GHDP 127-19 - Disability Income Insurance: The Unique Risk Flashcards
Introduction
Two most significant factors for disability income actuaries:
- Lack of substantial and reliable data
- High level of subjectivity in determining claims costs
Available Morbidity Data
- 1985 Commissioner’s Individual Disability Tables (CIDA, CIDB) replaced this table
- SOA table on Group LTD (Table 95) from the mid 90s often used for individual rates because it is more
up to date that the 1985 tables - Social Security Administration has published tables, but the characteristics of the Social Security
system make this data less reliable for industry use - SSA has the largest volume of data, so this information will become more useful
- SOA has conducted various studies and due to lack of data, these studies are devoured by the industry and perhaps overutilized (1975 report, 1987 report, etc)
- These studies don’t cover the late 80s/early 90s when disability experience deteriorated significantly
- In the 1990s, some have noticed that studies show increased morbidity as the indemnity increases, even without regard to the replacement ratio
- Some evidence to show that the larger the indemnity, the greater the unit claim cost, without considering the claimant’s income prior to disability
Variable Factors
1. Key issues:
- Motivation
- Stability
- Effect on Work Ethic
2. These issues are more subjective and harder to measure (not as objective as mortality)
3. Changes in social norms change the underlying assumptions in disability rates
- Recession, changing professional attitudes, etc all affect this
Pricing Challenges
- Must understand cyclical nature of business
- Discipline not to overract in either direction
- Inexperienced actuary assigned to the disability income line
1. Must understand cyclical nature of business – fine-tuning and quick reaction to social and economic changes are a necessity for disability actuaries
- During good economic times, claims experience and profits will be more favorable than assumed
- During bad economic times, the rates may not be adequate due to higher morbidity
- Must resist temptation to overreact
2. Historically, the industry has not shown the discipline to avoid overreaction in either direction
- In good times, tended to relax its product language, underwriting and rates
- In bad times, tended to tighten them excessively
- E.g. Recovery benefits – provide benefits after the insured returns to work on a full-time basis
▪ Very little industry data available
▪ New coverage type
▪ Assumptions can’t be fully evaluated for 10-20 years
3. Inexperienced actuaries are usually assigned to the disability product line, further complicating the problem
- Disability is a secondary or tertiary product for many companies and represents a fraction of the total income
- Lack of objective approaches and mature data requires a seasoned actuary to call upon their years of experience; however, inexperienced actuaries don’t have this background
- Many companies disability losses may be tied to the fact that less experienced actuaries are completing the work
- Scarcity of experienced actuaries and adverse experience in the 1990s led many individual companies to exit the business
Disability Reserves
1. Two key reserves:
- Active Life Reserve
- Disabled Life Reserve
2. Typical disability policy is on a level premium basis
- In early years, premium is greater than morbidity. This excess must be set aside to offset the greater morbidity at older ages when premium is inadequate
- Active life reserve is the depository for this excess premium (and assumptions should address investment earnings on these reserves)
- In most cases, there is no cash or surrender value
- Some recent policies do offer a return of premium benefit
3. Disabled life reserve is established, reflecting each disability claim and its projected length
- Significance of disabled life reserve has increased in recent years due to substantial increase in monthly indemnity levels and length of average benefit period
4. Reinsurance may be used to diminish the impact of large swings in disabled life or claim reserves for small or medium sized companies
Experience Studies
1. Loss ratio experience has been the most common method of tracking claim experience until recently
- Loss ratios are less than satisfactory due to many variables associated with disability income – length of benefit period, length of elimination period, duration, etc
2. Morbidity studies (based on actual-to-expected experience) are more reliable for evaluating and building rates
3. Differences in extra-benefit riders and basic contract language continue to call heavily on actuary’s personal experience and judgement
4. Difference in claims costs by sex of claimant is receiving substantial attention
- Higher claim cost for women tends to disappear by the mid-50s and falls below male rates at older ages
5. Minimum of 5 years may be needed before judgment can be made about the profitability of a particular contract. Depending on contractual guarantees, length of time may even be 10 years
Other Pricing Factors
1. Persistency Assumptions
- Lower occupation classes, lower incomes, younger ages, smaller premiums, quarterly premium modes, shorter benefit periods and shorter elimination periods all tend to have poorer persistency
2. Expense Rates and Costs
- How are expenses allocated
3. Cost of Taxes
- Must be built into the premium
4. Interest Rate
5. Premium Volume
6. Profit Margin
- Contingency factor in profit margin must be greater than in life insurance due to large number of variable factors and more unknowns
Company Philosophy
1. Throughout the process, actuary must identify and keep in mind the key background assumptions of the company philosophy:
- What is the quality and experience of disability underwriting?
- How competitive is the marketplace in which it will be sold?
- What is company’s claims philosophy?
- Does company adhere strictly to contract language or have a liberal interpretation? o What is the quality and experience of the salespeople?
▪ Are they familiar with disability income?
▪ Are they familiar with completing a disability income application?
▪ Do they do a high-quality job of field selection?
2. Periodic and consistent evaluation needed to determine whether the pricing assumptions are achieving proper results
3. None of the assumptions will prove to be accurate, but the hope is that, in aggregate, the assumptions will generate the necessary profit margin
Evaluation of Results - Introduction
- Individual disability income results are very limited, so group disability data has been the source of more disability studies.
- 1985 CIDA table is still the primary individual morbidity table
Life Versus Disability Volatility
1. Life insurance – mortality studies use age, sex, medical, nonmedical, standard, substandard, permanent and term factors
2. Disability insurance – all of those plus elimination period, benefit period, occupation, income, indemnity, regional and classification are needed
3. No industrywide data exists in all of these areas
4. Projecting Trends
- Use subjective judgment and management experience to project trends into the future
- Due to high volatility, statistical trends for disability income are less reliable than for life * Period of Study
- To be valid, must be done over a period of years, preferably a minimum of 5 years
- Social changes evolve over a period of years
- Period must be broad enough to smooth out the highs and lows of economic swings, as the
industry has tended to overreact to these swings
Morbidity Versus Loss-Ratio Studies
1. Morbidity
- Actual-to-Expected are the most preferable method of examining disability income experience
- Two basic elements:
▪ Rate of Disability – number of disabled lives per thousand lives exposed
▪ Rate of Recovery – measures the length of disability
Changes in rate of recovery take much longer to emerge - Few companies have enough exposure to develop meaningful data for valid morbidity studies
▪ Even the few industry studies available tend to lose credibility and value as they break down into smaller cells
2. Loss Ratios
- Majority of industry and company disability studies are based on this (due to lack of adequate morbidity data)
- Two basic types of ratios
▪ Cash-Claims Ratio – cash-claim dollars paid out during the period divided by the earned premiums during the period
▪ Incurred-Claim Ratio – cash claims plus the active life reserve plus the claims reserve, divided by the earned premium during the period (this ratio is far more reliable) - Cash ratio is inadequate because it does not consider claims reserve and fails to measure future liability of open claims
▪ Also uses future premium, some of which represents payments for claims in the future on a level premium policy, and therefore understates the true loss ratio
▪ In early years, cash ratio will be extremely low
▪ Policy with a short benefit period will show a higher cash-loss ratio - Incurred-loss ratio is a more sound method, though it included interest earned on the active life and claim reserves
▪ Interest component can be removed and results in the Net Loss Ratio, for an even better view of the morbidity itself
3. Sensitivity to Trends
- Must be cautious in drawing conclusions from short-term results and sensitive to trends
- Trends based on past experience may be valuable indicators of direction
- Comparing to other companies’ experience through annual statements may give a clue to companies performance, but analyst must also consider differences in own company’s block of business
4. Annual Statement Schedules
- Schedule H provides the primary data for intercompany analysis
▪ Contains only loss-ratio data
▪ No differentiation based on duration of blocks of business
▪ Helps examine year-to-year trends
- Schedule O is a good measure of whether or not an insurer is setting aside large enough claim reserves to have covered open claims for previous years
Claim Study Parameters
1. Important parameters to analyze in a disability portfolio:
- Occupation Class – significant differences in morbidity and claims experience
- Occupation – each class has several dozen different occupations
- Policy Form – each policy form has unique characteristics and new forms carry unknown risks
- Extra Benefits – optional or additional benefits require significant reserve allocations
- Age
- Duration – very important factor. Loss ratios are naturally higher on older blocks of business
- Elimination Period –premiums vary according to elimination period length
- Benefit Period – rates vary by benefit period
- Indemnity – recent studies show that the larger the indemnity, the poorer the experience
- Income – closely related to indemnity but also may be a measure of insured’s stability in his/her occupation
- Geography – some indication that densely populated areas may have higher morbidity
- Agent and Agency – information on the quality of the producer’s field selection
- Sex – higher morbidity for females up to mid-50s, when trend begins to level and then flip
- Mode – annual premium payment mode generates more favorable experience than any other mode
- Smoking Status – lower rates for non-smokers
2. Combination of Parameters
- Accurate information by parameter can be valuable, but the ability to study the experience of one cell as it affected by variations in other parameters is extremely valuable
▪ E.g. How does benefit period experience vary by elimination period? How does occupation class experience vary by age?
- Obviously, further breakdown of results leads to smaller cells with less credible data
- Shortfalls in data should not deter the analyst from making an attempt to examine those results, while always recognizing the limitations of the data and relying on experience and judgement
- Important to analyze results regularly and not wait for the problems to clearly emerge
Persistency Studies
- Examination and analysis of persistency is a key element in determining financial results
- Same parameters as those listed for claims studies also apply to persistency
- Persistency trends emerge early in a contract’s life and therefore more conclusions can be drawn
- Blocks of business with poor persistency tend to result in poorer claims experience
- Insured’s stability and motivation are critical factors in persistency and morbidity
- Some companies use a stability or persistency rater to measure an applicant prior to issue
- Use of this rater is uncommon at the present time and relatively unscientific
- Heavy front-end acquisition expenses mean that the policy must be in force for several years before a profit can be earned, so persistency becomes very important
Roles of Actuarial, Underwriting, and Claims Departments
- Evaluation of disability results is not solely a function of the actuarial department
- Subjectivity of disability income and scarcity of data require the underwriter and claims examiner to assume a role in the evaluation process - Actuary performs statistical evaluation of morbidity in claims experience, but analysis requires input from underwriters and claim examiners
- Changes in underwriting rules or certain characteristics or problems with a particular contract form may be noted - Underwriter and claims examiner may be able to observe trends that will not be evident in claims analysis for some time
- Result of most analyses will identify areas to observe for possible problems, rather than list definitive conclusions and actions to be taken
Impaired-Risk Experience
- In Life insurance, about 3-5% of all approved applicants are other than standard. In Disability, this number is frequently in excess of 20%
- This cell must be studied by itself
- Scarcity of data in this smaller cell is again an issue
- Variety of possible underwriting actions with each impairment such as exclusions, endorsements or extra premiums
- Larger companies can study the more common impairments such as low-back problems, mental and nervous disorders, obesity and high blood pressure
- Underwriter must play a major role in this analysis, along with claim examiner and actuary
- Reinsurer should be able to provide more reliable information than any individual company
