrued, “reserves”are formally related to entries for amounts that the company has become obligated to pay, but for whichthe reimbursable event has not yet occurred, and thus these costs will accrue in the future. Our broadloose use of the acronym “IBNR” will encompass the following formal claim liability parts:1. Incurred But Not Reported Claim Liabilities—Liabilities for claims that are anticipated but havenot been reported to the health plan as of the valuation date. In this report, if we want to refer tothis narrow formal definition, we will use the phrase “true IBNR.”2. In Course of Settlement (ICOS) Claim Liabilities—Liabilities for claims reported and receivedbut not yet adjudicated and paid as of the valuation date.3. Due and Unpaid (D&U) Liabilities—Liabilities for claims that have been reported, adjudicatedand processed, but for which final payment has not been recorded as of the valuation date. Anexample is a claim that has been adjudicated but as of the valuation date is being held until thenext date on which the health plan processes claim checks.4. Outstanding Accounting Feeds—Liabilities which have been acknowledged as payments, but forwhich no check has yet been cut as of the valuation date. The most common examples arepayments agreed to be made to pharmacy benefit managers who process pharmacy claims at thepoint of sale and then bill the health plan monthly or bi-monthly for the claims. This liabilitydefinition overlaps with the D&U definition, with the distinction possibly being a system-tosystem interface or batch processing claims versus payments made directly to a third party (e.g.,claimant).5. Disputed or Resisted Claims—Liabilities for claims that are in dispute, such as those for which aknown litigation situation exists.6. Margin—Liability for a reasonable and prudent level of conservatism to cover adverse claimdeviation. Such a margin can be an explicit amount or implicitly provided for in the variousactuarial calculations. 2009 Society of Actuaries, All Rights ReservedLewis & EllisPage 8

Comparison of IBNR MethodologiesWe will also use “IBNR” instead of the phrase “unpaid claim liabilities,” which is used by the managedcare and health maintenance organization industry, as well as use “IBNR” instead of “incurred but notpaid” (IBNP), which many actuaries use as a more formal description of all claim liabilities.For the purpose of this report, “IBNR” does not include:1. Loss Adjustment Expenses (LAEs)—Liabilities for the administrative costs associated with theadjudication of unpaid claims.2. Present Value of Amounts Not Yet Due (PVANYD)—This reserve covers claims that wereincurred on or before the valuation date which have not accrued as of the valuation date.3. Active Life Reserves—Active life reserves represent the combination of contract reserves andunearned premium reserves. The term "active life" differentiates the reserve nature from reservesrelated to insureds in claims status. Unearned premium reserves are typically an asset entry andrepresents premium that has been collected and entered in the ledger, but are actually allocated toa time period after the valuation date. A contract reserve is a reserve set up when a portion of thepremium collected in the early years is meant to help pay for higher claim costs arising in lateryears.4. Premium Deficiency Reserves—A premium deficiency reserve is a reserve that is establishedwhen future premiums and current reserves are not sufficient to cover future claim payments andexpenses for the remainder of a contract period.5. Provider Liabilities—Provider liabilities represent the reporting entity’s obligation to make futurepayments to providers under some form of risk-sharing arrangement.6. Provider Insolvency Reserves—Additional liabilities that may arise if a capitated providerbecomes insolvent. 2009 Society of Actuaries, All Rights ReservedLewis & EllisPage 9

Comparison of IBNR MethodologiesDefinitionsWe consider the following to be common definitions for phrases used in conjunction with health claimreserves and IBNR.Active Life Reserves 1 : The combination of contract reserves and unearned premium reserves. The term“active life” differentiates these reserves from reserves related to contracts in claims status or for“disabled lives.”Age-to-Age Development Factors: Factors to complete paid claims to date in which the factors are basedon the product of multiple representative ratios (i.e., the respective lag month for which the factor isgenerated through lag month of full completion) of one lag month’s cumulative paid claims to the priorlag month’s cumulative paid claims.Age-to-Ultimate Development Factors: Factors to complete paid claims to date in which the factors arebased on the ratio of the lag month’s cumulative paid claims to the fully complete ultimate claims.Claims Adjudication 2 : The process by which the insurer’s claim processing area determines that aninsured is eligible for payment and establishes an amount payable in relationship to the contractualbenefits.Claims Liability 3 : A claims liability is established when an event has occurred that creates an obligationto pay benefits, but complete payment has not yet been made as of the valuation date.Contract Reserves 4 : A contract reserve is established when some portion of the premium collected in acontract’s early durations is intentionally designed to help pay for anticipated higher claims costs in laterdurations.Claims Due and Unpaid: A reserve for claims which have been approved, but for which payment checkshave not been sent.Exposure: Unit of insured lives or premiums that contributed to exposure to a risk of a claim.Excess/Shock Claim: Larger amount claims that have on average longer lag and may cause significantchanges in total IBNR.1Lloyd, John C., “Health Reserves,” 3-5.Lloyd, “Health Reserves,” 3-5.3Lloyd, “Health Reserves,” 3-5.4Lloyd, “Health Reserves,” 3-5.2 2009 Society of Actuaries, All Rights ReservedLewis & EllisPage 10

Comparison of IBNR MethodologiesIncurred Date 5 : The date on which an obligation to pay was established relative to a claim. For medicalcoverages, this is the date on which services were rendered by a provider or the initial date of service for asequence of events which together constitute a claim.In Course of Settlement (ICOS): The reserve amount attributed to claims already known and identified bythe insurer but not yet adjudicated, settled and paid by the insurer. This reserve amount contrasts withclaim liabilities which have not yet been identified by the insurer (a.k.a. “true” IBNR). Also can bedescribed as reserves for claims that are on file in the company at the time the valuation is done, but havenot yet been approved or paid.IBNP 6 : The incurred but not paid (IBNP) liability reserve amount. Sometimes used formally in lieu of themore informal acronym “IBNR,” IBNP is another name, or acronym, for an insurer’s total claim reserve.IBNP is the sum total of all claim reserve parts (e.g., ICOS, true IBNR, etc.).Lag 7 : The time between the incurred date of a claim and the date on which a claim payment is made. Thistime can be broken into two parts: (i) the time between the incurred date and the date upon which it isreceived for consideration by the insurer and (ii) the time between the insurer’s initial consideration dateand the claim payment date.Loss Adjustment Expense 8 : The liability associated with the expense of processing claims that will bepaid after the valuation date.Present Value of Amounts Not Yet Due (PVANYD): Also called "disabled life reserves" in the case ofinsurance providing ongoing periodic benefits past the reserve valuation date because of a benefit triggerthat occurred on or before the valuation date (e.g., monthly loss-of-time benefits for disability due toaccident or sickness, monthly reimbursements or payments for long-term care expenses, etc.). Thecommon statutory definition is: “the reserve for claims unaccrued which may at the option of the insurerbe discounted at interest.” This reserve is rarely considered part of the health IBNR.PMPM: Per member per month, which is a statistic measure of the average monthly per capita incurredclaims where the per capita basis is membership (e.g., number of insureds, including primary insureds,spouses and children).Resisted Claims Reserve: Reserves for those claims in dispute and/or where the obligation to pay suchclaim is not reasonably clear as of the statement date.Seasonality 9 : Tendency for the amount of incurred claim liabilities to vary in a consistent and predictablemanner within the space of a calendar year. In health insurance, seasonality may be due to seasonalvariations in morbidity (the rate at which individuals seek medical care), benefit design (such as when a5Lloyd, John C., “Health Reserves,” 3-5.Lynch, Robert, “Method for Calculating IBNP Health Reserves with Low Variance,” 7.7Lloyd, “Health Reserves,” 4.8Lloyd, “Health Reserves,” 3-5.9Lynch, Robert G., Patent description “Method for Calculating IBNP Health Reserves with Low Variance,” Oct. 6,2005.6 2009 Society of Actuaries, All Rights ReservedLewis & EllisPage 11

Comparison of IBNR Methodologieshealth plan has an annual deductible or annual out-of-pocket cost-sharing maximum), or calendar effects(for example, variation in monthly claims caused by the differing number of days in each month, ordifferences in the number of working days in a month.)Valuation Date 10 : The date upon which an insurer’s financial reports are compiled by closing the insurer’sgeneral ledger, creating a set of cash accounting entries, and creating reserve estimates. Typical valuationdates are year-end, quarter-end or sometimes every month’s end.10Lloyd, John C., “Health Reserves,” 4. 2009 Society of Actuaries, All Rights ReservedLewis & EllisPage 12

Comparison of IBNR MethodologiesExecutive SummaryThe purpose of this section is to summarize the results of our testing and analysis of IBNR calculationmethods. Later sections of the report explain the methods themselves.With the wide variety of policy types, adjudication practices, lag times and other variables, it isimpossible to say that a given method is the perfect method in all cases. Even in our testing, differentmethods for a particular block performed better under different scenario tests. We have, however,analyzed our results in an effort to provide some basic guidelines to help you determine the best methodfor your particular circumstances. We have based our conclusions on only a subset of the scenario teststhat we created and tested. We have chosen to omit the rate shift, claim shift and disruption scenarios dueto extreme variance of the results. We have assumed that, in situations like this, the actuary would beforced to make manual adjustments in some way, and could never simply run an IBNR calculation withthe data as-is. As a result, we have focused on those scenarios that are more typical and that can, for themost part, be handled without any adjustments.1. Lag methods tend to be the most common methods used by health actuaries; however, our resultsconsistently show them to have the highest standard deviation. Even the more advanced lagmethods, while their performance is definitely better than the simple methods, still generate alarge standard deviation. Another problem with lag methods is that they require a significantamount of claims completion for a given month before they begin to develop any sort ofaccuracy. This can be seen in our results by simply looking at the mean error for the HMOMedicare block versus the Medicare Supplement block. For a block that completes fairly quicklylike the HMO Medicare block, the mean error is in the low single digits. However, for theMedicare Supplement block, the mean error is around 28 percent. Thus, the use of a secondmethod is required in order to achieve accurate results in the more recent incurral months. OurHybrid Loss Ratio

But, the methods considered for comparison should also be such that a practitioner could apply them without the need for special hardware or software packages. In order to easily compare the methods, L&E was asked to either use a commonly applied measure of accuracy or develop a new measure to score the IBNR methods. Reliances