OVER THE years, there have been many articles extolling the virtues of tiered benefits for critical ...
OVER THE years, there have been many articles extolling the virtues of tiered benefits for critical illness policies where the amount paid out depends on the severity of the illness. It has also been argued that income benefits are more suited to some illnesses. Both are used on South African products.
Supporters of tiered benefits argue that by eliminating 'windfall gains' and providing less cover for the less serious illnesses, there would be less anti-selection and policies would be cheaper. As a result, we would sell more policies and more people would have cover for the nastiest of the critical illnesses. This, the argument goes, is what customers need and they would buy it in droves.
This is the basis of the 'case for the prosecution' that accuses UK-style product design of being inefficient and not meeting customer needs. But do these arguments really hold water? Here I wish to set out a 'case for the defence'.
South African example
Tiered benefits are typical in South Africa, where the product was born. So let us go back to the start of critical illness and take a quick look at a typical current South African product to see just how tiered benefits might work in the UK.
On 3 December 1967 Christiaan N Barnard, Professor of Cardiothoratic Surgery, transplanted Denise Darvall's heart to Louis Washkansky in the first ever heart transplant operation. Dr Marius Barnard, Christiaan's brother, was part of the 30-strong team of doctors that performed the operation in Groote Schuur Hospital. Working with victims of heart disease drove Marius to help Crusader Life develop Dread Disease cover in South Africa (launched as a policy rider benefit in 1983).
Tiered benefits were a later development in South Africa but today feature on most South African 'dread disease' products. The table on page 22 shows a typical product design. How would a design like this fit into the UK market?
The ABI Statement of Best Practice has taken the UK market strides forward in terms of getting rid of small print and allowing policies to be compared more easily. Introducing tiered benefits would be a step in the wrong direction. In terms of clarity and being able to choose the most suitable policy, having tiered benefits would be a nightmare for customers and IFAs alike.
Some illnesses would need significantly more complex definitions so that the amount payable could be determined, for example, based on the severity of the stroke or the extent of invasion of cancer and, because this significantly affects the pay out, the customer would need to understand these complex differences.
Comparing policies would become significantly more difficult. Not only would you need to consider the illnesses covered, but also the definitions used for different benefit levels, the amount of benefit payable and, possibly, the type of benefit - capital or income. In the case of income benefits, the period over which the benefits are payable is another factor as these may vary from one provider to another.
Making a claim
With tiered benefits, the claims process could become significantly more problematic and even otherwise clear-cut cancer, heart attack and stroke claims could become problematic if the payment varied with severity. This means that tiered benefits carry a significant risk to the reputation of the industry and the product.
The South African structure of benefits may also leave customers with some awkward dilemmas as the critical illness cover normally ends on the payment of the first claim, leaving just life cover. If so, imagine the dilemma of a customer with kidney failure. They could claim 75% of the sum assured when they need dialysis. However, if the waiting list is not too long, it may be better to chance waiting for the full payout under major organ transplant. A similar dilemma may face a customer with cancer that is caught relatively early. Taking a partial payout could prevent a full payout later if the cancer spreads.
Those who argue in favour of tiered benefits tell us that if the benefit matches the severity of the illness, this will better meet the needs of most customers. But is this true?
Some policies in the UK do have an element of tiered benefits where less than the full sum assured is paid. Examples are child cover and single vessel angioplasty. However, both these examples add significant value because there would be no benefit otherwise paid and they do not cancel the main cover.
When someone gets sick, the impact on their lives depends on a huge number of factors. Not least of these are their personal motivation and the family support they get. Each one of us would react differently to the news that we are suffering from a critical illness.
Other factors include the occupation of the individual and how sympathetic the individual's employer is to the circumstances. As a simple example, the loss of an arm and a leg may have a much bigger impact on a concert pianist than a solicitor.
Paying off a mortgage
Many policies in the UK are bought, partly or wholly, to protect a mortgage. Imagine trying to use a South African-style policy to meet this need. Do you choose the cover that pays off the mortgage only on payment of the full benefit? Or do you advise the customer to choose a larger sum assured? Do you factor in conditions where the benefit is paid as income? In the example above, only a major organ transplant would pay 100% as a lump sum, but this condition accounts for less than 1% of claims.
In the final analysis, if you have lost your income because you cannot work, or if you cannot pay your mortgage, the financial consequences do not really depend much on which illness caused the problem.
Supporters of tiered benefits ask us to take it largely on trust that the approach would reduce anti-selection and therefore improve claims experience and reduce premiums. However, this depends on two assumptions - that there is significant anti-selection to be removed and that tiered benefits would actually remove it.
There is little evidence to support either of these assumptions. The little evidence that does exist suggests that anti-selection may be more linked to certain types of occupation. Tiered benefits are unlikely to prevent this.
Windfall payments
Of course, premiums could be reduced if we use tiered benefits simply as a means to offer less cover for certain conditions - especially for the conditions that are most likely to happen. If we only pay 50% for a cancer where 100% is currently paid, of course this would be cheaper. However, offering less cover in this way is unlikely to increase sales so long as the 'full cover' remains available.
Those who argue in favour of tiered benefits sometimes suggest that many critical illness claims are 'windfall payments' and that some of the illnesses now covered are not really critical at all. I recently heard 'windfall' in this context defined as any illness that is "nothing to worry about if it happens to someone else, but absolutely devastating if it happens to you personally".
Marius Barnard is famous for saying that there is no such thing as a "mild heart attack". This expression is only ever used by someone who has never had one.
Questionable impact
At best, it is questionable whether tiered benefits would have sufficient impact on anti-selection to reduce the price. The only significant premium reduction would be from any reduction in cover, which is unlikely to improve the standing of the product. It is also questionable, especially for customers with mortgages, whether customer needs would be better met by varying the benefits according to the severity of the illness.
What is beyond question is that tiered benefits would make critical illness products more complex and virtually impossible to compare. As a result, they would be harder to explain to the customer and harder to sell. The claims process would be more problematic, both for the customer and for the insurer.
All this would make the job of the IFA far more difficult. One of the great strengths of UK critical illness policies is the simplicity of the sales message: "If you get one of the specified illnesses, you get a lump sum."
Of course, there is always room for improvement, but to move the market forward new product designs and features must meet new customer needs and should not destroy the simplicity that has driven critical illness sales through the 1990s.
Critical illness is the exact opposite of cricket - we invented cricket but now the South Africans are far better at it than us. However, even allowing for its smaller population, the UK is now miles ahead of South Africa in critical illness sales.
Nick Kirwan is manager, product development, at SMA Pegasus
