South Africa: To Be Or Not To Be ... A Risk Transfer Arrangement

IFRS 4 provides guidance on whether medical schemes should assess capitation agreements as risk transfer arrangements or not.

When medical schemes enter into capitation agreements with, for example an ambulance, eye-care or dental service provider, these service providers agree to deliver these services to the members of the medical scheme for a fixed fee per member.  For accounting purposes, the question is: Should these arrangements be accounted for as risk transfer arrangements?

Definition of risk transfer arrangement

A risk transfer arrangement is a reinsurance contract as defined in IFRS 4 Insurance Contracts (IFRS 4)¹. This is a contractual arrangement in terms of which a third-party undertakes to compensate a medical scheme for all or a significant part of the loss that the medical scheme may suffer as a result of carrying on the business of a medical scheme. Risk transfer arrangements do not reduce a medical scheme's primary obligations to its members and their dependents, but the arrangements only decrease the loss the medical scheme may suffer as a result of the carrying on of the business of a medical scheme².

It should be considered if significant insurance risk has been transferred from the medical scheme to the service provider in terms of the capitation agreements.

Consideration of insurance risk transferred in terms of risk transfer arrangement

A medical scheme is in the business of issuing medical scheme insurance contracts to its members in terms of which healthcare benefits are provided. A medical scheme will suffer a loss when settling healthcare claims of its members. The purpose of the risk transfer arrangement is to compensate the medical scheme for all or a significant part of these losses suffered.

A medical scheme should account for capitation arrangements as risk transfer arrangements, if these arrangements meet the definition of insurance contracts³. For these arrangements to be insurance contracts, significant insurance risk⁴ should have been transferred from the medical scheme to the service provider as the service provider agrees to compensate the medical scheme for losses it will suffer in terms of the medical scheme insurance contracts.

IFRS 4 does not provide explicit quantitative guidance on what will constitute 'significant'. It describes insurance risk as significant only if an insured event could cause an insurer to pay significant additional benefits in any scenario excluding scenarios lacking commercial substance.

Whether insurance risk is significant will require judgment. Therefore, to account for the capitation arrangements as risk transfer arrangements, the medical scheme should be able to demonstrate that significant insurance risk has been transferred from the medical scheme to the service provider.

We recommend that on date of inception of each of the capitation arrangements, the medical scheme should do a comparison between:

• Claims expected to be incurred by the scheme before this arrangement (estimated claims)
  For example for a dental capitation agreement, the estimated dental claims of the members for the year
  and
• The amounts expected to be recovered from the service provider for the estimated claims (expected recoveries)
  For example for a dental capitation agreement, the estimated recoveries expected for the estimated dental claims of the members for the year.

We recommend that the amount of the capitation fee payable by the medical scheme to the service provider also be considered. If the expected recoveries from the service provider do not exceed the capitation fee it is doubtful that significant insurance risk has been transferred to the service provider.

Presentation of risk transfer arrangement

"An insurer shall not offset:

• reinsurance assets against related insurance liabilities; or
• income or expenses from reinsurance contracts against the expense or income from related insurance contracts.⁵"

Based on the above, medical schemes should show amounts receivable from the service provider separately from healthcare insurance liabilities to members. In addition in the statement of comprehensive income, claims of members should be presented separately from recoveries in terms of risk transfer arrangements.

The amount of the claims from members to be presented in the statement of comprehensive income which is recovered in terms of a risk transfer arrangement has to be determined.

Appendix III of the SAICA Medical Schemes Accounting Guide for the year-end 31 December 2013 provides an illustrative example of the accounting for a capitation agreement which is a risk transfer arrangement⁶. The illustrative example states that the amount to be disclosed as the benefit (i.e.: the claims in the statement of comprehensive income) is the amount that the medical scheme would have had to incur had there been no capitation agreement in place. We understand that the actual amount that the medical scheme would have incurred had there been no risk transfer arrangement in place is calculated based on the scheme rules (for example 100% or 200% of scheme tariff).

Footnotes

1 A reinsurance contract is defined in IFRS 4 as "an insurance contract issued by one insurer (the reinsurer) to compensate another insurer (the cedant) for losses on one or more contracts issued by the cedant" (IFRS 4 Appendix A).
2 SAICA Medical Schemes Accounting Guide for the year end 31 December 2013: Definitions used in the guide (p18).
3 IFRS 4 defines an insurance contract as "a contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (insured event) adversely affects the policyholder" (IFRS 4 Appendix A). 
4 IFRS 4 describes insurance risk as significant only if an insured event could cause an insurer to pay significant additional benefits in any scenario excluding scenarios lacking commercial substance (i.e. having no discernible effect on the economics of the transaction) (IFRS 4.B23). The additional benefits refer to amounts that exceed those that would be payable if no insured event occurred (excluding scenarios that lack commercial substance) (IFRS 4.B24).
5 IFRS 4.14(d)
6 Appendix III, example 2 (p75)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.