New Models Demonstrate How to Reduce Risk in Medical Reinsurance

16 May 2011, Ithaca, NY - With the national debate about how best to provide medical insurance heating up again, a new finance study examines the risks borne by medical insurers and demonstrates how to spread and minimize these risks.  The study, by Domingo Castelo Joaquin, associate professor of finance at Illinois State University, and Lina Chan, Fellow of the Society of Actuaries and a managing partner of CP Risk Solutions, was published as a demonstration for professionals in the insurance industry.  The researchers use Palisade Corporation’s @RISK to evaluate the opportunities provided through the practice of reinsurance, whereby one insurance company insures another against unexpectedly high claims.

Chan and Joaquin’s analysis focuses on a hypothetical reinsurance company that insures modest-size companies. This company is offered the opportunity to write backup insurance for a huge company that self-insures to provide medical coverage for its many employees. Selling this stop-loss coverage could be a make-or-break move for the reinsurance company, and the company needs to predict how such a deal would affect its resulting capital position.  So, rather than deciding for or against taking the deal, the reinsurance company explores taking out reinsurance for itself from a second reinsurer. 

To anticipate how purchasing reinsurance will affect the company’s bottom line, Chan and Joaquin turned to @RISK, the best-selling software that carries out Monte Carlo simulations in Microsoft Excel. These simulations express results in terms of probability and allow comparisons of various what-if scenarios. Chan and Joaquin analyze three different reinsurance scenarios with three different formulations of probability, and their findings favor the most conservative arrangement with the second reinsurer. The primary lesson of their analysis, however, is their approach to creating a risk-sharing strategy.  In their explanations of this process, they reveal a great deal about the thinking behind reinsurance.

“Lina Chan and Domingo Joaquin are to be congratulated on this important contribution,” Palisade Vice President Randy Heffernan commented.  “Although @RISK has always had a strong following among insurers and actuaries, we were especially pleased to see our software used in an analysis that will have such a positive practical effect on the industry.”  

» Read the related case study "@RISK sizes up a stop-loss opportunity in medical reinsurance .