CLK_F102_Chapter_5 Flashcards
Definition of IP
IP provides a benefit in the form of regular income (temp annuity) that continues until insured has recovered, dies or the annuity term ends, whichever comes first.
Policy benefits chosen aim to replace usually 2/3 of the income if insured is unable to work due to illness or accident.
Simplicity vs Complexity
Concept of IP is simple and appealing but the Ts and Cs introduced to manage risk to insurer increases IP complexity. Some of the confusing issues:
Definition of incapacity and fitness to work not always open to objective assessment (policy document must state clearly circumstances under which benefit is payable and benefit will cease) - this makes IP unattractive and may hinder sales
Payouts not always linked to current salary
May be necessary to apply benefit limits
Underwriting can be complex (due to occupation and past medical history)
There may be exclusions
1.Who are the main customers for IP?
- What are their interests?
Individuals (particularly the self employed with no comfort of an employer-sponsored scheme)
Employers - would want to pass on financial responsibility of sick employees after a limited period of invalidity. There may also be a legal requirement to do this.
Small professional practices - Locum Protection Insurance - provides salary and other employment costs of a temporary replacement professional so that the practice can continue running. A short deferred period would be applicable.
2.
To be sold products that:
Meet their needs
Are clear in purpose (risk covered and benefits payable)
Have a charging structure they find attractive (options and guarantees)
Are affordable (premium levels)
What are the main needs addressed by IP?
Replacement income
When policyholder is unable to continue in his own occupation or any occupation and cannot earn an income
Own occupation benefit definition - chosen if policyholder is self employed and there are few opportunities for equally well-rewarding work eg self employed vet
Any occupation benefit definition - chosen if there are lots of opportunities for work in that field - this type of benefit definition is cheaper
Income stream
Designed to match the policyholder’s monthly loan servicing costs
To cover other insurance premiums - although most insurance policies have a waiver of premium to cover the peril of policyholder incapacity
Product features: What are the general policy conditions of IP? And what are the aims of policy conditions?
Policy conditions should clearly specify, in words understood by policyholder, what the insured events are (and vice versa)
Unclear policy conditions run the risk of being interpreted by courts or the regulator in favor of the policyholder in the case of claim disagreements
Aims of policy conditions:
Reflect the true intention of insurer
Provide cushion against adverse events over which insurer has no control
Be simple and unambiguous, to assist sales, underwriting and claims processes
- at sale stage policyholder should be able to determine if risks important to him are covered
- clear conditions will make it clear to prospective policyholder what data should be provided to ensure correct information is supplied. From insurer view it will mean accurate underwriting and from policyholder view it will mean a rapid underwriting decision
To reduce the number of non-qualifying claims (would increase insurer claim expenses and harm its reputation and hence sales)
Product features: Benefit definitions (What are the conditions relating to benefit amount that must be defined?)
Also see last slide for application of question
In general
Benefits must be attractive
Benefit limits must be set such that there is an incentive to return to work
Conditions:
Replacement ratios
Defined as the ratio of past claim income (net of income tax) to pre claim income (net of tax)
- ratio must be easy to calculate from available data, reflect the reduction in disposable income after incapacity
The higher the replacement ratio the lower the incentive to return to work and the worser the morbidity experience
Some evidence that people enjoy the social aspect of being employed but returning to work after a long illness is not easy. Why?
- going to work is a habit
- stressed that you won’t be able to perform your old job
- worried that work demands of old job may make you sick again
- embarrassment if you are given a less demanding role (loss of status)
Cost of claims due to reluctance to return to work can be reduced by including conditions in policy to encourage rehabilitation into workforce eg linked claims period and return to part time work
Over-insurance
Definition: higher than appropriate replacement ratio.
How does it arise:
- over insurance from onset
- subsequent over insurance, through salary not keeping up with benefits (eg benefits increase automatically while salary reduced)
- a reduction in the tax levied on IP claims of existing policyholders
- multiple policies or receipt of other non disclosed sources of income while sick
How does over insurance make it difficult for insurer to control claims?
Moral hazards - temptation of policyholder to make a fraudulent claim or exaggerate it. Eg
- policyholder may take sickness so that they continue getting benefit if benefit > current salary
- if already claiming there won’t be an incentive to return to work
How to avoid over insurance?
Use robust product design
- appropriate max benefit formula at point of sale (a max replacement ratio, stringent limitations for higher salaries in excess of specified limits, overall max benefit limit, reduction of other benefits received eg state benefits).
- quality training of those conducting sale, reducing incentive to over insure
- regular reviews to ensure benefit limits remain appropriate
- clear conditions highlighting likely actions at claim stage in event of over insurance
if above fails at claims stage insure can cut back on benefits that exceed the maximum benefit formula
Product features: Benefit definitions (What are the conditions relating to benefit amount that must be defined?)
Continued
Escalating benefits and premiums
- IP policies can be level, where benefit paid remains @ same level specified at outset of policy - does not increase in and out of claim
- nowadays increasing benefits are common
- it’s not prudent to have escalation rates that exceed the expected rates of earnings as these would increase the replacement ratio and hence over insurance
- greater escalation of premiums than benefits will result in protection again adverse trends in claims and high inflation
Proportionate or rehabilitation benefits
- IP may offer rehabilitation or proportional benefit to those who return to work part time or in a less strenuous and lower paid role
- this can benefit both insurer (as a return to work is encouraged) and policyholder (whose path to full recovery is hastened)
- some product offer cash to finance recuperation needs before policyholder returns to full employment eg support, advice, counselling making the product attractive, thus increasing sales
Waiver of premium
- IP will include a waiver of premium benefit when benefit is payable. This will be charged for by a small % of premium rate
Product features: Benefit definitions (What are the conditions relating to benefit timing that must be defined?)
Waiting period
- A period (usually 3 months) after commencement of a policy during which a claim will not be paid.
- feature not so common as it’s not appealing to pay premiums but not be entitled to claim. Initial underwriting is a more effective way of dealing with anti-selection
Deferred period
- period relating to the first few weeks of sickness where insurer will usually not pay benefits
- makes premiums more attractive (lower) and benefits match closely the needs of insured
- reasons for most contracts having non-zero deferred period
- to eliminate severe claims
- gives insurer time to implement rehab procedures
- to integrate employer supplied benefits and state benefits
- to reduce the cost of claims
- to reduce insurers admin costs
- to meet true customer needs. Policyholder would not want to put in a claim for a couple of days off with flu
- it’s now common practice for insured to notify insurer when they have been sick for a period less than the deferred period. Why:
- insurer will offer advice and rehabilitation services at an early stage. Early intervention may help to reduce or eliminate the claim at end of deferred period
- claims management process and insured gets free benefit in the form of advice service but insurer is hoping it’s more than paid for by claims costs being saved
- early intervention will also mean that when deferred period ends it will be in a position to perform a thorough claims assessment process and be in a position to pay a valid claim. This relieving the pressure to asses a claim quickly at end of deferred period.
Linked-claims period
- applies where a policy has no deferred period. Insured can return to work without fear of completing another deferred period if they fall sick shortly after returning to work.
Expiry age or term
- expiry age is the age at which the benefits cease and so often the same as the expected retirement age (as a pension is assumed to be the source of income after retirement)
Product features: claim definitions
Occupational definitions
The effect of occupation on price charged
- IP rates depend on policyholder’s occupation
- categorisation of occupations is related to the claims experience
- claims experience is related to no. Of sickness inceptions and length of periods of sickness
The effect of occupation on claim payment
Most definitions are occupational:
- inability to perform own occupation
- inability to perform own occupation and other suited occupation by education, status and training
- inability to perform own occupation for an initial period (eg 1st 2 years of claim), followed by inability to perform any occupation thereafter
- inability to perform any occupation
Expected claims cost is highest for own occupation definition and lowest for any occupation definition
However application of any occupation definition may be seen as unfair
Occupations that carry above average accident or health risk (eg mining) would usually only be offered cover on an any occupation definition since the costs of comprehensive cover would be too high and difficult to quantify. Why are insures usually reluctant to offer cover to such workers?
- risk of claim is high
- claims need to be paid longer as worker might need to be fully recovered before returning to work
- these features will mean if cover is offered premiums will be too high and unattractive to consumer
How would IP policy he modified so that the risk is acceptable to insurer and policy attractive to consumer?
- long deferred periods would reduce the risk for the insurer. Workers would however find this modification unattractive as employers usually offer short term sickness benefits and state benefits are inadequate
- changing occupation definition from own occupation to occupation to which insured is suited by education and training after 6 months of benefits would reduce/control this risk so that insured benefits are not paid for long
- offer short term sickness benefits with short deferred periods eg 60% of pre-sickness earnings for 12 months, then 40% for the next 12 months
Product features: claim definitions continued
Alternative incapacity criteria
Occupational claims definition may be unsuitable for those not in paid employment eg unemployed
Alternatives to occupational definition define claim event in terms of an inability to perform various test irrespective of occupation
These tests assess the impact of the disability on insured’s ability to perform tasks required by an occupation or that are required in day to day life
Examples of possible tests:
- activities of daily living (ADL)
- functional assessment tests (FAT)
- activities of daily working (ADW)
- personal capability assessment (PCA)
ADLs assess policyholder’s ability to perform a no of normal tasks everyday tasks and include: feeding, dressing, washing, toileting, mobility, transfer
A common requirement for benefit payment is failure if insured to perform maybe 3 of the above tasks unaided
advantages and disadvantages of PCA to occupation based criterion
Advantages
- PCA are precisely described so fewer disputes
- occupational definition are subject to interpretation as to which occupation the insured may be suited to
- PCA tests describe generic skills to be capable of work and so applicable to all occupations. Assessors don’t need to spend time getting familiar with different occupations.
- PCA test imply a measured level of incapacity and so unlikely to result in windfall claims
Disadvantages
- some people may not satisfy the PCA test to qualify for claim but may also struggle to find gainful employment. Such cases lead to marketing risk
- potential policyholders May see PCA test as irrelevant to the risks they face… had nothing to do with me being prevented from working by illness or accident
Product features: other policy conditIons
Additional conditions on policy wording could exist such as:
A clause to notify insurer if there is a change of residence or change in occupation
Occupational changes
- some policies require that policyholder informs insurer of occupational change with the intention to modify the premium, although current practice does not require such notification
Residence and location
- place of residence might not be used as a rating factor due to marketing and other considerations
- however it will be used in determining prices if there is evidence that claim costs vary by place if residence
- with the growing availability of 1st class health care around the world, the insistence of if notification is reducing
why would insurer ask to be notified of residence change and how would policy terms be reconsidered?
- change in permanent residence is a change in risk factors
- insurer is concerned about whether the risk of sickness and accident is different in new location from originally assessed. This will be influenced by the extent to which the occurrence of infectious diseases is mitigated by the provision of good quality health care.
- if change in risk is significant then insurer might increase premiums or place restrictions or exclusions on the benefit that would be paid
Residence affects risk in three ways from insurer’s perspective^
- where policyholder lives when underwritten (influenced premium rate)
- where policyholder lives when disability is incurred (area can lead to disability or illness)
- where policyholder lives when benefit is payable (quality health care can lead to quicker recovery)
Product features: What are the different variants of IP?
Guaranteed and reviewable rates
Guaranteed
Where premiums are guaranteed for the full term or the policy eg level increasing @ a fixed rate of day 5% Pa or increasing according to some index
Reviewable
Where the insurer reserves the right to review premiums @ each review period should claims experience across the whole portfolio be poor and may reduce premiums if experience is good.
Usually premiums will be guaranteed for the 1st 5 years and reviewable thereafter
Review used by insurer as na opportunity to make good any adverse claims experience of the past
Characteristics of IP that make it difficult for the insurer to fully assess the risk at the outset and so be in a position to offer competitive guaranteed premiums
- risks associated with IP change over time in ways insurer can’t foresee
- some diseases like polio no longer cause long term sicknesses and some have become treatable
- diseases that went unrecognised have become causes of long term sicknesses
- there are a lot of changes in the workforce eg shift work and automation
- employers expectations have changed eg employees have to retrain for different job after long periods of sickness
- a policy might have a term of more than 30 years. The insurer’s expected cost of claim for such a policy will have a large standard error so the guarantee premium will include a large contingency loading which may make the premium look expensive to the policyholder
However fully reviewable product can be difficult to review in practice. Why?
- there are limits on premium increases - doubling premiums can lead to selective lapsing
- insurer can suffer financial losses if it does not increase premiums on business expected to have poor experience and might create PRE where policyholders think such an increase would never happen in the future
- review can result in selective lapsing (healthy lives lapse or decline a premium increase for a lower benefit) and selection agains insurer where unhealthy lives either claiming or in poor health accept the increase. This will leave the insurer with an unhealthy pool of lives thus resulting in higher claims and even bigger premium increases
Product features: What are the different variants of IP?
Continued…
Guaranteed insurability and other options (GIO)
The ability to increase the SA at office standard rate for the current age without supplying further medical evidence eg marriage, buying a house…
GIOs will usually be available if policy is issued at standard rates ie where there was no rating on account of medical conditions
Qualifying events are those that should lead to the need for increased insurance so that there is no incentive to over insure
GIO are less common with IP as point of IP is to replace salary and more common with protection products
GIOs now offer the ability to change cover, annually, in line with change on income
No claims discount
Some contracts will have a discounted premium if no IP claim has been made, this is a way of rating the policy experience to make up for any limited underwriting done at outset
With profits and unit linked IP designs
With profits
Policies exist with a bonus declared each year that builds up to give a benefit on death or at expiry (IP claims are unaffected by the bonus)
Receipt of bonus not dependent on good claims record - it is in the design
Premiums for with profits will be higher that for without profits due to savings element
Unit linked
IP exists with morbidity charge deductions being made from units fund in the place of a mortality charge under a whole of life
Group IP
Group IP is brought by employers wishing to provide benefits to their employees. I’m some countries employers have a legal obligation to provide statutory sick pay to their employees in the 1st few weeks of sickness
Could be used to provide statutory sick pay and to pay benefits after the statutory period
Benefits
level of benefits
- benefits usually based on salary gross of tax with an offset in respect of any State incapacity benefits
- some insurers offer benefits based on net salary
- gross salary benefits make administration of the schemes easier
additional benefits
Over and above coverings scheme members salaries, additional cover may be provided on:
- employee/employer pension contribution
- employee/employer state welfare contributions
continuation option
May be offered
It allows employee to take out an individual policy in the group policy without additional health evidence when he leaves employer
Benefits limited to those offered under the group policy. Why?
- employee could have left employer due to health reasons
- anti selection is likely as those that take out a continuation cover are those who likely consider themselves to need it
