CH 22 (WM) Flashcards
Describe the risk of selection against the insurer w.r.t. health options. [1]
An excess of lives in poor health using the options to obtain large amounts of long-term insurance✓✓ at premium rates that are insufficient to cover the expected mortality / morbidity✓✓.
Why does restricting the points of time at which the option can be exercised reduce the risk of anti-selection? [0.75]
The policyholder cannot then immediately exercise the option on discovering that he is a poor risk✓✓, eg when he has just discovered that he has extremely high blood pressure✓.
Provide examples of health options which are common for long-term insurance policies. [3.25]
to purchase additional assurance✓ without providing further evidence of health✓ at the normal premium rates✓ (for a life of that particular age)✓ at the date on which the option is exercised✓
to renew a long-term insurance policy✓, eg a term critical illness insurance✓ at the end of its original term✓ without providing additional evidence of health✓
to reinstate mortality cover✓ after an accelerated critical illness plan✓ has paid out on a specified disease event✓ (buy-back option)✓.
Describe how the terms and conditions for the exercise of the option could be designed to reduce the risk of selection against the insurer. [3]
The terms and conditions under which the option can be exercised should be clearly set out in the original policy.✓✓
Sometimes an option can only be exercised at fixed points of time✓✓, eg at the end of every five years of a twenty-year term insurance✓✓.
or at any time providing a qualifying event has occurred✓✓, eg the birth of a child✓, taking up a new job at a higher salary✓.
The extent of the option will also be specified✓, eg the additional sum insured cannot exceed the original sum insured✓✓.
The cost of options
The cost of an option is the value of the excess of the premium that should, in the light of full underwriting information, have been charged for the additional insurance over the normal premium rate that is charged. option will have no cost.
People who satisfy the underwriting criteria (or would do, if they were subjected to them) are referred to as select lives (as described in Subject CT5).
If a life who is in good health and who would be expected to satisfy normal underwriting requirements exercises the option, the option will generate little additional cost. The exercise of the option by lives in poor health will generate considerable additional costs.
So the exercise of an option by a currently “select” life incurs the company in little extra cost.
The total expected additional costs of an option depend on the health status of those that choose to exercise the option, and the proportion of lives that choose to exercise the option.
In general, the smaller the proportion that exercises the option, the worse will be the subsequent mortality / morbidity experience of those exercising the option. If a substantial proportion exercises the option, then their subsequent mortality / morbidity experience will on average be less extreme.
The cost of a health option is (roughly speaking) the product:
proportion of lives exercising option average extent that health of lives exercising option is worse than
F101-22: Pricing (4) – Options and guarantees Page 5
Some factors affecting health options are: ●
The term of the policy with the option. The longer the term, the longer the policyholder will have the option, and the more likely it is that, at some time, his/her health will deteriorate, thus making the option appear worthwhile.
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The number of times the policyholder gets the chance to exercise the option. For example, this may be every five years, on every policy anniversary or at any time whatsoever.
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Conditions attaching to exercising the option. For example, this might be limiting the size of the option or restricting the choice of contracts available under the option.
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The encouragement given to policyholders to exercise the option. As discussed in the tuition material, if take up of the option is low it tends to be only those who have most to gain who exercise the option. As explained in Question 22.3(i) above, this can be a good thing, as it could keep the total cost of the option low.
On the other hand, encouraging more of the healthy lives to exercise the option will not cause any additional expected loss, and should contribute to the company’s total profit as the company will essentially be issuing lots of new policies to lots of good risks, which should be a profitable proposition.
Publicising the option more widely can achieve greater take up by healthy lives, but care should be taken that the benefit (from future profits) is not outweighed by the risk of attracting a bigger proportion of the loss-making high risk lives from taking up the option as well.
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The extra cost to the policyholder who exercises the option. If the option involves a steep increase in premiums, then the healthier lives might shop around to try to get the same cover cheaper elsewhere. This means that the company will lose out on the potential profit that these policyholders would have generated.
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Selective withdrawals. A healthy life may cancel a ten-year renewable term insurance policy after two years because he or she discovers that the cover without options is much cheaper. The company has not in this case collected the option loading from this person for very long, but is still left with the unhealthy lives who are more likely to exercise the option to the cost of the company.
