Claims are a good thing. The insurance industry exists to pay them and the typical claims philosophy...
Claims are a good thing. The insurance industry exists to pay them and the typical claims philosophy will refer to the need for all 'valid claims' to be paid promptly.
In most circumstances 'valid claims' will also be those that were allowed for by the actuary when pricing a product. However, it is essential that there is close liaison between the claims and actuarial disciplines at all times and particularly during the product development phase to ensure that opportunities for dispute are kept to a minimum.
The problem for insurers comes not from expected claims but from unexpected claims, the source of which includes:
l Unclear policy wording
l Insurance Ombudsman rulings
l Medical advances
l New diseases
l Economic changes
l Random fluctuations
l Fraud.
Some of these factors are more controllable than others.
For example crystal clear policy conditions, combined with well trained and knowledgeable sales intermediaries will help keep misunderstandings to a minimum. However, difficulties can still arise as we have seen with permanent total disability benefits and income protection insurance.
For PTD, there have been far too many declined claims reflecting the subjective nature of occupation-based definitions and the need for disability to be permanent. Insurers have tried to improve matters by redefining PTD disability to be less subjective and we now have definitions based not only on occupation but also on activities of daily work (ADWs).
Meanwhile, for income protection ombudsman rulings have suggested that an 'any occupation' definition for disability will be considered to be nearer to 'own occupation' than was originally intended by the industry. This has resulted in cover on this basis now being offered on terms much closer to 'own occupation'.
External risks
But the factors that are most difficult to control are the external social and environmental risks such as medical advances and new diseases. By their very nature these will be unknown quantities at the time a policy is developed.
We need look no further than the advent of AIDS in the 1980s for a prime example of a new disease and how the insurance industry reacted.
The reaction was indeed swift and included a significant increase in life premiums for new business and the removal of guaranteed insurability options.
IP conditions were changed so that a claim from AIDS would be excluded.
Insurers also had to increase reserves for in force policies if the premiums were guaranteed.
Policies with reviewable premiums were less of a problem as these could be increased if necessary.
Fortunately AIDS has been less of a problem than originally predicted in the UK and premiums have reduced significantly, as the trend in term insurance premiums over the last few years clearly demonstrates.
Another example of how the degree of risk can change over time is IP cover for teachers, where premium rating is now based on a more expensive occupation class due to poor claims experience. The main cause of these claims tends to be stress, another modern 'disease' not specifically factored into the price.
For critical illness there has been concern in the CI market recently over prostate cancer and angioplasty which have, as yet, not impacted on product design.
Prostate cancer is one of the many forms of cancer that is covered under the cancer definition. However, it is a very common cancer in males. It is believed that as many as one in seven men aged 40 have prostate cancer and most men over the age of 80.
The potential problem for insurers is the increasing availability of improved and more sensitive diagnostic techniques. These techniques involve the detection of increased levels of Prostate Specific Antigen (PSA) in the blood and may lead to an increase in the early detection of prostate cancer. The fact that this test is cheap and readily available means it could have an impact on premiums. As yet the test is not sensitive enough to detect the very small cancers identified by the research leading to the findings above. However, it highlights the need to keep the situation under investigation and consider the possible impact on product design.
In recent years the number of angioplasty operations taking place have increased by over 10% a year. These procedures are relatively simple, can be performed in a day and are much cheaper than a cornary artery bypass graft. The incidence in the UK is nowhere near the US where operations are recommended almost as a matter of course in the fight against heart disease and this suggests that the number of procedures will continue to increase.
However, many of the definitions used in the market require surgery to be performed on at least two arteries and this procedure is less frequent. To this extent there is a cushion. There is however, the danger that in future multiple artery surgery will become the norm as a preventative measure. Any saving in premium rates from reduced heart attack incidence could be more than compensated by increased claims under the surgery definitions.
Finally, random fluctuations are to be expected in the amount of claims in any portfolio. Paradoxically this happens as part of the normal process of statistical variation. It would be expected that claims in some years will be slightly higher than average but that this would be balanced overall by lower than expected claims in other years. The important point is to continuously monitor experience to ensure that the actual variation falls within given limits and does not represent a shift in the underlying expectation.
Handling the unknown
So how does the insurance industry deal with the unknown?
Well firstly, it can share the risk with the insured by offering reviewable rates. This allows the premium to be increased if experience is adverse. Ideally, there will be no need for such action but the option allows an insurer to set lower rates initially in the knowledge that premiums can be increased at a later date.
The downside for the insured is of course that premiums may go up. However, insurers are always aware of policyholders' reasonable expectations and would only raise rates in extreme circumstances.
The alternative is guaranteed rates. If the risk is not to be shared with the insured then the insurer will be more prudent with its assumptions and set aside larger reserves the result of which will be a higher premium than if rates were reviewable. The advantage to the insured is that premiums will remain unchanged but this will come at a price.
Finally, products for new business may be redesigned to reflect the changes in environmental or social risks.
Product changes
For Critical Illness there has been a lot of talk recently regarding the tiering of benefits so that less serious critical illnesses have a reduced benefit pay out. For example 25% of sum assured on angioplasty.
Alternatively the policy wording could change, for example with a specific exclusion for prostate cancer in the cancer claim definition.
In the extreme these less serious illnesses could be removed from the product and replaced by new emerging diseases that are considered critical. This is one idea from a joint Investment and Life Assurance Group (ILAG) and Institute of Actuaries working party who are attempting to 'future proof' critical illness products. The trick is to be able to change the critical illnesses covered while the contract is in force without alienating policyholders who could have previously claimed from the removed diseases. This may fall foul of the unfair contracts legislation but it is an interesting idea and one which may be of benefit to policyholders in the longer term.
One problem with redesigning products is that there is often a reluctance on the part of insurers to alter existing products unless the whole industry moves the same way. In terms of critical illness for example, competition led to new diseases being added to the contract. Once on the product it is difficult to remove diseases or change the wordings unless the whole market does so. A strong lead from the ABI, FSA or the reassurers would then be necessary to pass changes through.
The lead from the ABI in ensuring minimum standard definitions for the main critical illnesses is a good example. However future changes necessary to definitions such as the prostate cancer example may be delayed if the ABI cannot get agreement from the industry quickly enough.
Changes in claims experience - either above or below that initially expected in pricing - can impact both current premium rates and future product design.
The timing of these changes is not necessarily immediate and will depend upon whether the industry as a whole reacts or whether an individual company decides to do so on its own. Failing to modify either product terms or rates when claims experience changes significantly is unwise. If experience improves, other offices that lower their premiums or improve their product terms will win business at the expense of those who do not. If it worsens, the office that fails to put premiums up or tighten its terms will probably increase its business - but then lose money on it.
Martin Smith is product development actuary at GE Frankona Re
