Introduction
COVID-19 is having a far-reaching impact on many industries in the UK and globally, with the health insurance industry being no exception. With the NHS having enlisted the help of the private healthcare sector and the resultant postponement of many treatments, many insurers have seen a decline in claims volumes since the pandemic took hold. In addition, in order to continue to provide value for policyholders there have been wide ranging adjustments made to health insurance products such as cash back for customers hospitalised with COVID-19, extension of coverage periods and premium adjustments. 

The current decline in claims volumes means that some writers of health insurance policies are currently seeing increased underwriting profits. However, most clients we have spoken with in the industry believe that these profits will be short lived, with ‘pent up’ claims demand likely to unwind as the virus subsides and private healthcare provision opens up. This poses numerous interesting questions for insurers from both an insurance reserving and broader accounting perspective. A number of health insurers have also committed to sharing any short-term exceptional financial benefits with policyholders, which introduces further matters for consideration. 

This article looks at some of the key questions that we consider insurers should be asking when determining how to reflect the current and forecast impact of the pandemic and changes in private healthcare provision in their financial statements under both UK GAAP and IFRS reporting.

1. If there is an expectation of an increase in claims in next year’s accounting period due to ‘pent up’ claims demand as a result of COVID-19, should an increase in claims reserves be recognised in the current period?

When answering this question, the key aspects that need to be considered are the risks covered by the existing contract and the loss event. Each of these terms are explored below.

a) What defines the risks covered by the existing contract?

The initial aspect to consider when determining if an increase in claims reserves is required is to understand which risks are covered by the policies written. This is decided based on the obligations of the issuer under the insurance contract[1] and as such in most cases is dependent on the policy wording. 

For many health insurance contracts, the coverage period for the insurance policy is a year or less. Due to this, even though there has been a reduction in claims volumes in the current policy period due to COVID-19, which is expected to be offset in the following period, future expected claims not covered by the terms of current contracts cannot be provided for. For example, if the insurer was notified of the claim after the policy coverage period had elapsed and the terms of the policy require claims to be notified prior to the period of cover ceasing, the insurer has no obligation to settle a claim in such circumstances. As such, it would not be possible to justify that an additional liability is required for these claims, which will arise beyond the contract boundary horizon[2].

Alternatively, it may be that the policy wording permits a policyholder to make a claim for a period of time once the contract boundary has passed. Similarly, we are aware of certain insurers who have afforded policyholders additional time to make claims post the end of their policy term. Both of these scenarios introduce the need for critical judgement as to whether the facts and circumstances extend the period for which the insurer is obligated to compensate a policyholder.

There are numerous other factors which need to be considered when assessing what the contract boundary of a given policy is in order to determine all relevant cash flows of a policy[3]. We examine some of the more common features below.

Renewal options and guarantees

Key features to consider are the option to renew and what is guaranteed upon renewal. Depending on the extent to which an insurer is able to fully reprice the risks upon renewal (by changing either premium or level of benefits), the contract’s rights and obligations may relate only to the period before renewal, or extend beyond it. If the renewal options have repricing mechanisms inbuilt which take into account all insurance and financial risks (but not lapse or expense) in relation to the next twelve months, then the contracts are annual contracts. However, if the repricing does not or cannot factor in all these risks then judgement would need to be made as the contracts may become longer term and could potentially include the expected claims in subsequent periods. Such incidents could occur through market pressure or state regulation not allowing to fully reprice[4]. 

Changes to contract benefits

Some insurers have offered payment holidays and extensions to policy periods in response to COVID-19. One issue to consider would be whether these are new contracts or modifications of existing contracts. Another issue would be to consider the period covered by such contracts during which an insurer is exposed to risks of a claim. This would be especially important to consider for some contracts protecting against multiple events where only some types of protection resulted in payment holidays or extensions to periods covered. These offerings will need to be reviewed to determine the impact on the contract boundary as they could result in changes to contract periods or changes to the pattern of incidence of risk. This may subsequently have an impact on the claims reserves required in the current period and could lead to adjustments being required to current models and calculations. The unearned premiums earning patterns could also require re-assessment to determine if they will be impacted by any changes in contract boundaries.

b) When and what is the loss event?

The second aspect that requires consideration is when the loss event has occurred, as the timing of the loss event, and what the policy terms define the loss event to be, impacts when the obligation arises for the insurer. 

The range of products within the health insurance space is relatively broad and the exact nature of insurance cover provided will vary. Some insurers’ policy terms specify the cover they provide as relating solely to the costs of ‘treatment’. Whereas others view their obligations under the insurance contract written as relating to the policyholder’s condition. For example, a policyholder who has suffered a chronic back injury, depending on the type of cover they have under their policy, could expect their insurer to compensate them for all costs relating to their rehabilitation and recovery from the injury should their policy cover their condition. Alternatively, their insurer may only cover the costs of treatments that have occurred during the policy period, provided the claim was approved, or a specified number of physiotherapy sessions if their policy covers the costs of certain, pre-approved treatments. This could be accounted for either at the pre-approval stage or at date of invoicing for the treatment. This distinction is important in deciding what the ‘loss event’ is, i.e. the occurrence of the injury/illness or the point in time at which the insurer is obligated to reimburse the cost of treatment. In considering this question it would be important to know whether, if the policyholder were to not renew their policy, the insurer would still be obliged to meet the cost of their treatment for a condition that manifested itself during the policy period. It would be important to take into account both the written terms of the policy and any other regulation or communication that may have created a valid expectation on behalf of a policyholder.

A health insurer’s accounting policies should seek to outline what the loss event is for the business they have written and their policy for the recognition of claims reserves in relation to the occurrence of loss events. However, with potentially increased lag times between a policyholder’s underlying health issues arising, to seeing a doctor, to making an insurance claim, the assessment as to when the loss event has occurred may require significant judgement in interpreting the contractual terms and may be a source of estimation uncertainty. 

Provision should be made, usually on an estimated basis, for claims events which have occurred but have not yet been reported, using appropriate statistical and other techniques to address any uncertainty arising[5]. Careful consideration is required by Management and Directors in seeking to estimate the cost of loss events which may have occurred but have not yet been notified to them, giving due regard to what the insurer views as the trigger for recognising a loss event based on the terms of the policies they have written. Many health insurers already have an accounting policy for recognising and estimating an incurred but not reported (IBNR) element of their claims reserves. Accounting policies should be applied on a consistent basis period on period and should only be amended if the change results in more reliable and/or more relevant information about the effects of transactions, other events or conditions on the entity's financial position, financial performance or cash flows[6]. Some health insurers may argue that the business impact of COVID-19 is a reason to revisit their accounting policy in this area, but this would require careful consideration by directors and management and discussion with auditors. Irrespective, given the focus on the determination of loss events in calculating loss reserves, due consideration should be given to the extent of disclosure in the financial statements, with particular thought on disclosure of management’s critical accounting judgements and key sources of estimation uncertainty.

An insurer’s view as to which event triggers the recognition of a loss event should already be well understood and is unlikely to be impacted by the COVID-19 pandemic in isolation. Health insurers will need to give careful consideration as to how any amendments to their standard policy terms and conditions, or other legally binding pronouncements made, may impact upon the contract boundary and in turn which obligations an insurer needs to provide for in its financial statements for the current year.

2. Are there other reasons why an insurer might recognise additional claims reserves in relation to COVID-19?

Insurers should consider whether there have been any changes to the insurer’s obligations in response to COVID-19. Many insurers have announced measures to benefit customers which has resulted in a change to the insurer’s obligations. A common measure announced by insurers is cash benefits for overnight stays at NHS hospitals. This adds additional types of protection and may result in additional claims and further liabilities for health insurers, which will need to be considered when assessing the current claims reserves or other liabilities recognised by the business. As this is a new offering, there may not be historic claims patterns to base the reserves on and estimates will be required to determine the quantum of the claims reserves required and in particular any IBNR element of the reserve.  

The reliability of past claims data to forecast the current reserves and in particular the IBNR element should also be reassessed to determine if the valuations make sense in the current COVID-19 environment. As an example, an assessment should be made on the impacts relating to infection prevention procedures that are required in response to COVID-19. This may result in an increase in treatment durations, which may lead to an increase in claim costs and as such an uplift could be required to claims reserves. Alternatively, the same measures and delays could mean reduction in the costs of claims in the current period, if the treatment continues into the next period, not covered by the terms of the current policy.

In addition, unearned premium reserves may require reassessment to ensure that the earning pattern is still appropriate. For example, if it is estimated that there is heightened risk towards the end of a policy period, a straight-line basis for unearned premium may result in a material difference from a calculation based on the pattern of incidence of risk. Similarly, if it is concluded that the current policy period is extended then the unearned premium would be released over a longer period.

3. If an insurer has made commitments to return any financial benefit to policyholders, how might this impact the financial statements?

In addition to the measures announced surrounding cash benefit for overnight stays at NHS hospitals, there have been announcements from some insurers such as repayments of premiums and commitments that the insurer will not ultimately benefit financially from COVID-19. For such announcements, the key consideration that would need to be made is on the level and type of communication to policyholders and an assessment of whether this has resulted in an obligation which is either contractual or constructive. This question needs to be considered together with the question of the rights and obligations arising from the existing contracts (i.e. assessment of the contract boundary). An assessment can then be made as to whether this would result in additional policyholders’ claims which would have an impact on the claims reserves balance, or if this will have an impact elsewhere on the financial statements of health insurers. For example, if insurers promised a refund of premiums the impact may be on the unearned premium. 

An insurer would also need to consider whether a reliable estimate can be made of the amount of the obligation. For those insurers who had made clear announcements such as premiums for a certain number of months will be returned to policyholders, a reliable estimate may be easier to calculate. Where less prescriptive statements have been made such as any exceptional financial benefits arising from COVID-19 will be passed back to customers, without indicating which customers, or the level of benefits or method of calculation, further consideration would need to be given as to whether an obligation exists. If an obligation exists, consideration will need to be given as to its scope and the reliability of an estimate in determining whether a provision should be recognised, or a contingent liability disclosed.

There will be a significant amount of judgement in determining whether health insurers’ liabilities will require adjustments to take into account the impacts of COVID-19. As a result, there is the possibility of a range of impacts dependent on the judgments made and the commitments different insurers have made to their policyholders.

As with all judgements, it will be important to have a clear process that includes robust challenge and documentation of the reasons supporting key decisions. Clear explanation of the judgements made will be required within the financial statements as well as the impact this has had on the measurement of liabilities. Early discussions with auditors will be key for agreement on these judgements.


Footnotes

(1) Article 18 of the Solvency II Directive provides further guidance on the boundaries of insurance and reinsurance contracts relevant for entities reporting under Solvency II or which have adopted accounting policies based on Solvency II in their statutory accounts.

(2) As per IFRS 4:14 & FRS 103:2.13, “Nevertheless, this IFRS does not exempt an insurer from some implications of the criteria in paragraphs 10–12 of IAS 8. Specifically, an insurer shall not recognise as a liability any provisions for possible future claims, if those claims arise under insurance contracts that are not in existence at the end of the reporting period (such as catastrophe provisions and equalisation provisions).”

(3) As per IFRS 4:16 & FRS 103:2.15, “If an insurer applies a liability adequacy test that meets specified minimum requirements, this IFRS imposes no further requirements. The minimum requirements are the following:
a. The test considers current estimates of all contractual cash flows, and of related cash flows such as claims handling costs, as well as cash flows resulting from embedded options and guarantees.
b. If the test shows that the liability is inadequate, the entire deficiency is recognised in profit or loss.”

(4) IFRS 4:B29 & FRS 103:A2.32 provides an example of changes in the level of insurance risk. 

(5) ABI SORP, paragraph 94

(6) IAS 8:14 & FRS 102:10.8