The futures look bright.

• Author: Ray, Russ
• Position: Health Care

If your company is considering taking the self-insurance route to control healthcare costs, maybe you should investigate health insurance futures contracts. Some say the new hedging tool defies Murphy's law, because you just can't lose.

Health insurance futures contracts, a powerful new hedging tool soon to be released by the Chicago Board of Trade, may help companies freeze previously uncontrollable health-care costs. This innovative technique can benefit any organization, regardless of how fast and unexpectedly its costs and claims are rising. It may be especially useful for companies interested in self-insuring but afraid of health-care cost volatility.

Here's how it works: The Chicago Board of Trade has created an index that tracks how fast national health-care costs are rising and at what rate medical services are used. A representative sample of 10 major health insurers supplies information to the CBOT on the number of insureds, premiums collected, claims paid and so on. The policies reflect similar group sizes, covered benefits and deductible and coinsurance levels.

The CBOT's insurance pool manager analyzes the submitted information and assembles an index reflecting the pool's aggregate policy characteristics. The CBOT updates the index every January and July, and futures contracts are then bought and sold accordingly. Futures contracts based on January information will expire in the following June, September, December and March, while contracts based on July information will expire in the following December, March, June and September.

The index reflects claims paid per $100,000 of premiums collected. Specifically, the index's value at the end of each quarter will reflect claims incurred during the previous quarter that are paid by the end of the current quarter. For example, the value of the June index at the end of June (called the June "settlement" price or closing price) will be, for each $100,000 in premiums, the claims filed between January 1 and March 31 and paid between January 1 and June 30. Thus, if $65 million in claims were paid out for $100 million of premiums in force from the pool, the "settlement" or ending value of the June index would equal $65,000: ($65 million / $100 million) x ($100,000) = $65,000.

The settlement price of the June index, which is 65 here, is the loss ratio for January through March, with a runout through June. Health-care hedgers use the staggered indices (June, September, December and March) to...