The health care cost trend rates to be applied to the base period gross per capita claims costs represent the expected annual rates of change in the gross cost of the specific health care benefits provided under the plan. The health care cost trend rate assumption generally contains three components:
- The initial trend rate, which is used to project current per capita claims costs to the next year
- The ultimate rate, which is the rate at which health care cost trends will level off in some future year
- The number of years and pattern of change between the initial and ultimate rates
requires that these rates be developed using past and present health care cost trends, which would implicitly consider estimates of health care inflation, changes in health care utilization and delivery patterns, technological advances, and changes in the health status of plan participants. It also notes that different types of services, for example, hospital and dental care, may require different trend rates.
The initial trend rate assumption should reflect the employer's recent retiree-specific health care cost experience, adjusted as appropriate for expectations of next year's costs. The ultimate trend rate assumption should reflect long-term expectations of future general inflation, plus some additional amount to reflect that retiree health care costs are expected to continue to rise at a greater rate than general inflation. The ultimate rate is limited by the general expectation that health care spending will not continue to rise at current levels forever. The pattern of decline in inflation rates and the number of years between the initial and ultimate rates is generally the most subjective component of the health care cost trend rate assumption.
Developing future trend rates begins with an analysis of past years' actual experience. If estimates of the assumed per capita claims costs are made for various categories of health care services, for example, hospital care and dental care, separate trend rates would be developed for each such category. This historical analysis would typically be developed from the same source as the data used for developing the base period gross per capita claims cost discussed in PEB 126.96.36.199
. The extent of the historical periods necessary to develop an appropriate estimate is a matter of judgment. It is also important to consider any recent plan changes that may reduce the usefulness of historical data.
When historical data is not available, or is not considered reliable or indicative of the plan's expected experience, trend rates can be developed from per capita costs of other employers, adjusted to best reflect the terms of the employer's plan and the demographics of the participants.
Estimates of future health care trends should not rely on history alone. The analysis of past trends is supplemented by assumptions about the magnitude and direction of changes in future trend rates from present rates. In developing estimates of future trends, it is important that preliminary estimates be tested against general inflation and productivity estimates to ensure that health care remains logically correlated to other economic factors. This approach is similar to that used in developing projections of the Consumer Price Index.
The assumption about health care cost trend rates represents the expected annual rates of change in the cost of health care benefits currently provided by the postretirement benefit plan, due to factors other than changes in the demographics of the plan participants, for each year from the measurement date until the end of the period in which benefits are expected to be paid. Past and current health care cost trends shall be used in developing an employer's assumed health care cost trend rates, which implicitly consider estimates of health care inflation, changes in health care utilization or delivery patterns, technological advances, and changes in the health status of plan participants.
Differing services, such as hospital care and dental care, may require the use of different health care cost trend rates. It is appropriate for that assumption to reflect changes in health care cost trend rates over time. For example, the health care cost trend rates may be assumed to continue at the present level for the near term, or increase for a period of time, and then grade down over time to an estimated health care cost trend rate ultimately expected to prevail.
An assumption about changes in the health status of plan participants considers, for example, the probability that certain claims costs will be incurred based on expectations of future events, such as the likelihood that some retirees will incur claims requiring technology currently being developed or that historical claims experience for certain medical needs may be reduced as a result of participation in a wellness program.
As in any actuarial valuation, a number of alternative scenarios may need to be considered before the most probable assumptions are identified. These may vary by the length of time the near-term trend pattern is expected to continue and the timing and degree of the grading down to the ultimate trend rate. It may not be unrealistic to assume that, at some point, the trend rate would approach the forecasted general inflation rate.
In the periodic reporting of OPEB cost, the difference between actual versus estimated rates of change in per capita claims cost, and between actual versus expected benefit payments in the year just completed, will result in actuarial gains or losses, as discussed in PEB 3
. Accounting for these gains or losses is discussed at PEB 3.2.7
. In addition, the most recent trend rate experience should be considered in the development of the trend rate estimates to be used in measurement of the following period's OPEB cost and obligation.
Rates of increase in health care costs experienced in the past and estimated to occur in the future will vary from employer to employer, and even from plan to plan within each reporting entity, depending on a number of factors:
- Actual retiree health care inflation experienced in prior years
- Expected cost increases—e.g., premium increases on the part of the insurance carrier
- Type of health care coverage offered—traditional indemnity, health maintenance organization (HMO), or preferred provider organization (PPO)
- Specific categories of services covered—major medical or basic medical, prescription drugs, etc.
- Demographics of the covered group—age, gender, and geography
- Effectiveness of cost and utilization controls, such as contracts with specified providers, catastrophic case management, and hospital pre-admission reviews
- Regulatory changes that may affect the cost of providing health care (e.g., the Affordable Care Act)
Accordingly, and consistent with the base period per capita claims cost assumption, the health care cost trend rates assumption must be developed on a plan-specific basis.
As health care costs continue to rise, assumed health care cost trend rates have a significant impact on postretirement benefit obligations and the periodic expense related to those obligations. Employers should reevaluate the health care cost trends rates as part of each actuarial valuation to ensure they reflect the best available information as of the measurement date.