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Press Release 13 of 2022: The collapse of Health Squared Medical Scheme

On 18 August 2022 Health Squared Medical Scheme served the Registrar of the Council for Medical Schemes (CMS)  with an urgent electronic court application seeking leave of the High Court (South Gauteng) for voluntary liquidation. On the same day, Health Squared addressed a letter to its members notifying them of the same court application. Health Squared’s application for leave to voluntarily liquidate was to be heard on 30 September 2022. Subject to the leave of voluntary liquidation being granted, the actual application for liquidation was to be heard on 20 September 2022. Health Squared also stated in the notice to members that from 1 September 2022 it will no longer be doing the business of medical a scheme.

Health Squared stated that the primary reason for applying for leave to voluntarily liquidate was its financial deterioration caused by the 2020 and 2021 high COVID-19 claims. In addition to this, Health Squared stated that it experienced substantial member loss which led to a solvency decline which by the end of July 2022 was at 2.15% and was projected to be between 0.2% and 2.3% by the end of the year.

Health Squared was formed by a merger between Spectramed Medical Scheme (Spectramed) and Resolution Health Medical Scheme (Resolution). At the time of the merger, both medical schemes could be described as failing entities. Spectramed had been consistently losing young and healthy members, with a total principal membership of 10 317 by the end of September 2018, a pensioner ratio of 29.6, a rate of chronic beneficiaries at 43.8%, average age of 50.2 years and a solvency ratio of 20.4%.

On the other hand, Resolution had also been experiencing substantial member losses, with its total principal membership standing at 13 845 by the end of 30 September 2018, a pensioner ratio of 17.8%, the rate of chronic beneficiaries at 27.0%, average age of beneficiaries at 42.6 years and a solvency ratio of 15.2%.

The schemes’ Exposition document extolled the virtues of the merger in that it was projected to create a more significant risk pool which would reduce claims volatility and provide an opportunity to restructure their benefits. Resolution was expected to benefit from Spectramed’s younger age profile, and Spectramed was expected to benefit from Resolution’s higher solvency ratio. The merger was projected to provide the merged scheme with countervailing powers, and the merger was projected to save the merged scheme R30.6 million in 2019. The schemes noted that given the prevailing market conditions it would be difficult for each of them to attain significant growth separately. However, they contended that a merged scheme stood a better chance in organic and inorganic growth.

To fully understand how Health Squared ended up where it is today, one also must understand the basic principles of how medical schemes operate. Medical schemes work on the basis of the following principles; open enrolment, which means unlike insurance companies, medical schemes cannot reject an application for members based on risk, for instance, community rating, which means that members belonging to the same benefit option pay the same monthly contributions regardless of their health status and social solidarity which means that young and healthy members tend to claim less and therefore subsidise the old and sickly members who tend to claim more. The basis for this is that when the young and healthy become old, they will also be subsidised by the young and healthy. That is why waiting periods are imposed on people who join medical schemes when they are old and when they are sick if they have not contributed to the medical scheme risk pool. For cross-subsidisation to work and for the medical scheme to be financially stable, the number of young and healthy members must always exceed the number of old and sickly members.

After assessing the Exposition document, the CMS was concerned that unless the merged Scheme manages to attract substantial young and healthy members or a merging partner with a good healthy profile, it will not survive long, and under these circumstances, a merger could just be delaying the inevitable. CMS approved the merger with certain directives which included that: the merged Scheme must submit a business plan on how it will consolidate some of its options, the merged Scheme must submit a business plan in terms of Regulation 29. The merged Scheme was directed to curb its non-health expenditure to an average of R200.00 per beneficiary per month (pbpm), instead of just re-negotiating its contracts for administration, managed care, marketing and distribution services and the procurement of services must be subjected to a competitive tender process. All these services were rendered by Agility Health (Pty) Ltd and Agility Chanel (Pty) Ltd.

One of the first acts of the merged Scheme, Health Squared was to appeal against these very directives which were imposed to ensure its longevity and to protect the interest of members not because the directives were unreasonable or not in the interest of members but because Health Squared argued that these were conditions which the Registrar does not have the power to impose. If these directives were in the interest of members, and Health Squared saw it fit to challenge the directives then one must wonder, in whose interest the trustees of Health Squared were acting?

Health Squared’s business plans submitted in terms of Regulation 29, which were intended to turn around the Scheme were consistently not adhered to, in that the solvency projections were never met, and budgets were exceeded. In November 2020 CMS cautioned Health Squared for non-compliance with the approved 2020 business plan because the marketing fees exceeded the R11.9 million budget by R20.3 million, the NHE budget was exceeded by R15.1 million, and the administration fee of R200 pabpm budget was exceeded by R89 in October 2020, four months before the end of the year.

In November 2021 the Registrar wrote to Health Squared asking that the Scheme agrees to the appointment of a statutory manager in terms of section 5A. of the Financial Institutions (Protection of Funds) Act 28 of 2000 (FI Act). Health Squared responded in December 2021 agreeing to the appointment of a statutory manager and providing a list of three candidates from which the Registrar could select one person for appointment. Of course, there was no way the Registrar could agree to the provided list because even though the law requires agreement between the Scheme and the Registrar for the appointment of a statutory manager, the responsibility to appoint rests with the Registrar who is a public servant and with this comes many responsibilities including PFMA accountability. But also, working on the list provided by Health Squared would have raised questions of the independence and objectivity of the appointed person. Even though it was not spelled out in Health Squared’s agreement to appoint a statutory manager it was clear that Health Squared wanted to be in control of the process, by ensuring that someone it could trust is appointed to the position of statutory manager.

The procurement of a statutory Manager via the request for quotations (RFQ) issued by the CMS faced several challenges, including no response, insufficient responses & failure to meet the prequalification criterion. In addition, National Treasury issued directives to all state entities to suspend procurement above R30 000 following a Constitutional Court ruling on Preferential Procurement Policy Framework Act (“PPPFA”). By the time the procurement process was concluded and a name was presented to Health Squared, Health Squared rejected the appointment because it was too late and the statutory manager would not serve any purpose. This was factually and legally incorrect because at the time the Scheme agreed with the Registrar on the need for a statutory manager in December 2021, Health Squared had solvency standing at 5.57% compared to 5.03% according to its May 2022 management accounts. However, it was picked up that the June 2022 actuarial report attached to the Scheme’s submission confirmed a 3% solvency ratio. The Scheme was asked to clarify the discrepancy, but it has never done so to date.

In the FI Act a statutory manager must be allowed full access to all accounting records, financial statements, and other medical scheme records. Within three months of the appointment, a statutory manager must report to the Registrar, informing him what steps could be taken to turn the medical scheme around. If the statutory manager believes that the medical scheme cannot be turned around, he must inform the Registrar if a merger will be a suitable solution, or if the medical scheme must be placed under curatorship or liquidated. Against this background, Health Squared’s view that it was too late to appoint a statutory manager could not hold water.

Having rejected the appointment of a statutory manager, we now know, based on the preliminary report and the evidence obtained by the Curator, Mr Joe Seoloane, that the Board of Health Squared and its consultants knew that the most logical step for the Registrar to take would be to apply to place the scheme under curatorship. A plan was devised to outmanoeuvre the Registrar by bringing an urgent application for leave to liquidate the scheme voluntarily. Having denied the Registrar an opportunity to appoint a statutory manager, it was thought that the Registrar would have no ground to oppose the application because he has no actuarial report.

Even though no name was put forward for who will be the liquidator, evidence obtained by the statutory manager shows that a character close to one of the consultants and close to the process was put forward and agreed to by the Board. The Board and its consultants estimated that the liquidation would cost about R100 000 000 and devised a plan to ensure that the liquidation plan goes accordingly. The plan involved making sure that Agility’s invoices are settled in advance so that when the liquidation process starts, Agility will not be a large creditor and, therefore cannot scupper the liquidation plan, including the choice of the liquidator. The plan also involved one of the consultants submitting two invoices, but only one of the invoices was to be paid so that they could remain a creditor to the scheme and ensure that the liquidation goes according to plan. The lawyers were authorised in advance to challenge anything and everything that stood in the way of the liquidation plan.

The Registrar successfully brought an application for Health Squared to be placed under provisional curatorship pending the liquidation application. On 8 September 2022, Health Squared was placed under provisional curatorship. The order of provisional curatorship had a return date of 20 September 2022, in which anyone opposed to it could argue their case, and the judge would either confirm curatorship or discharge it. The Scheme had already been granted leave to apply for liquidation, and its application for liquidation was to be heard on 27 September 2022.

From 9 September 2022, the Curator attended to his duties and managed to take over the bank account of Health Squared and its management with no opposition. On 15 September 2022, Health Squared’s lawyer, purportedly acting on the mandate of the Board, which was provided to him before Health Squared was placed under provisional curatorship, approached both the Curator and the Registrar, asking that the return date on provisional curatorship be postponed to the 27 September 2022 to be heard together with the liquidation application. This request was rejected as out of hand firstly because the scheme had a provisional Curator meant that he had replaced the Board, and the lawyer in question could not act without the Curator’s authority. But secondly, the request for a postponement was a legal ploy to avoid confirmation of the Curatorship, which would ensure that the lawyer and the Board are taken out of the liquidation application. But if the two applications were heard on the same day, the lawyer and the Board continued involvement with their liquidation plan would be guaranteed.

Realising that the game was up, the lawyer filed a notice to appeal against an interim ruling to place Health Squared under curatorship as a last-ditch effort to suspend the curatorship and delay its hearing that in the meantime, the liquidation application will go ahead as planned. Even though the terms of office of the trustees the lawyer purports to represent ended in September 2022, the allure of self-interest still made the fight worthwhile for them.

Many members of Health Squared complained that they were not given sufficient notice to find an alternative scheme. In terms of the law, the Scheme only had to provide the Registrar with a 15-day notice but does not state how much notice the members should be given. However, Health Squared rule 27 provides that members must be balloted before a decision to liquidate the Scheme is taken, but this was ignored even though scheme rules are legally binding. Instead of convening an AGM in June or before the end of June, the Board postponed the AGM to August and September to ensure that the Scheme is liquidated before the AGM and avoid accountability to members.

What has become clear is that the short notice to members was driven by the need to outmanoeuvre the Registrar and nothing else. The Registrar was then left with no option but to try and intervene to ensure that former members of Health Squared could move to alternative medical schemes without having to deal with waiting periods. What must be noted here is that other medical schemes are entitled by law to impose waiting periods to protect their financial stability. However, the Registrar was appealing to them on humanitarian grounds and where not imposing waiting periods would not place their financial stability in a precarious position.

Seven medical schemes were selected to participate in the negotiations because they had over 100 000 members and their solvency and pensioner ratios were in good condition. It was later discovered that some of the members of Health Squared were civil servants, and GEMS was also included in the negotiations so that it could take over the civil servant members. For the negotiations to succeed, the medical schemes needed to know the exact number of members still at Health Squared and their risk profile. To this end, the seven Schemes agreed in principle that during the negotiations, they will desist from actively seeking to take over Health Squared’s membership outside this process.

The CMS issued a press release encouraging members to wait for the negotiations’ outcome. The negotiations eventually failed because it was discovered that despite the principle agreement by the medical schemes, some of them were working with their brokers (including Health Squared itself) to take over the good risk from Health Squared such that the exact number of members left a Health Squared and risk could not be determined. Despite this, some schemes were willing to accommodate Health Squared members, and some even made concessions that they would give the first 500 members admission without waiting periods. The names of the medical schemes that made these concessions were not publicly announced because the concessions did not exclude the applications already in their systems and naming the schemes would have resulted in large volumes of applications to those schemes, which, based on the open enrolment principle, they could not turn these applications down.

It was determined that if one scheme had a high volume of applications even if taken with waiting periods, such a scheme would not survive long as the sudden growth and utilisation would adversely impact its sustainability. In the meantime, Health Squared is under the control of a Curator. The CMS did not seek the appointment of a curator because he believed the Scheme could be turned around but because there was a need to ensure that members of Health Squared who were still struggling to move to different schemes were assisted to do so and that those who still needed cover also in line with the High Court ruling were assisted. This has, however, been made difficult by the announcement of the scheme that from 1 September 2022, it will stop doing the business of a medical scheme. As a result of this, most members reversed their monthly contributions, including those who were paying in arrears and thereby depriving the scheme of much-needed resources.

The Curator also commissioned an actuarial report to determine how Health Squared ended in its position.  Contrary to Health Square’s assertions that the primary cause of its insolvency was the high COVID-19 claims, the actuarial report found that COVID-19 claims had “close to zero effect” on the scheme’s drop in solvency. The actuarial report found that comparatively, Health Squared benefit options were highly overpriced when compared with other medical schemes but they were under-priced when looking at the profile and utilisation rates of its members.  This was so because the claims ratio of the old and sickly members far exceeded the number of the young and healthy members. The actuarial report found that since the merger, Health Squared has been losing a substantial number of members with no net gains.

Health Squared was clearly inefficient. It is trite that in a competitive market less efficient firms will fail. The responsibility of the CMS is not to protect medical schemes from failing, but to ensure that even in the state of failure the interest of members is protected. These include ensuring that members are assisted to join other medical schemes and that as they do so they are admitted and treated in line with the law and ensuring that the assets of Health Squared are disposed of in terms of the applicable law.

The Curator’s own preliminary report echoed the findings of the actuarial report and went further to point out that there were governance issues that warrant further investigation. The Curator pointed out that Health Squared has since 2019 paid about R90 million to Agility for marketing services, even though the scheme failed not only to gain membership but failed to retain its membership and lost about 30% of members between December 2019 and August 2022.

The Curator found no evidence that the scheme has ever imposed any penalties on Agility for failure to grow the scheme or to maintain its membership. The Curator also found that despite the dire financial position in which the Scheme was, the BoT never considered any austerity measures to mitigate the impending catastrophe. In this regard, the Curator indicates that the Chairperson of the BoT inserted himself in committees where he was not required and drew fees for it.

At no point did the BoT decide to review its own remuneration fees. Instead, the BoT decided to stop holding its meeting in its offices and started holding meetings at the Maslow Hotel in Sandton. Presumably, this is where those board members who were flying in from different destinations were booked. One would think that for a scheme in dire financial straits would opt for virtual meetings as the most cost-effective.

The Curator also found that whilst the BoT and the Administrator, Agility would have enjoyed a close relationship prior to and post the merger, the wheels seem to have come off sometime during the early part of 2022. Apparently, this was caused by the tensions between Agility and the scheme’s own actuaries. The Curator also points out that this was worsened by Agility’s failure to sign up a mysterious employer group with about 3000 members that were promised to the Scheme without details of who the alleged employer was. According to the five-year agreement between Health Squared and Agility, Agility was supposed to sign up 2000 new principal members each year. The undertaking made in the merger Exposition documents, that Agility will be penalised for the reduction in membership, never materialised and in fact, it was not made part of the agreement. The Agreement makes provisions for termination based on non-compliance, but this was never done until it was clear that the scheme was dead and there was no point to continue paying for marketing services.

The CMS has learnt some lessons from Health Squared’s failure that still plays out in court. CMS is often criticised for being heavy-handed or too soft when dealing with alleged irregularities committed in medical schemes.  Health Squared was the first medical scheme to be requested to agree to the appointment of a statutory manager because Section 5A of the FI Act is fairly a new provision. Since then, two more schemes have been asked to agree to the appointment of a statutory manager with one agreeing and the other resisting. Board of Trustees (BoT) are generally very resistant to regulatory intervention and tend to be litigious. As such, the CMS often faces resistance and pushback even in simple circumstances where a directive is issued requiring the Board to change or put in place a simple governance measure. If that directive is based on a finding that the BoT has failed to do something or has acted irregularly, resistance is always almost guaranteed.

When the regulator is faced with a BoT that is resisting all its attempts to protect the interest of members, it is never too early to intervene decisively. The regulator must streamline its procurement processes to ensure that timely regulatory interventions are not slowed down by procurement processes. Schemes that are approved for mergers will be placed under serious close monitoring based on their financial health and member risk profile until the regulator has satisfied itself that the entity can operate independently. Where a merger of two failing schemes will not result in an immediate improvement and compliant solvency ratio it will be difficult to approve such a merger.

Health Squared’s merger Exposition document like all merger exposition documents was prepared by independent actuaries for both the respective schemes. This should also be a lesson to professionals that assist medical schemes in preparing and submitting regulatory documents to be more realistic and honest when doing so because where the Regulator is supposed to hold them accountable, the Regulator will do so. The Regulator has in the past reported an auditor to IRBA and refused him further approval to audit medical schemes because he was found to have assisted the erstwhile Community Medical Aid Schemes (COMMED) to cover up its true financial position.

Lastly, members of medical schemes must start taking a keen interest in the affairs of their medical schemes. The Regulator has over the years noticed that medical schemes members do not attend the Annual General Meetings (AGM). Even medical schemes with over 100 000 members and a mere 30 members quorum for an AGM struggle to reach a quorum in their AGMs. Members also have a role in holding trustees accountable but if members do not partake in scheme events, they miss these important opportunities. Members must not wait until there are sick or until they have a dispute with a scheme to start showing interest in the affairs of the scheme. CMS’ budget at R194 million is very minuscule compared to the R105 billion worth of industry it regulates. It, therefore, stands to reason that for the CMS to function optimally all the stakeholders must play their role in ensuring that the affairs of medical schemes are run properly and in line with the law.

Download the Press Release here.


Issued by:

Mr Zongezile Baloyi

Executive: Corporate Services

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