Medical aid schemes help people to pay for healthcare needs and medical expenses in exchange for monthly contributions. Sometimes medical schemes in South Africa enter into capitation agreements with another party whereby the medical scheme pays, to such party, a pre-negotiated fixed fee in return for the provision of specified benefits to the members.
The schemes might use a capitation agreement, for example, in the area of managed health care. According to the Medical Schemes Act (MSA), managed health care means clinical and financial risk assessment and management of health care, with a view to facilitating appropriateness and cost effectiveness of relevant health services within the constraints of what is affordable, through the use of rules-based and clinical programmes’.
A scheme may engage with a managed care provider to provide such services for a fixed fee based on the number of members. Other examples of capitation agreements relate to emergency services.
At first glance, some may say that these capitation agreements are reinsurance contracts held by the medical scheme. But are they?
IFRS 17 defines a reinsurance contract as insurance contracts issued by one entity (the reinsurer) to compensate another entity for claims arising from one or more insurance contracts issued by that other entity (underlying contracts).
The definition of a reinsurance contract is principles-based and not dependent on whether the issuer thereof is legally registered as a reinsurer or not.
Let’s backtrack: why is a medical scheme contract with its member considered to be an insurance contract? IFRS 17 defines a contract as an insurance contract if it transfers significant insurance risk. Insurance risk is significant if, and only if, an insured event could cause the issuer to pay additional amounts that are significant in any single scenario, excluding scenarios that have no commercial substance (that is, no discernible effect on the economics of the transaction).
A medical scheme accepts significant insurance risk from the member by agreeing to compensate the member should a specified uncertain event occur that adversely affects the member, for example by bearing certain of the medical or healthcare costs in the event that a member becomes ill. The costs that the medical scheme could be required to bear exceed the contributions payable by the member.
Back to capitation agreements. Two key questions need to be answered: (1) Do all capitation service providers bear significant insurance risk? and (2) Do all capitation agreements compensate the medical scheme for claims arising from its members? The simple answers are ‘possibly’ and ‘no’. The devil is in the detail.
Given that, by their nature, capitation agreements are fixed-fee service contracts, it is possible that the capitation service provider may be exposed to significant insurance risk because the number and extent of the services they are required to perform are unknown and their costs of fulfilment could exceed the fee payable by the medical scheme. However, this is not sufficient for the capitation agreements to be reinsurance contracts held by the medical scheme. The medical scheme must be compensated for claims arising from its members. The compensation does not have to simply be in the form of writing out a cheque to the medical scheme (similar to traditional reinsurance); it could take the form of actually providing healthcare and medical services that the medical aid has promised its members, for example ambulance transport.
However, if the capitation service provider simply arranges for a third party to provide the specified healthcare or medical services to the members of the medical scheme and does not bear the cost of those services, or it provides administrative-type services for the medical scheme, such as financial risk assessment of its healthcare programme, then it is not compensating the medical scheme for claims from its members. Such capitation agreements would not be reinsurance contracts under IFRS 17. They are contracts for services received by the medical scheme.
Based on what has been observed in the medical scheme industry in relation to the implementation of IFRS 17, it is imperative that medical schemes correctly classify their capitation agreements.
Let’s look at two examples to help us better understand whether the medical scheme has reinsurance contracts that it holds. It is important to note that in both examples, the capitation agreement does not absolve the scheme’s promise to its members to provide said services.
Example 1
Medical scheme A enters into a capitation agreement with MRI for it to manage the provision of emergency services to A’s members in return for a fixed fee per month based on the number of members covered by this benefit option. MRI does not provide the emergency services or bear the cost thereof. It simply arranges for third-party service providers to provide the emergency services as and when required, and A remains liable to pay the third-party service providers.
In this case, is this arrangement a reinsurance contract held by A?
No. This is because MRI is only engaged to manage the provision of emergency services and not to provide the actual services or to bear the cost thereof. Therefore, MRI does not compensate A in any way for the insurance risks borne by A in respect of the claims arising under A’s contracts with its members.
Example 2
Let’s contrast this with example 2.
Medical scheme B promises its members that they will receive the following benefits if required as part of their medical aid plan:
- Remote medical advice and information
- Emergency medical response to the scene of a medical emergency
- Medical transportation to hospital
- In-hospital transfer
In turn, B enters into a capitation agreement with FARE 911 to manage and provide these services to its members for a fixed fee per month based on the number of members covered by this benefit option.
In this case, is the arrangement with FARE 911 a reinsurance contract held by B?
The answer is yes. FARE 911 is required to provide the actual emergency services to the members of B and it takes on the risk that its costs of doing so, exceed the fee paid to it by B. Thus, FARE 911 is exposed to significant insurance risk. Furthermore, since ultimately B remains responsible to its members for the provision of the emergency services, by being able to require FARE 911 to provide the services to its members, B is being compensated by FARE 911 for such claims by members.
Remember to always delve into the detail of such contracts to determine if IFRS 17 is applicable or not.
AUTHOR
Suvanna Pitamber, Senior IFRS Technical Manager, BDO South Africa
