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IP 54–1

Statutory Issue Paper No. 54

Individual and Group Accident and Health Contracts

STATUS

Finalized June 23, 1998

Original SSAP: SSAP No. 54; Current Authoritative Guidance: SSAP No. 54R

Type of Issue:

Common Area

SUMMARY OF ISSUE

1. Current statutory accounting guidance on income recognition and policy reserves for individual

and group accident and health contracts, as defined in Issue Paper No. 50—Classifications and

Definitions of Insurance or Managed Care Contracts In Force (Issue Paper No. 50), is addressed in

Chapter 13, Aggregate Reserves for Accident and Health Policies and Chapter 18, Premium Income, in

the Accounting Practices and Procedures Manual for Life and Accident and Health Insurance Companies

(Life/A&H Accounting Practices and Procedures Manual). That guidance addresses income recognition

and policy reserves related to individual and group accident and health contracts. Under current statutory

accounting, premiums are recorded on a gross basis when due from policyholders and policy and claim

reserves are computed based upon specific contract provisions and the methods described in the NAIC

Model Law, Minimum Reserve Standards for Individual and Group Health Insurance Contracts

(Individual and Group Health Model Law), the Long-Term Care Insurance Model Regulation, and the

Actuarial Standards of Practice promulgated by the American Academy of Actuaries. Further, policy and

claim reserves must, in the aggregate, place a sound value on both present and future liabilities.

2. GAAP requires insurance contracts to be classified as short-duration or long-duration contracts.

Long-duration contracts are those contracts expected to remain in force for an extended period and

include certain noncancelable and guaranteed renewable accident and health contracts. All other

insurance contracts are considered short-duration contracts and include most property and liability

insurance contracts. Premiums from short-duration contracts ordinarily are recognized as revenue over the

period of the contract in proportion to the amount of insurance protection provided. Claim costs,

including estimates of costs for claims relating to insured events that have occurred but have not been

reported to the reporting entity, are recognized when insured events occur. GAAP guidance requires

policy reserves for individual and group accident and health classified as long-duration to be established

using actuarial assumptions applicable at the time the insurance contracts are made, or for short-duration

contracts, using an unearned premium reserve.

3. The purpose of this issue paper is to establish statutory accounting principles for policy and claim

reserves for all individual and group accident and health contracts consistent with the Statutory

Accounting Principles Statement of Concepts and Statutory Hierarchy (Statement of Concepts). Credit

accident and health insurance contracts are discussed in Issue Paper No. 59—Credit Life and Accident

and Health Insurance Contracts.

SUMMARY CONCLUSION

Income Recognition

4. Premiums shall be recognized as income on the gross basis (amount charged to the policyholder

or subscriber exclusive of copayments or other charges related to the receipt of healthcare services) when

due from policyholders or subscribers, but no earlier than the effective date of coverage under the terms

of the contract. Due and uncollected premiums shall follow the guidance in Issue Paper No. 10—

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Uncollected Premium Balances (Issue Paper No. 10), to determine the admissibility of premiums and

related receivables. Premiums waived by the reporting entity under disability provisions contained in its

policies and contracts, and reported in operations as a disability benefit, are included in premium income.

5. Premium income shall exclude premiums that have been received by the reporting entity on or

prior to the valuation date but which are due after the valuation date (i.e., advance premiums as discussed

below).

6. Premium income shall be reduced for premiums returned and allowances to industrial

policyholders for the direct payment of premiums.

7. Premium income shall be increased by reinsurance premiums assumed and reduced by

reinsurance premiums ceded. Reinsurance premiums assumed and ceded shall be defined and addressed in

Issue Paper No. 74—Life, Deposit-Type and Accident and Health Reinsurance.

8. Advance premiums are those premiums that have been received by the reporting entity prior to or

on the valuation date but which are due after the valuation date. The total amount of such advance

premiums is reported as a liability in the statutory financial statement and is not considered premium

income until due. The gross premium, not the net valuation premium, is recorded as the advance premium

in recognition of the company's liability to refund such premiums in the event the policy is terminated.

9. As discussed in Issue Paper No. 47—Uninsured Plans, amounts received on behalf of uninsured

plans or the uninsured portion of partially insured plans shall not be reported as premium income.

Administrative fees for servicing the uninsured plans shall be deducted from general insurance expenses.

Conversely, income relating to the insured portion of any plan shall be reported as premium income.

Reserve Requirements

10. The aggregate reserve for individual and group accident and health contracts generally consists of

a policy reserve and a claim reserve as well as certain other miscellaneous reserves discussed in

paragraphs 26 and 27. The aggregate reserve reflects the future liabilities arising under accident and

health insurance policies. Policy reserves have traditionally been referred to as active life reserves and

include unearned premium reserves. Policy reserves reflect that premiums cover future liabilities in

addition to current claim costs and expenses. Claim reserves, sometimes referred to as disabled life

reserves, are required on claims which involve continuing loss. The reserve in this case is a measure of

the present value of future benefits or amounts not yet due as of the statement date (the unaccrued

portion) which are expected to arise under claims which have been incurred as of the statement date. The

aggregate reserve for individual and group accident and health contracts does not include claim liabilities

which are the amounts payable at the reporting date (the accrued portion) and reflect the reporting entity’s

liability for benefits due as of the statement date. Claim liabilities are further discussed in Issue Paper No.

55—Unpaid Claims, Losses and Loss Adjustment Expenses.

11. Policy reserves for individual and group accident and health contracts shall include an unearned

premium reserve and, as applicable, an additional or contract reserve where constant or level premiums

are assumed for certain noncancelable or guaranteed renewable contracts. The claim reserve shall consist

of a reserve for the present value of amounts not yet due.

12. Statutory policy reserves shall be established for all unmatured contractual obligations of the

reporting entity arising out of the provisions of the contract. Where separate benefits are included in a

contract, a reserve for each benefit shall be established as required in Appendix A-820. A prospective

gross premium valuation is the ultimate test of reserve adequacy as of a given valuation date. Statutory

reserves meet the definition of liabilities as defined in Issue Paper No. 5—Definition of Liabilities, Loss

Contingencies and Impairments of Assets (Issue Paper No. 5). The actuarial methodologies referred to in

the following paragraph meet the criteria required for reasonable estimates in Issue Paper No. 5.

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13. The reserving methodologies and assumptions used in calculating individual and group accident

and health reserves shall meet the provisions of Appendices A-010, A-641, A-820 and A-822 and the

actuarial guidelines found in Part 9 of the NAIC Financial Examiners Handbook. Further, policy reserves

shall be in compliance with those Actuarial Standards of Practice promulgated by the Actuarial Standards

Board.

Policy Reserves

14. Unearned premium reserves shall be required for all accident and health contracts for which

premiums have been reported for a period beyond the date of valuation other than premiums paid in

advance. The minimum unearned premium reserve that applies to the premium period beyond the

valuation date shall be based on the valuation net modal premium if contract reserves are required and the

gross modal unearned premium reserve if contract reserves are not required. If premiums due and unpaid

are carried as an asset, such premiums must be treated as premiums in force, subject to unearned premium

reserve determination. The value of unpaid commissions, premium taxes, and the cost of collection

associated with due and unpaid premiums must be carried as an offsetting liability. In no event, however,

shall the aggregate policy reserve for all contracts be less than the unearned gross premium under such

contracts. Additionally, the reserve shall never be less than the expected claims for the period beyond the

valuation date represented by the unearned premium reserve, to the extent not provided for elsewhere.

15. Contract or additional reserves on accident and health contracts shall be recorded when premiums

and benefits are not earned or incurred at the same incidence over the policy period (e.g., contracts having

premiums determined on an issue-age basis where premiums and related morbidity, risk of loss, and the

cost of coverage are not evenly matched). This evaluation may be applied on a rating block basis if the

total premiums for the block were developed to support the total risk assumed and expected expenses for

the block each year, and a qualified actuary certifies the premium development (e.g., community-rated

contracts).The additional reserves shall be set aside from the early years’ level premiums to pay the

claims that experience indicates will be incurred as the policy continues in force. The fact that the

reporting entity may have the right to increase premiums or to decline renewal of the policies for certain

reasons has no bearing on whether or not a contract or additional reserve should be held. These reserves

shall apply to regardless of whether or not benefits are currently being received, and are in addition to

unearned premium reserves discussed in paragraph 14.

16. Contract or additional reserves shall also be recorded where, due to the gross premium structure,

the future benefits exceed the future net premiums (e.g., group conversion policies) or where the contract

provides for the extension of benefits after the termination of the coverage (e.g., deferred maternity and

other similar benefits).

17. A terminal reserve for accident and health contracts is the policy reserve at the end of a policy

year to cover the assumed difference between future benefits and future net premiums. The components

used to compute a terminal reserve shall consist of an interest rate, a mortality and/or morbidity table, and

a valuation method (e.g., net level, one-year full preliminary term, and two-year full preliminary term)

and where allowed, other assumptions. A terminal reserve is based on the assumption that all net

premiums have been received, all interest earned, and all benefits paid to the end of the policy year.

18. Since terminal reserves are computed as of the end of a policy year and not the reporting date, the

terminal reserve as of policy anniversaries immediately prior to and subsequent to the reporting date are

adjusted to reflect that portion of the net premium that is unearned at the reporting date. This is generally

accomplished using either the mean reserve method or the mid-terminal method as described in paragraph

22 of Issue Paper No. 51—Life Contracts (Issue Paper No. 51). Other appropriate methods, including an

exact reserve valuation, may also be used.

19. For individual accident and health contracts, negative reserves on any benefit shall be offset

against positive reserves for other benefits in the same policy but the mean reserve on any policy shall

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never be taken as less than one-half the valuation net premium. The majority of group accident and health

policies are written in conjunction with group life or other policies. If these policies are an experience

rated package, positive or favorable margins on one of the contracts can offset the need to establish

additional reserves on the other contracts.

Additional Reserves

20. When the expected claims payments or incurred costs, claim adjustment expenses and

administration costs exceed the premiums to be collected for the remainder of a contract period, a

premium deficiency reserve shall be recognized by recording an additional liability for the deficiency,

with a corresponding charge to operations. For purposes of determining if a premium deficiency exists,

contracts shall be grouped in a manner consistent with how policies are marketed, serviced and measured.

A liability shall be recognized for each grouping where a premium deficiency is indicated. Deficiencies

shall not be offset by anticipated profits in other policy groupings. Such accruals shall be made for any

loss contracts, even if the contract period has not yet started.

Claim Reserves

21. Claim reserves shall be accrued for estimated cost of future health care services to be rendered

that the reporting entity is currently obligated to provide as a result of premiums earned to date and that

would be payable after the reporting date under the terms of arrangements, regulatory requirements or

other requirements if the insured’s or subscriber’s illness or disability were to continue. It shall include a

reserve for disability benefits covered under premium waiver provisions. For individual and group

disability claims with a duration of less than two years, reserves may be based on the reporting entity’s

experience, if credible, or other methods, as appropriate. Generally, reserves for disability income claims

with durations of greater than two years shall be determined based on a tabular method using the age of

the insured at the date of disablement, the number of months the insured already has been disabled, and

the number of months remaining in the benefit period.

Reserve Recognition

22. The difference between the aggregate reserve for accident and health contracts at the beginning

and end of the reporting period shall be reflected in the summary of operations, except for any difference

due to a change in valuation basis.

Change In Valuation Basis

23. A change in valuation basis shall be defined as a change in the interest rate, mortality or

morbidity assumption, or reserving method (e.g., net level, preliminary term, etc.) or other factors

affecting the reserve computation of policies in force and meets the definition of an accounting change as

defined in Issue Paper No. 3—Accounting Changes (Issue Paper No. 3). Consistent with Issue Paper

No. 3, any increase (strengthening) or decrease (destrengthening) in actuarial reserves resulting from such

a change in valuation basis shall be recorded directly to surplus rather than as a part of the reserve change

recognized in the summary of operations. The impact on surplus is based on the difference between the

reserve under the old and new methods as of the beginning of the year. This difference shall not be graded

in over time unless an actuarial guideline adopted by the NAIC prescribes a new method and a specific

transition that allows for grading.

Supplemental Benefits

24. In addition to the basic policy benefit, the contract may provide supplemental benefits.

Supplemental benefits include, but are not limited to, accidental death benefits, dental and waiver of

premium benefits. If the terms of the contract provide for these benefits, appropriate reserves shall be

established in accordance with the applicable standards within this Codification.

Reserve Adequacy

25. As discussed in Appendix A-010, a prospective gross premium valuation is the ultimate test of

the adequacy of a reporting entity’s accident and health reserves as of a given valuation date and shall be

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determined on the basis of unearned premium reserves, contract or additional reserves, claim reserves

(including claim liabilities), and miscellaneous reserves combined; however, each component shall be

computed separately.

Additional Reserves Not Included Elsewhere

26. Reserve for experience-rating refunds or the dividend liability in group policies are discussed in

Issue Paper No. 66—Accounting for Retrospectively Rated Contracts.

27. Additional actuarial or other liabilities are commonly held for such items as:

a. Surrender values in excess of reserves otherwise required or carried;

b. Additional reserves required based on cash flow testing and/or asset/liability matching

requirements; and

c. Additional reserves for policies which contain conversion privileges or future contingent

benefits.

Contracts Subject to Redetermination

28. This statement also applies to other contracts which are subject to redetermination such as Federal

(and State) Groups – subject to rate adjustments through audits by the Office of Personnel Management

(“OPM”). Reporting entities are required to give Federal Groups the lowest rates that are being charged to

similar groups.

29. Amounts due from insureds or subscribers and amounts due to insureds or subscribers under

contracts subject to redetermination meet the definitions of assets and liabilities as set forth in Issue Paper

No. 4—Definition of Assets and Nonadmitted Assets and Issue Paper No. 5, respectively.

30. Contract redeterminations shall be estimated based on the experience to date. The method used to

estimate the liability shall be reasonable based on the reporting entity’s procedures, and consistent among

reporting periods. An examination of contract requirements in relation to the rates being charged and the

current status of applicable audits (e.g., OPM, Health Care Finance Administration and other Federal,

state or government department) is a common method used to estimate such contract redeterminations.

31. Premium adjustments for contracts subject to redetermination are estimated for the portion of the

policy period that has expired and shall be considered an immediate adjustment to premium. Accrued

premium adjustments shall be recorded as a write-in for other-than-invested assets, with a corresponding

entry to premiums; accrued return premium adjustments shall be recorded as a liability with a

corresponding entry to premiums.

32. If, in accordance with Issue Paper No. 5, it is probable that the additional premium adjustment is

uncollectible, any uncollectible premium shall be written off against operations in the period the

determination is made and the disclosure requirements outlined in Issue Paper No. 5 shall be made.

33. Premium adjustments for contracts subject to redetermination shall be determined and billed or

refunded in accordance with the policy provisions or contract provisions. If such premiums are not billed

in accordance with the policy provisions or contract provisions, or the policy provisions or contract

provisions do not address the due date of such premiums, the accrual shall be nonadmitted. This is

consistent with the guidance for audit premiums established in Issue Paper No. 10.

Disclosures

34. Disclose the aggregate amount of direct premiums written through managing general agents or

third party administrators. For purposes of this disclosure, a managing general agent means the same as in

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Appendix A-225. If this amount is equal to or greater than 5% of surplus, provide the following

information for each managing general agent and third party administrator:

a. Name and address of managing general agent or third party administrator;

b. Federal Employer Identification Number;

c. Whether such person holds an exclusive contract;

d. Types of business written;

e. Type of authority granted (i.e., underwriting, claims payment, etc.);

f. Total premium written.

35. If a premium deficiency reserve is established in accordance with paragraph 20, disclose the

amount of that reserve.

DISCUSSION

36. This issue paper adopts the current statutory accounting guidance for premiums, policy reserves,

and claim reserves associated with accident and health contracts. However, paragraph 20 of this issue

paper expands the current requirements for reserving for contracts where due to the gross premium

structure, future benefits exceed future premiums.

37. The statutory accounting principles outlined in the conclusion above are consistent with the

conservatism, consistency and recognition concepts in the Statement of Concepts which state:

Conservatism

Financial reporting by insurance enterprises requires the use of substantial judgments and

estimates by management. Such estimates may vary from the actual amounts for numerous

reasons. To the extent that factors or events result in adverse variation from management’s

accounting estimates, the ability to meet policyholder obligations may be lessened. In order to

provide a margin of protection for policyholders, the concept of conservatism should be followed

when developing estimates as well as establishing accounting principles for statutory reporting.

Conservative valuation procedures provide protection to policyholders against adverse

fluctuations in financial condition or operating results. Statutory accounting should be reasonably

conservative over the span of economic cycles and in recognition of the primary responsibility to

regulate for financial solvency. Valuation procedures should, to the extent possible, prevent sharp

fluctuations in surplus.

Consistency

The regulators’ need for meaningful, comparable financial information to determine an insurer’s

financial condition requires consistency in the development and application of statutory

accounting principles. Because the marketplace, the economic and business environment, and

insurance industry products and practices are constantly changing, regulatory concerns are also

changing. An effective statutory accounting model must be responsive to these changes and

address emerging accounting issues. Precedent or historically accepted practice alone should

not be sufficient justifications for continuing to follow a particular accounting principle or practice

which may not coincide with the objectives of regulators.

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Recognition

Liabilities require recognition as they are incurred. Certain statutorily mandated liabilities may

also be required to arrive at conservative estimates of liabilities and probable loss contingencies

(e.g., excess of statutory reserves over statement reserves, interest maintenance reserves, asset

valuation reserves, and others).

Claim Reserves - Indemnity and Managed Care Contracts

38. As discussed in paragraph 21, claim reserves shall be accrued for estimated amounts that would

be payable after the reporting date if the insured’s illness or disability were to continue. For health

maintenance organizations claims reserves shall be provided if the benefits for the event extend beyond

the contract period. For claims with a duration of less than two years, there are a variety of acceptable

methods for calculation. Some of them are: (a) use of the disabled life table—either a published table or

one based on the insurer’s experience; (b) use of an estimate made by the insurer’s claim department for

each policy (the individual judgment approach); or (c) other appropriate estimation techniques.

39. The method used to compute the claim reserve must be appropriate in the circumstances.

Historical development might provide information as to the appropriateness of the method used by

developing statistics to show that its method would (or actually did) produce adequate reserves for prior

valuation periods. If the loss-of-time policy provides a waiver of premium benefit, the reserve for policies

that are having their premiums waived should be included with the disabled life reserves.

Level Premiums - Indemnity Contracts

40. As discussed in paragraph 15 of this issue paper, contract or additional reserves on accident and

health contracts shall be recorded when premiums and benefits are not earned or incurred at the same

incidence over the policy period. The Life/A&H Accounting Practices and Procedures Manual requires

contract reserves on individual accident and health policies but does not specifically extend this

requirement to group policies. This issue paper clarifies current SAP to require contract reserves on group

accident and health policies, including those group accident and health contracts that are individually

underwritten.

Future Contingent Benefits - Indemnity Contracts

41. A reporting entity shall establish a reserve for future contingent benefits which extend beyond the

termination of the policy, subject to specific contract provisions. Such provisions which accrue and are

payable at some future date, are predicated on a condition or actual disability which existed at the

termination of the contract and which is usually not known to the reporting entity at the time of the

termination (e.g., deferred maternity benefits). In situations where the actual disability is not known to the

reporting entity at the time of the termination, the reserve shall be computed based on relevant pricing,

periodic, or industry studies of similar benefits on terminated policies. Reporting entities shall separately

compute a reserve for deferred maternity benefits and any other extended benefits under group contracts.

Extension of Benefits - Indemnity Contracts

42. An additional reserve shall be required for group accident and health contracts which contain a

conversion privilege. The minimum additional reserve shall equal the excess morbidity costs assumed in

the premium payable on the terminated coverages. If future guaranteed rates are inadequate to meet future

obligations, then additional reserves shall be established. A reserve shall be established to cover the

expected benefit payments for any policy having a conversion privilege or other similar extension of

benefits when the policy is terminated with no additional premiums due but the benefits extend beyond

the termination date. However, for cases where the experience of the case or the experience of a block of

cases is reflected back to the policyholder, the dividend liability or provision for experience rating refunds

is a direct offset to the need to establish an additional reserve.

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GAAP Literature

43. Consistent with Issue Papers Nos. 50 and 51, FASB Statement No. 60, Accounting and Reporting

by Insurance Enterprises (FAS 60), relating to individual and group accident and health contracts is

rejected for the reasons set forth in those issue papers. However, some of the elements regarding income

recognition have been used in this issue paper.

Drafting Notes/Comments

- Issue Paper No. 50 addresses Classifications and Definitions of Insurance or Managed Care

Contracts In Force.

- Issue Paper No. 51 addresses Life Contracts.

- Issue Paper No. 52 addresses Deposit-Type Contracts.

- Issue Paper No. 55 addresses Unpaid Claims, Losses and Loss Adjustment Expenses.

- Issue Paper No. 59 addresses Credit Life and Accident and Health Insurance Contracts.

- Issue Paper No. 66 addresses Accounting for Retrospectively Rated Contracts.

- Issue Paper No. 74 addresses Life, Deposit-Type and Accident and Health Reinsurance.

RELEVANT STATUTORY ACCOUNTING AND GAAP GUIDANCE (only pertinent excerpts are

included below)

Statutory Accounting

44. Chapter 13, Aggregate Reserves For Accident and Health Policies, of the Life/A&H Accounting

Practices and Procedures Manual provides the following guidance on individual and group accident and

health reserves:

Accident and health insurance provides protection against economic losses resulting from

accident and/or sickness. This insurance may be provided under individual policies, under group

or franchise policies, or it may be provided under certain special types of policies which bear

unique titles such as credit insurance. The economic losses which accident and health insurance

policies cover, or the types of benefits provided, will vary with different policies. For example,

reimbursement for hospital, surgical, or medical expenses may be provided under a hospital

expense policy, while under other policies, a more comprehensive form of coverage, known as

major medical insurance, may be offered. Similarly, policies may provide monthly benefits for loss

of income from disability, either on a short term or a long term basis, or only for disabilities due to

accident. Loss of life from accident may be covered under accidental death policies, while under

certain limited accident policies, only accidental death from air travel may be covered. Therefore,

accident and health policies may be categorized by the form of policy through which the coverage

is provided; it may be categorized according to the benefits provided by the policy; or it may be

categorized by the contingencies insured against. These variations in types of policies and the

benefits provided must be considered in discussing the reserves for accident and health

insurance policies.

Accident and health policies are offered by life companies, casualty companies, fraternal benefits

societies, and certain specialty companies. While the coverage originated with casualty

companies, it is now the life insurance companies which provide the majority of accident and

health insurance. The history of the business is important because many of the concepts

currently used originated from casualty insurance practices and use casualty terminology. Since

the life insurance companies began writing this insurance, the form of the policies and the

concept of coverages have changed, which also produced changes in reserving practices.

At one time, all reporting of accident and health insurance was on the miscellaneous blank, which

was originally designed for the casualty companies. The policies then offered were referred to as

commercial policies under which the insurer had the right to cancel or fail to renew coverage.

Some noncancellable accident and health insurance was written with specific reserve

requirements for those policies. The premium rates for commercial policies were often on a

uniform rate basis, with the same premium applying to a broad range of ages. Under the casualty

concept, the reserves for these commercial policies consisted primarily of an unearned premium

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reserve and claim reserve. The unearned premium reserve was intended to recognize that

portion of a premium which covered a policy period extending beyond the valuation date. Claim

reserves were required to recognize the liability of the company for claims which had not been

paid or were being processed. The titles assigned to the various claim reserves were intended to

reflect their payment status; however, over the years, procedures have changed and certain of

the reserves are calculated differently but still bear the same titles. Reserves in the statutory

financial statement required for accident and health insurance are measures of the value of

liability for future obligations of an insurer. Two basic types of reserves are required to value the

future liabilities arising under accident and health insurance policies. “Policy reserves” have

traditionally been referred to as active life reserves and unearned premium reserves and are a

recognition that premiums cover future liabilities in addition to current claim costs and expenses.

“Claim reserves,” sometimes referred to as disabled life reserves, are required on claims which

involve continuing loss. The reserve in this case is a measure of the present value of future

benefits or amounts not yet due as of the statement date which are expected to arise under

claims which have been incurred as of the statement date. “Claim liabilities,” to be discussed in a

later chapter, are a measure of an insurer’s liability for benefits due as of the statement date.

In many respects, the reporting of accident and health insurance is similar to that used for life

insurance but the reserving of accident and health insurance differs significantly from that used

for life insurance. The separation of the claim reserve is an example of unique accident and

health reserving and will be discussed later. This chapter will analyze accident and health

reserves from a general standpoint and reference will be made to the numerous regulations on

accident and health reserves which have been recommended by the NAIC and which have been

promulgated at various times by the different states. It is not intended that those reserve

recommendations be restated in this chapter but comments will be made to enhance their

understanding.

Individual Accident and Health Policies

Individual accident and health policies, other than credit insurance, are separated for reserve

reporting purposes in the statutory financial statement into six classifications. The definitions are

included in the instructions for the statutory financial statement and are based principally on the

renewal agreement of the policy. There is some variation in the reserve requirements which apply

to the different renewal classifications of policies but most reserve requirements apply to all

individual policies.

Legal Requirements for Reserves

For life insurance, the standard valuation law defines the minimum standard which a company’s

aggregate reserves must meet. However, for accident and health insurance, the statutes of most

states provide that the insurer shall maintain an active life reserve which shall place a sound

value on its liabilities under its accident and health policies and be not less than the reserve

according to the appropriate standards set forth in regulations issued by the insurance

department. In other states which have not adopted specific reserve requirements for accident

and health insurance, the requirement for reserves may be based on more general statutory

requirements or on the instructions to the statutory financial statement. Those instructions

provide that a reserve must be carried for any policy which provides guarantee of renewability,

and the standards adopted by the NAIC in December 1964, are indicated to be an acceptable

basis for such additional reserves. The report of the Industry Advisory Committee on Reserves

for Individual Accident and Health Policies, approved by the NAIC in December 1964 has served

as the basis for the reserve regulations promulgated by many insurance departments. Revisions

in the regulations may change the reserve requirements, as well as provide for new morbidity

tables, without a change in the reserve law of a state as is true for life insurance.

Unearned Premium Reserves

These reserves are established for all accident and health policies and are equivalent to the

amount of the gross premium for that portion of the premium period which extends beyond the

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valuation date. The unearned portion may be computed on a pro rata basis using the actual due

dates, or it may be computed on the “monthly pro rata method,” which assumes that all premiums

are collected evenly throughout the month. Special consideration should be given to the method

used if there is a high concentration of premiums due on a given date because of company

practices in the dating of policies. Care must be taken to insure consistency between unearned

premium reserves and premiums reported as due and unpaid. For example, if a company is

taking a due and unpaid premium for a policy as an asset, the appropriate portion of that

premium should be included in the unearned premiums just as if the premium had actually been

paid.

Active Life or Additional Reserves

These reserves arise as a consequence of the rating concept for the policy where a constant or

“level premium” is assumed over a specified period of years during which the cost of insurance

increases with the increasing age of the insured lives. This is similar in concept to the reserves

provided for term life insurance policies, but again, there are distinct differences. The active life

reserve is required of all in-force policies, which would include policies on those lives which are

currently disabled and receiving benefits, and is in addition to any reserves required on those

lives in connection with the claim. Active life reserves are necessary because the level premiums,

as with life insurance, will likely prove to be inadequate to meet future claim costs as the policies

mature. The additional reserves are, therefore, set aside from the early years’ level premiums to

pay the claims that experience indicates will be incurred as the policy continues in force. The fact

that the insurer may have the right to increase premiums or to decline renewal of the policies for

certain reasons has no bearing on the calculation of the active life reserves. These additional

reserves are not required of policies with certain renewal agreements.

Specific morbidity tables, valuation methods and interest rates have been included in the NAIC

recommendations as minimum standards. The policy reserves established and maintained by a

company should place a sound value on both present and future liabilities under those policies

and should not be less than the minimum values determined by the methods and bases

described therein.

The morbidity tables specified in the NAIC recommendations should be viewed as minimum

standards. While these morbidity tables have been developed from industry experience data, it

has not been possible to recognize all the variations in policy benefits or underwriting

philosophies of all companies. Appropriate modifications should be made to reflect the actual

benefits provided in the policy. Similarly, recommended morbidity tables do not exist for certain

benefits so there is a need to develop reserves based on the insurer’s recent morbidity

experience, or on recognized published morbidity experience, such that a sound value is placed

on the liabilities under that benefit.

The NAIC recommendations permit alternative valuation procedures and assumptions. Often the

great variety of benefits and options in accident and health policies make it impractical to

precisely value each variation. Approximations such as those involving age groupings, groupings

of several years of issue, or average amounts of indemnities are among those mentioned. Others

include the computations of the reserve for a policy benefit as a percentage of some other policy

benefit or the use of composite annual claim costs for all or any combination of the benefits

included in the policies.

The insurer may employ the use of either the level premium, the one-year preliminary term, or the

two-year preliminary term valuation methods. The reserves may be shown as mean reserves

diminished by appropriate credit for valuation net deferred premiums or as mid-terminal reserves

plus the gross or net unearned premium reserves. In no event, however, may the aggregate

reserve for all policies be less than the unearned gross premium under such policies. For

statement purposes, the net reserve liability may be shown as the excess of the mean reserve

over the amount of net unpaid and deferred premiums or, regardless of the underlying method of

calculation, it may be divided between the unearned gross premium reserve and a balancing item

for the “additional reserve” which is generally based on the mid-terminal reserves. The insurer is

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required to attach to the statutory financial statement a description of the valuation standards

used in calculating the reserves, and to specify the reserve basis, interest rates, and methods.

Because of the aggregate and average nature of policy reserves, deficiency reserves are

normally not required for accident and health insurance. Negative reserves on any benefit may

be offset against positive reserves for other benefits in the same policy but the mean reserve on

any policy should never be taken as less than one-half the valuation net premium.

Reserves for cash value, return of premium, or other nonforfeiture benefits should be calculated

using interest, mortality, and morbidity, provided the value of benefits payable upon death is

included in the calculation; otherwise, reserves should be calculated on a sinking fund basis

using interest and morbidity only. The aggregate policy reserves established for these, over and

above any policy reserve required for other policy benefits, should not be less than the aggregate

of any withdrawal benefits then payable. Where cash value or return of premium benefits are

payable periodically, reserves should be calculated on a recurring term period basis, consistent

with the payment cycle.

Group Policies

All organizations that qualify to purchase group life insurance may also, by most state laws,

purchase accident and health insurance. In many states, the definition of what constitutes an

eligible group for accident and health insurance is entirely left up to any set of good underwriting

practices established by the insurance company.

Some insurers may act as administrators of accident and health plans under which the plans

bear the risk of claims. Such plans are commonly terms “administrative services only” plans and

are described in this manual as “uninsured plans.” For additional discussion see Chapter

8Other Admitted Assets.

The insurer’s aggregate reserves should not include any amounts arising from uninsured

accident and health plans or the uninsured portion of partially insured plans. The insured portion

of any partially insured plan should be treated as any other insured plan with appropriate

reserves established.

Legal Requirements for Reserves

The minimum reserve for active lives is the gross unearned premium. Unlike life insurance,

where due and outstanding premium is a net valuation premium and reserves are also net

valuation premium reserves, group accident and health due and outstanding premium and

unearned premium reserves are reported on a gross basis. There is, therefore, no need to

calculate loading or establish the excess of the cost of collection over loading for group accident

and health policies. The liabilities established on due and outstanding premiums are discussed

elsewhere in this manual.

Unearned Premium Reserves

The methods of computing group unearned premium reserves may vary between companies and

even within a company, depending upon the premium due dates of the policies involved. The

monthly pro rata gross unearned premium is a common method used. The assumption of uniform

issuance is applied in the monthly pro rata method. At the end of the month in which the premium

is due, one-half of the premium is considered to be earned and one-half is considered to be

unearned.

Unearned premium reserves also may be based on the actual due date of the premium; this has

been referred to as the “daily pro rata” method. It is the most precise basis. Sometimes a

combination of the two methods is used. An unearned premium reserve of zero is established for

all policies with monthly premium due dates of the first day of the month. For all other monthly

policies, a uniform distribution is assumed. Most group accident and health policies are billed on

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a monthly basis but, in a few cases, quarterly, semiannual, and even triannual modes are

encountered. Premium modes other than monthly can be handled in similar fashion.

Additional Reserves

Some states may require an additional reserve for policies which contain a conversion privilege.

The minimum reserve should be the excess of the morbidity costs assumed in the premium to be

payable on the terminated coverages. If the rates guaranteed into the future are inadequate to

meet future obligations, then additional reserves should be established. However, for cases

where the experience of the case or the experience of a block of cases is reflected back to the

policyholder, the dividend liability or provision for experience rating refunds is a direct offset to the

need to establish an additional reserve. Also, it should be noted that the vast majority of group

accident and health policies are written in conjunction with a group life policy. In the case of an

experience rated package of group life and group accident and health, policyholder margins

available from the group life contract may also reduce the need to establish an additional reserve.

A detailed discussion of the group dividend liability and experience rating refunds may be found

below.

Reserve For Future Contingent Benefits

In addition to the unearned premium reserves for all group accident and health policies, a

company may be required to establish a reserve for future contingent benefits. The most

common of these is for deferred maternity benefits.

Employer groups frequently have female employees leaving for maternity reasons. These

employees usually leave at some time before giving birth and are not members of the group at

the time their hospitalization claim is presented. For this reason, most group policies are written

to insure conception rather than birth. The requirement, therefore, is that the female employee be

a member of the group at the time of conception for her to receive benefits upon giving birth.

One other contingent benefit that may be set up is a special reserve for major medical policies

that have a high front-end deductible, such as $5,000 to $10,000. A claim reserve may not have

been established since the insureds have not used up the deductible but future contingent

benefits may be in the process of building as the deductibles are satisfied.

According to the NAIC instructions, any policy having similar extension of benefits must have

such a reserve. It is intended that this reserve should be set up on the assumption that all

insurance under policies containing an extension of benefits will terminate on the statement date.

Other Reserve Considerations

Claim Reserves

The treatment of active life reserves for accident and health policies has been discussed in three

categories — individual, group, and credit. The requirements for each category were sufficiently

unique to warrant separate consideration. The standards and practices employed in the

computation of claim reserves, however, are for the most part the same for individual, group, and

credit and will apply jointly unless specific reference is made to one line of business.

Claim reserves are reported as accident and health reserves. Estimated amounts that would be

payable after the statement date if the insured’s liability were to continue represent the unaccrued

benefits which make up the claim reserve. The accrued benefit, i.e., the amount payable on the

balance sheet date, is reported as the claim liability in the balance sheet. Separating accrued and

unaccrued portions of claims provision often is difficult because many methods of computing

claim reserves generate one total amount based upon the company’s past experience.

Disabled Life Reserves For Loss-Of-Time Policies

The calculation of disabled life reserves for claims with a duration of more than two years is

straightforward. The disabled life factors are based upon the age of the insured at the date of

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disablement, the number of months the insured already has been disabled, and the number of

months remaining in the benefit period.

For claims with a duration of less than two years, there is a variety of acceptable methods for

calculation. Some of them are: (a) use of the disabled life tableeither a published table or one

based on the insurer’s experience; (b) use of an estimate made by the insurer’s claim department

for each policy (the individual judgment approach); (c) use of a “rule of thumb,” such as setting

the reserve equal to the prospective claim payments for 3 1/2 times the elapsed period of

disability; or (d) a combination of the first three methods.

For any method it uses, the insurer should have statistics to show that its method would (or

actually did) produce adequate reserves for prior valuation periods. If the loss-of-time policy

provides a waiver of premium benefit, the reserve for policies that are having their premiums

waived should be included with the disabled life reserves. A portion of the liability for incurred but

not unreported loss-of-time claims may be unaccrued.

A shortage in the statutorily-determined reserves for loss-of-time claims may develop, since the

experience of these claims is consolidated for those of more than and less than a duration of two

years. Because of the legal requirement, claims of more than two years’ duration must have

tabular reserves in accordance with statutory requirements. The minimum reserves for these

claims are set, therefore, and at least that amount should be reported. Consolidated experience

may indicate, because of earlier terminations of payments and lump sum settlements, that these

reserves are redundant. In any case, the reserve for the initial two years of incurrence must be

sufficient in its own right and must not be reduced to offset a redundancy in the reserve for claims

beyond two years’ duration.

Claim Reserves For Other Than Loss-Of-Time Policies

The incurred claim reserve for various hospital and medical expense coverages may have an

unaccrued portion. For example, if an insured has been hospitalized for 20 days as of a given

valuation date, and it was estimated that he would be hospitalized for another 10 days for the

same sickness, then the reserve for the 10 days of benefits should be established as a claim

reserve. In practice, a total reserve for a given claim generally will be established and then

divided by some predetermined means between claim reserves and claim liability. Due to the

great latitude given the insurer in determining reserves for other than loss-of-time policies, the

insurer is required to provide statistics that support the adequacy of the reserves for each major

line of business.

The emergence of discount and the existence of certain minimum-premium policies and excess

risk reinsurance may distort the above-mentioned tests. The adequacy of reserves is also

affected by other factors, such as the existence of contractual premium clauses under which the

insurer can require an additional premium to be paid under certain stipulated conditions.

45. The Life/A&H Accounting Practices and Procedures Manual provides the following guidance on

individual and group accident and health premiums:

CHAPTER 18 PREMIUM INCOME

Accident and Health Policies

Accident and health insurance policies typically provide a grace period after the due date for the

premium to be received before the policy is terminated. If the company is relatively assured of

collecting the late premium, and has established an appropriate unearned premium reserve, it is

permitted to record such due and uncollected premium as an admitted asset.

On accident and health policies, other than group, with premiums payable more frequently than

quarterly, all due and unpaid premiums are not admitted if more than one period premium is

overdue. Group premiums more than 90 days overdue also are disallowed as an admitted asset.

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If gross accident and health uncollected premiums are recorded as income and as an asset,

commissions on uncollected premiums are included in the liability for unpaid commissions.

The method used for determining the amount of uncollected premiums should be the same for

group as for individual policies. This usually is done by preparing an inventory of premiums billed,

due prior to the statement date but uncollected. If the company pays a different rate of

commission on first-year premiums than on renewals, the premiums should be grouped to

facilitate the calculation of the unpaid commissions.

Because the policyholder can terminate the policy at any time simply by not paying the premium,

the company should consider its lapse experience in determining the amount it records as

uncollected premiums. Recording older due premiums (although not more than 90 days past

due), which have little or no unearned premium reserve, may overstate the company’s financial

condition. Direct mail mail-order insurance is a good example of business having high lapse

rates. Many companies record no uncollected premiums on these policies.

Some insurers may act as administrators of accident and health plans under which the plans

bear the risk of claims. Such plans are commonly termed “administrative services only” plans and

are described in this manual as “uninsured plans.” For additional discussion see Chapter

8Other Admitted Assets.

Amounts related to uninsured plans or the uninsured portion of partially insured plans must not

be reported in premiums. Conversely income relating to the insured portion of any plan must be

reported as premiums.

Generally Accepted Accounting Principles

46. The AICPA Audit and Accounting Guide: Health Care Organizations provides the following

guidance:

Revenue

10.04 Revenue usually is recorded when coverage is provided to an enrollee or the service is

provided to a patient or resident. Revenue is classified based on the type of service rendered or

contracted to be rendered. Examples of revenue include—

 Patient service revenue, which is derived from fees charged for patient care. This

may be based on diagnosis related group (DRG) payments, resource-based

relative value scales (RBRVS) payments, per diems, discounts, or other fee-for-

service arrangements.

 Premium revenue, which is derived from capitation arrangements.

 Resident service revenue, which may be related to maintenance fees, rental

fees, or amortization of advance fees.

Accounting for Loss Contracts

13.05 A prepaid health care provider enters into contracts to provide members with specified

health care services for specified periods in return for fixed periodic premiums. The premium

revenue is expected to cover health care costs and other costs over the terms of the contracts.

Only in unusual circumstances would a provider be able to increase premiums on contracts in

force to cover expected losses. A provider may be able to control or reduce future health care

delivery costs to avoid anticipated losses, but the ability to avoid losses under existing contracts

may be difficult to measure and to demonstrate. Associated entities such as hospitals, medical

groups, and individual practice associations (IPAs) may enter into similar contracts with prepaid

health care providers in which they agree to deliver identified health care services to the

providers’ members for specified periods in return for fixed fees.

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13.06 FASB Statement No. 5, Accounting for Contingencies, states that a loss should be

accrued in financial statements when it is probable that a loss has been incurred and the amount

of the loss can be reasonably estimated. Accordingly, losses should be recognized when it is

probable that expected future health care costs and maintenance costs under a group of existing

contracts will exceed anticipated future premiums and stop-loss insurance recoveries on those

contracts. For purposes of determining whether a loss exists, the expected future health care

costs include all costs other than general and administrative, selling, maintenance, marketing and

interest. The term maintenance costs refers to costs associated with maintaining announcement

records and processing premium collections and payments. The estimated future health care

costs and maintenance costs to be considered in determining whether a loss has been incurred

should include fixed and variable, direct, and allocable indirect costs. Contracts should be

grouped in a manner consistent with the provider’s method of establishing premium rates, for

example, by community rating practices, geographical area, or statutory requirements, to

determine whether a loss has been incurred.

RELEVANT LITERATURE

Statutory Accounting

Statutory Accounting Principles Statement of Concepts and Statutory Hierarchy

Accounting Practices and Procedures Manual for

Life and Accident and Health Insurance

Com

panies, Chapter 13, Aggregate Reserves for A

ccident and Health Policies, and Chapter 18,

Premium Income

- Issue Paper No. 3—Accounting Changes

- Issue Paper No. 4—Definition of Assets and Nonadmitted Assets

Issue Paper No. 5—Definition of Liabilities, Loss Contingencies and Impairments of Assets

- Issue Paper No. 10—Uncollected Premium Balances

- Issue Paper No. 47—Uninsured Plans

- Issue

Paper No. 50—Classifications and Definitions

of Insurance or Managed Care Contracts In

Force

- Issue Paper No. 51—Life Contracts

- Issue Paper No. 55—Unpaid Claims, Losses and Loss Adjustment Expenses

- Issue Paper No. 59—Credit Life and Accident and Health Insurance Contracts

- Issue Paper No. 66—Accounting for Retrospectively Rated Contracts

- Issue Paper No. 74—Life, Deposit-Type and Accident and Health Reinsurance

Generally Accepted Accounting Principles

- AICPA Audit and Accounting Guide: Health Care Organizations

State Regulations

No additional guidance obtained from

state statutes or regulations.