Module 8 - Initial Pricing of Group Insurance Products Flashcards
Outline risks facing insurers if they overprice or underprice their group insurance products.
Pricing of group insurance products must be both competitive and profitable. Premiums must adequately reflect the risk of providing coverage to a specific group and be sufficient to both cover incurred claims and expenses related to administering the plan and generate a profit for the insurer. Overpricing for segments of the market results in lost business, while underpricing attracts unprofitable business.
Identify factors considered by insurers in the pricing of group insurance.
(a) Types of claims
(b) Claims frequency
(c) Claims costs
(d) Expenses incurred servicing the plan (i.e., plan expenses or retention charges)
(e) Anticipated profit and applicable taxes.
Items (a), (d) and (e) are known entities—items the insurer can quantify with certainty. The insurer knows the types of claims and cost of doing business from its own experience and sets its own profit targets for each line of business, while provincial, territorial and federal governments dictate taxes. Items (b) and (c)—how often a claim will occur and how much it will cost—are largely unknown at the time the insurer prices a group benefits plan. The insurer must estimate these factors, based on reasonable assumptions from its block of business or from a particular plan’s claims experience, depending on the funding arrangement. These assumptions form the basis for measuring the risk present in any group.
Provide examples of when an insured claim is incurred and the nature of those claims.
A claim is incurred when an insured person experiences an insured event, such as dying, becoming disabled or having a prescription for a drug filled by a pharmacist. These examples illustrate that not all claims relate to catastrophic events such as death or extended periods of disability. Most group benefit plans include coverage for limited amounts of vision care claims, and since these expenses cover predictable and budgetable expenses they are not considered catastrophic claims. Plan sponsors also use insurance to subsidize medical and dental expenses as well as loss of earnings during short-term absences from work due to illness or injury.
Describe how insurers cover the potential cost of a waiver of premium claim or a conversion charge when pricing life insurance plans.
Basic life, optional life and dependent life insurance policies may include a waiver of premium provision should a plan member become totally disabled (i.e., in the event of total disability, no premium is charged to continue the plan member’s life insurance coverage). In this case, the insurer holds a life waiver of premiums reserve for the waiver of premium claim, calculated as the present value of the future liability, accounting for the loss of premiums, increased mortality risk and potential coverage to age 65 (the age at which waiver of premium coverage typically stops).
Basic life, optional life and dependent life insurance policies may also allow a plan member whose coverage terminates to convert the group coverage to an individual policy (subject to certain limits) at standard rates, without providing evidence of insurability. The charges insurers levy for conversions count as claims and offset the increased potential risk to the insurer from insured plan members who have not provided evidence of their current state of health. Insurers normally express the conversion charge as a rate per $1,000 of coverage converted. The rate may vary by age and sex of the insured, and by the type of policy purchased.
Define mortality rate and the formula used to calculate it
The frequency of death claims is the “mortality rate.” Insurers normally calculate mortality rates separately by age and sex. For a particular population, the annual mortality rate is the number of individuals who die in a 12-month period divided by the number of insured individuals living at the beginning of the year.
𝑀𝑜𝑟𝑡𝑎𝑙𝑖𝑡𝑦 𝑅𝑎𝑡𝑒 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐷𝑒𝑎𝑡ℎ𝑠 /𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐼𝑛𝑑𝑖𝑣𝑖𝑑𝑢𝑎𝑙𝑠 𝐼𝑛𝑠𝑢𝑟𝑒𝑑 𝑎𝑡 𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑜𝑓 𝑌𝑒𝑎𝑟
Define morbidity rate and the formula used to calculate it
The rate at which plan members become disabled is the “morbidity rate” or “incidence rate.” This rate varies by occupation, industry, age, sex, economic climate and geographic region. It is calculated as the number of plan members who become disabled in a 12-month period divided by the total number of plan members insured for disability benefits at the beginning of the year.
𝑀𝑜𝑟𝑏𝑖𝑑𝑖𝑡𝑦 𝑅𝑎𝑡𝑒 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐷𝑖𝑠𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 / 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐼𝑛𝑑𝑖𝑣𝑖𝑑𝑢𝑎𝑙𝑠 𝐼𝑛𝑠𝑢𝑟𝑒𝑑 𝑎𝑡 𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑜𝑓 𝑌𝑒𝑎𝑟
Define utilization rate and the formula used to calculate it
The frequency of extended health care and dental claims is known as the “utilization rate,” expressed as the percentage of insured individuals who incur a claim. The utilization rate can be measured in terms of the overall plan or broken down by component for plan members and dependents. For example, the overall health care plan utilization rate is the percentage of insured individuals who submit any type of health care claim, and utilization rates of each component included in health and dental claims can be measured separately for plan members and dependents.
𝑈𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐷𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑡 𝐼𝑛𝑠𝑢𝑟𝑒𝑑 𝐼𝑛𝑑𝑖𝑣𝑖𝑑𝑢𝑎𝑙𝑠 𝑆𝑢𝑏𝑚𝑖𝑡𝑡𝑖𝑛𝑔 𝐶𝑙𝑎𝑖𝑚𝑠 / 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐼𝑛𝑑𝑖𝑣𝑖𝑑𝑢𝑎𝑙𝑠 𝐼𝑛𝑠𝑢𝑟𝑒𝑑 𝑎𝑡 𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑜𝑓 𝑌𝑒𝑎𝑟
Provide examples of claims where the benefit amount is known when the plan member becomes insured.
The death claim amounts for life insurance benefits and accidental death benefits are a predetermined amount, known at the time when coverage for the plan member takes effect.
Provide examples of claims where the benefit amount is unknown at the time the claim is incurred.
The exact amount of a Weekly indemnity/short-term disability (WI/STD) claim is unknown at the onset of the claim (the weekly benefit amount is known, but the duration of the payments is unknown). The actual claims cost is known only after payments terminate. Benefit duration can range from one day to 52 weeks.
Long-term disability (LTD) claims are similar to WI/STD claims in that the total amount of the claim is unknown at the onset of the claim (in this case, the monthly benefit amount is known, but the duration of payments is unknown). Again, the actual claims cost is known only after payments terminate. Benefit duration can last from several months to several decades because benefit payments can terminate for several reasons, including death recovery or at age 65. For LTD claims, insurers estimate the total payout of a disability claim and report this total as a reserve that estimates the present value of this future liability.
Describe the role of reserves
Insurers set aside sums of money to pay future claims. These funds are called reserves. Each type of reserve is independent of the other and reflects a specific and distinct liability. Some reserves represent a known liability (e.g., life waiver of premium reserve or a disabled life reserve), while others represent a potential liability (e.g., incurred but not reported reserve). Insurers treat reserves as part of claims when setting premium rates.
Explain how a life waiver of premium reserve is usually determined.
Insurers establish a life waiver of premium reserve when an insured plan member becomes totally disabled and life insurance coverage for the disabled plan member remains in force without premium payments, even if the plan sponsor terminates the group contract. The prospect of paying a death claim without collecting premium payments requires insurers to treat the waiver of premium reserve like a death claim in the year the waiver claim is incurred. Insurers usually estimate the waiver of premium reserve at approximately 20% of the amount of life insurance coverage; however, the actual reserve amount varies depending on actuarial factors.
Explain how a disabled life reserve is usually determined.
A disabled life reserve recognizes the liability for future LTD payments for disabled plan members. It is an estimate of the present value of all future payments to an LTD claimant. Insurers estimate the value of a disabled life reserve at approximately 60 times the monthly benefit amount; however, the actual reserve amount varies depending on actuarial factors.
Define an incurred but not reported (IBNR) reserve and explain how it is usually calculated.
An IBNR reserve (also called an unreported claims reserve) is a portion of the group benefits plan premium set aside for claims incurred in one contract year but not reported (i.e., submitted for payment) until the next contract year. The IBNR reserve also recognizes the possibility that the group insurance contract may terminate before these claims are reported, leaving the insurer liable to pay the claims without receiving additional premiums. The amount of the IBNR reserve is a function of the time lag between when a claim is incurred and when it is reported to the insurer. Insurers usually calculate the amount of the IBNR reserve based on a percentage of annual premiums for life, accidental death and dismemberment (AD&D), LTD and WI/STD or a percentage of annual claims for health and dental. Note that insurers may use annual premiums when annual claims do not represent future health or dental claims. The percentage insurers use to calculate the IBNR reserve differs by benefit.
While disabled life reserves and life waiver of premium reserves relate directly to a specific claim, insurers calculate IBNR reserves based on each benefit as a whole.
Identify the components affecting a group’s net premium rate and gross premium rate calculations.
Insurers base the net premium rate on the frequency of claims, the amount of paid claims and claims-related reserves (life waiver of premium reserve, disabled life reserve and IBNR reserve).
The gross premium rate is the net premium rate plus non-claims-related costs for the plan including administration expenses, risk charges, profit margins and premium taxes. The total of these non-claims-related costs are also referred to as “retention charges.” Note that insurers include premium taxes in their retention charges and factor them into the premium rates. They do not include sales taxes in their retention charges but rather apply these taxes after calculating the premiums.
There are various ways in which insurers reflect pool charges. They can be expressed as separate premium rates or as a percentage of gross premiums, or they can be included in the retention charges.
Describe the components of retention charges that are included in a group’s gross premium rate.
(a) General administration expenses and claims administration expenses. General administration expenses relate to acquisition and servicing of a group insurance plan. Claims administration expenses relate to the cost of claims settlement, including claims adjudication and claims payment.
(b) Risk charges. These are charges levied on refund accounting benefits to cover the possibility of a group terminating coverage in a deficit position.
(c) Profit margins. These are profits earned through either an explicit charge in the insurer’s expense formula or a margin built into other expenses charged to the plan sponsor.
(d) Applicable taxes. Tax implications for group benefit plans vary by province and territory and by the type of funding arrangement (i.e., nonrefund, refund or self-insured).
(e) Some insurers add the pool charge to the retention to determine the gross premium rate for benefits with pooling.
Identify the ways insurers express retention charges for nonrefund accounting, refund accounting and self-insured groups.
Insurers may express retention charges as a percentage of total premiums, paid claims or incurred claims; as a flat dollar amount; as a fixed cost per plan member; or as a fixed fee per transaction in the case of claims, contract amendments and other services. The basis varies by insurer and by type of plan expense.
For nonrefund accounting groups, insurers normally express total expenses, including premium taxes as a percentage of total premiums. For refund accounting and self-insured groups with an administrative services only (ASO) arrangement, insurers itemize expenses and express them in terms of an expense or retention formula.
