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Now let us see how this principle would be applied under the bill. Chart K illustrates it.

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Let us assume that an insurance company wishes to sponsor a comprehensive health-insurance plan which we shall call plan X. It offers this plan to the public, and the individual persons who wish to become insured under this health plan pay premiums to the insurance company and the insurance company issues to the individuals the health policies under this particular comprehensive plan. These premiums have been calculated by the actuaries of the insurance company as scientifically as possible. However, because we will assume the plan is one which may reach into new fields and there may not be complete experience, there is always the possibility that benefit payments will exceed the actuarily determined risk. The company decides to spread the risk. It could do so by paying a premium to the Federal reinsurance fund. The Federal reinsurance fund under the bill would agree to make a reinsurance payment equal to three-quarters of the abnormal losses in any year; that is, the losses which exceed an amount determined under a formula which I shall explain in a moment.

One important thing to get out of this chart is the fact that the Federal reinsurance fund is not reinsuring any particular individual. The sole obligation of the Federal reinsurance fund is to the carrier itself. It is an insurance of the carrier's experience under a particular plan and not a direct obligation from the Federal Government to the individual policyholders.

It might be well to review how it would operate administratively. Our next chart (L) illustrates the flow of a reinsurance application and the issuance of a reinsurance contract. Here we have the insurance carrier. Let us assume it is the same carrier which is sponsoring

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the plan X which we have been discussing. Most insurance carriers are regulated by State law and an insurance carrier has to file its plans and premium rates with the State insurance authorities.

Let us assume that has been done in the case of plan X and that the carrier has decided it wishes reinsurance. It would then file with the Department of Health, Education, and Welfare an application for reinsurance of plan X. This application would spell out the details of the plan, would have sample policy plans attached, specify the rates, and so forth. It would be the obligation of the Secretary, under the bill, to review the plan to ascertain whether the terms of it would promote the purposes of the act and whether they meet the standards established by the Secretary under the law for reinsurance.

Assuming that this review is made in the Department and the plan is determined to be one that would promote the purposes of the act, the Secretary must also find that the carrier itself is financially sound and that it is operating in accordance with State law. These determinations, as the Secretary has indicated in her testimony, would be made in the first instance by the State insurance authorities and the Secretary would in all probability rely on those determinations.

At this point we might go back and see which of the items we have covered on chart I.

We have illustrated point 1, that the reinsurance program would be voluntary for each carrier. A carrier would become reinsured only if it voluntarily applied for the reinsurance.

Point 2, we have seen that the regulation of the carriers remains with the States. The Federal Covernment would not establish any regulations other than the standards or specifications under which plans would be reinsured. It would not regulate the carriers as such.

And we have illustrated point 3, as the Secretary has indicated in her testimony, that the Federal Government would have no authority

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to reinsure a plan unless it had been found that comparable reinsurance was not available from private sources. In other words, in addition to approving the plan and approving the financial soundness of the carrier, the Secretary would have to find that comparable reinsurance was not available from private sources.

That covers these first three points. If these findings had been made, the Secretary would be authorized to write a reinsurance contract or issue a certificate of reinsurance relating to plan X. The reinsurance contract would specify the terms of the contract.

Now here I wish to reemphasize a point made by the Secretary in her testimony, that the reinsurance only applies to particular plans. This insurance carrier might have a number of other health plans outstanding but if it applies for reinsurance with respect to only one of them, then the obligations of the reinsurance fund would relate only to that particular plan which was reinsured and not to the other plans which the insurance carrier might sponsor.

That, then, is the principle of the reinsurance, and this is how it would operate administratively.

Now, what, precisely, is the obligation of the Federal Government ? What is the amount of a reinsurance payment that is indicated on this chart? Well, Chart M illustrates the reinsurance payment formula. On the left-hand side, by the total height of this bar here, we have indicated the premium income of insurance company A in a given year. We have, also, indicated the anticipated distribution of that premium income between three items; first, the lower part of the bar indicates the anticipated benefit payments. The white in the middle indicates the amount which the carrier would anticipate setting aside for contingencies, and if it were a stock company, for profits. The upper portion of the bar indicates the amount which it would anticipate hav. ing to pay for administrative expenses.

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The division of the total premium income would be determined in advance by the actuaries of the carrier, and it would be included in the application for reinsurance. It would be one of the items which would have to be approved by the Secretary in approving the plan.

We have a ratio, then, of the administrative expenses to the total premium income, and you will note in the bill that there is a definition of the administrative expense ratio. Let me repeat that this ratio is determined in advance by the actuaries of the company and approved by the Secretary.

Assuming that the anticipated distribution of the total premium income under the plan has been agreed upon, when does the reinsurance obligation come into play? Well, clearly, if the actual experience of the carrier is such that its benefit payments do not exceed the anticipated benefit payments—that is, if it has not suffered any financial discomfort—there would be no reinsurance payment. Secondly, under the formula in the bill, there would be no reinsurance payment unless the actual benefit payments exceeded the anticipated benefit payments plus the amount that would be set aside for contingencies and profits.

In other words, the carrier would have to absorb the loss of its anticipated contingency reserve, or rather the amount it would set aside for the reserve in a given year, and its profits before reinsurance payments would be made.

Now, finally, in developing the formula, it was concluded that the carrier should be required to absorb one-eighth of the amount that it would anticipate paying for administrative expenses before the Federal reinsurance fund would make any payments. This one-eighth is a kind of cushion which was designed largely for the purpose of removing the very sensitive nature of this point at which the calculations are made of anticipated benefit payments and contingencies and profits. In other words, this division, or this distribution of the total premium income is unquestionably a difficult one to make, and the actuaries may not hit it on the nose. Therefore, it was thought that there should be some cushion in there, and one-eighth of the administrative expenses is the amount that is written into the bill.

This means that the Federal reinsurance fund would not make any reinsurance payment for losses unless they exceeded anticipated benefit payments plus contingencies and profits, plus one-eighth of the estimated administrative expenses.

It should be noted that the greater the cushion, the lower the premium rates would be. In other words, if we were to raise this oneeighth to one-fourth, and make a cushion that high, the Federal reinsurance fund would not pay off as often. Therefore, premium rates could be lowered. But, on the other hand, it would not be as useful to the carriers since the Federal Government would not share in as many different losses.

This cushion could be analogized to the deductible item in an automobile policy. It is like the $50 deductible provision with which we are all familiar. Now, on the right-hand side of the chart, we have indicated the examples of actual benefit payments of the carrier. You will see that this bar goes no higher than the anticipated benefit payments, so that no reinsurance payment would be made in this case. Our second bar goes up only to the red line which is the critical point, and there would still be no reinsurance payment. The third bar of

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actual benefit payments goes above that. This is what I have been referring to as an "abnormal year."

Now, to the extent the actual benefit payments in this abnormal year exceed this red line, the reinsurance fund would pay three-fourths of the excess. You will see it says here on the chart:

The reinsurance fund pays three-fourths of the amount by which the actual benefits exceed this level.

That is the reinsurance formula written into the bill. As the Secretary has testified, the essence of it is a spreading of the risk so as to enable carriers to go into new ventures where they have less experience. By the reinsurance payment formula, whereby the Federal Government would absorb three-fourths of abnormal losses, in a given year, the company would be enabled to spread its risk and to move into areas in which it would otherwise dare not venture.

Secretary HOBBY. Mr. Chairman and members of the committee : As the chart presentation has indicated, the program set forth in the bill before you is built upon well-established insurance principles. It embodies the safeguard that the reinsurance is only partial.

Furthermore, except as to administrative costs during the first 5 years, it is designed as a self-supporting program, financed from actuarially determined reinsurance premiums.

While we believe that this program holds great promise for the American people, I want to mention three limitations.

First, it can help only those who are willing to include healthinsurance premiums as a necessary part of the family budget and those who are covered by insurance plans maintained by their employers, in whole or in part.

Second, it may not immediately solve some of the problems of coverage for those who are now aged or for those who already are chronically ill.

Third, it is apparent that the success of the plan depends on the willingness of the carriers actually to make use of it and to assume new and broader risks.

These reservations, however, do not detract from the positive gains which we think the bill can achieve. We are confident that the plan can bring significant benefits for the American people. We believe that use of the reinsurance fund by carriers would induce them to experiment more broadly and more rapidly and to accelerate new ventures in the voluntary health field. If carriers are protected through reinsurance which provides a sharing of unexpected losses, obviously they should be able to expand the scope of protection that they offer.

For example, perhaps the number of exclusions from coverage under certain forms of health insurance can be reduced, perhaps the benefits can be made far more comprehensive as to total limits, thereby providing better protection against major medical expenses. Perhaps the number of days of hospital confinement for which reimbursement is provided might be greatly increased. Perhaps policies need not terminate

the attainment of age 65 or some other stated age, or upon termination of employment, as many policies now do, or perhaps terms may be found under which it is possible to provide insurance to individuals now considered uninsurable. Finally, perhaps more noncancelable policies can be written at prices people can afford to pay.

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