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Vhi - developing a healthy investment strategy Back  
Willie Shannon explains how Vhi Healthcare arrived at an appropriate investment strategy.
Vhi Healthcare is the largest private medical insurer in the country insuring almost 1.6 million people. Set up as a statutory body in 1957 its key corporate objective is to provide private medical insurance at a reasonable cost to as many people as possible. The fact that almost 45 per cent of the population has private medical insurance on a voluntary basis, a penetration level which is far higher than in any other country in the world, is evidence of Vhi Healthcare’s success.

The medical insurance system in Ireland is almost unique in the world in that it is community rated. This means the same premium must be charged to all subscribers irrespective of age or medical history. From its inception Vhi Healthcare has always had an enormous commitment to customer service. Evidence of this commitment to constantly improving standards can be seen in the following awards achieved in the last six months.
• Contact Centre and Contact Centre Manager of the year, won in the face of intense competition from companies such as the major banks.
• Mark of Excellence award. Vhi Healthcare is the first organisation in the Republic of Ireland to be awarded this, an EU recognised quality award, which is significantly more demanding than the Q Mark.

Risk equalisation

The major issues facing Vhi Healthcare relate to the absence of risk equalisation and commercial freedom. As noted above Ireland has a community rated system which requires an insurer to charge all subscribers the same premium for the same cover irrespective of age. In essence the younger members of the population subsidise the older, higher-claiming, members. As these younger members grow older and make higher claims they are in turn subsidised by new younger members coming through.

A risk equalisation scheme is an essential component of community rating. Its purpose is to equitably neutralise the differences in health insurers’ costs that arise due to variations in risk profiles without penalising the more efficient insurer. This matter was comprehensively considered in a 1999 Government White Paper, on Private Health Insurance.

The White Paper concluded that without risk equalisation, each health insurer would have a strong incentive to target low-risk individuals (preferred risk selection) so as to be able to charge a lower community rate (or take a higher profit margin) than its competitors.

Even with compulsory open enrolment, health insurers could seek to achieve a better risk profile by, for example, selective marketing techniques, targeting group occupational schemes, benefit design, or selective quality of service. Although insurers may not deliberately set out to attract healthier than average individuals, this could still arise because it is these individuals who tend to be more willing to consider moving between insurers. Any process, whether deliberate or accidental, which gives rise to significant differences in risk profiles between insurers is known as risk selection.

If risk selection arises, it would be expected that per capita claims costs would spiral for those insurers who are left with a higher proportion of less healthy individuals. This, in a community rated environment, would lead to significant market instability and erosion of public confidence.

The current status is that all the political parties are agreed that a Risk Equalisation scheme should be introduced, the EU are also in favour and it is simply a case of putting it on the Statute Book. The need for a risk equalisation scheme is also supported by the Irish Society of Actuaries, and numerous other independent bodies.

Commercial freedom

Vhi Healthcare is currently very restricted in terms of what it can and cannot do. For example, Vhi must obtain the specific consent of the Minister for Health and Children for any amendments to its existing schemes or for new schemes, which it may wish to operate. Even more significantly legislative change is required to allow Vhi to expand its product range into other areas such as travel insurance, critical illness etc. The conclusion of the 1999 White Paper was that ‘the Government consider that the most appropriate course of action would be to provide Vhi with the same freedom as its current and potential competitors in the areas of product development and pricing’.

The fact that Vhi Healthcare is still awaiting this amending legislation is clear evidence of how long the formal process of amending legislation can take. This is putting the organisation at a clear disadvantage to its competitor.

Investment strategy - basic principles

Vhi Healthcare’s operations gives rise to funds which are held in reserve in order to meet the emerging insurance liabilities which together with funds internally generated can be invested to form an important source of income.

The largest liabilities in Vhi’s balance sheet are unearned premiums and outstanding claims. Due to the nature of the business written, these liabilities are short tail and would be expected to be largely paid within 18 months of the balance sheet date. The liabilities are all denominated in euro.

At any time Vhi is likely to have in excess of ?400 million under management and clearly the goal is to maximise the return so as to achieve savings for the members.

Investment strategy - key considerations

Solvency position: Traditionally Vhi Healthcare, as a statutory body has operated at very low margins of profitability which has resulted in its solvency margins being below what would be considered as acceptable for a normal insurance company. The solvency ratio is expressed as a percentage and is calculated by dividing the free assets by gross premiums written. At 28 February 2002, Vhi’s solvency ratio was 30.5 per cent whereas the accepted norm for insurance companies is 40 per cent.

In developing an investment strategy Vhi was conscious that because of its thin reserves, the strategy should not expose the organisation to material risk of falls in investment values.

Investment guidelines

Vhi decided to devise a set of investment guidelines to set out parameters for each of its three investment managers. The purpose of the guidelines is to restrict the level of risk on the investment portfolio to an acceptable level whilst giving the fund manager as much flexibility as possible.

• Fund duration to be for a maximum of three years.
• Only issues of credit rating A and above to be used for non Government issues
• Where the credit rating of a holding is downgraded below the minimum it must be sold within three months

The fund managers are required to report on a monthly basis in a format determined by the guidelines and meetings take place on a quarterly basis to review their performance.

Benchmark performance

The fund managers have been set a performance benchmark over and above what Vhi could expect to achieve itself and it is fair to say that the investment managers have exceeded their targets in all cases. Of course having three different managers helps stir the competitive juices!

The main consideration when deciding on investment guidelines is the degree of risk that is acceptable. Once this is done, appropriate investment guidelines can be determined. Vhi Healthcare has been fortunate in that in the past year or so Government bonds and short-term fixed rate investments have been the place to be but more importantly the risk profile is acceptable and in keeping with the objectives and strategy of the business.

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