The Importance of IBNR in Self-Funded and Traditional Health Plans

Understanding and accurately predicting future liabilities is crucial to the sustainability and success of insurance companies and self-insured employer-sponsored health plans. Incurred But Not Reported (IBNR) liabilities is an important concept and a tool available to help accurately gauge future liabilities. While the significance of IBNR in the self-funded health benefits space is often underappreciated and overlooked, it is an important risk management strategy. It’s also more than an annual report – IBNR is a priority in creating financial stability and strategic decision-making.

Understanding IBNR

IBNR liabilities represent the amount of money insurance companies set aside to cover claims that have already occurred but have not yet been reported, or fully settled. Without diving deep into the details, IBNR can be defined in many ways depending if it is based on when things are: reported (IBNR), paid (IBNP), and many others (processed, approved…). These are all very similar, but each varies by time of measurement and what additional items are known and considered. This concept is particularly relevant in lines of insurance where there is a significant delay between the occurrence of a claimable event and the reporting or settlement of the claim. It also varies widely by the type of coverage being talked about, health claims have a longer lag than dental, vision, or RX claims that often have very little IBNR because they are most often instantly adjudicated and/or approved.

Insurance companies must maintain sufficient reserves to meet all payments on past claims, even those they do not officially know about yet.

Financial Stability and Solvency

One of the primary reasons IBNR is critical is its impact on an insurer’s financial stability and solvency. Large changes in IBNR can cause major changes to financial statements. Insurance companies must maintain sufficient reserves to meet all payments on past claims, even those they do not officially know about yet. Underestimating IBNR can lead to inadequate reserving, potentially compromising an insurer’s ability to fulfill its obligations to policyholders. On the other hand, overestimating IBNR can unnecessarily tie up capital that could be otherwise invested or used for other business decisions. Thus, accurately estimating IBNR is a balancing act that directly affects an insurer’s financial health and regulatory compliance.

Pricing and Underwriting Decisions

IBNR also plays a vital role in pricing and underwriting decisions. Insurers and self-funded groups use historical data and actuarial models to estimate future claims costs, this includes IBNR and many other factors.  If rates are projected only on what claims are known about in a period, they could be missing a large portion of the claims and thus understate the total claims and thus understate the funding requirement. Running a health plan is a game of understanding the overall risk of the population and implementing things to maximize benefits to the members while minimizing risk. By understanding the patterns and trends in IBNR, insurers can adjust their pricing strategies to reflect the true cost of assuming certain risks. This helps in maintaining competitive pricing while ensuring profitability/solvency.

Risk Management and Strategic Planning

Effective IBNR estimation is a key element of risk management and strategic planning within both self-funded groups and insurance companies. By providing an accurate picture of future liabilities, IBNR analysis helps plan sponsors identify potential areas of risk and implement strategies to mitigate them. This might involve diversifying the insurance portfolio, revising policy terms, or enhancing loss prevention and claims management practices.

Furthermore, IBNR estimates are critical for reinsurance negotiations and decisions. Insurers and self-funded groups often transfer part of their risk to reinsurers, and the understanding of potential IBNR liabilities is essential in structuring reinsurance contracts.

Challenges and Advances

Estimating IBNR is inherently challenging due to the uncertainty and variability of claims reporting and settlement processes. To properly calculate IBNR liabilities it requires sophisticated statistical and actuarial techniques combined with thoughtful actuarial judgement. There are no good shortcuts to calculating IBNR, and just because a person downloads an “actuarial model” does not mean the estimates are actuarially certified. Many insurers and consultants like Axene Health Partners are increasingly exploring advanced analytics, machine learning, and big data to improve the accuracy of their IBNR estimates, but to date, we feel that the classic developmental method of IBNR calculation, combined with good actuarial judgment is as good if not better than these newer “buzzword” methods.

Conclusion

The importance of IBNR in the insurance industry cannot be overstated. It lies at the heart of ensuring financial stability, making informed pricing, and underwriting decisions, managing risks effectively, and planning strategically for the future. As the industry continues to evolve, the role of IBNR in shaping the future of insurance remains as relevant as ever, underscoring the need for ongoing innovation and precision in its estimation.