In the second part of our series discussing the next generation of critical illness cover, Neil Reynolds examines reviewable and renewable products
One of the ways in which critical illness (CI) product design could, and in fact must, change is the removal of onerous guarantees. However, it needs to be remembered that guarantees come in two forms - premiums and coverage (illnesses covered and their definitions). Much of the recent focus on guarantees has been on the former, but we should also consider whether guaranteed coverage is in the best interests of policyholders.
Medical advances
While, superficially, guaranteed coverage seems attractive since the cover is known for the whole policy term, there is also a downside. Medical advances can be positive because they can lower claims - due to reasons such as various drug and genetic developments; but also negative because of more claims - due to medical advances such as the troponin test for heart attack.
If the positive prevail, then the cover offered by the product could be for diseases which, in say 10 or 20 years' time, could be less serious, less common or even non-existent. If this is accompanied by guaranteed premiums, then the policyholder is paying too much for this reduced coverage.
On the other hand, new diseases come along which were not around when a product was launched and which are therefore not covered by the policy irrespective of how serious they are. A product, where coverage was reviewable, would allow these new diseases to be included.
If we want a policy to pay out on getting 'one of a list of serious diseases' then it follows logically that the list and the definitions of those diseases need to be reviewable. To continue to market a product under the CI brand, reviewability of cover offers a way forward.
But is all of this legal? What is the regulatory position of changing the coverage of in-force business? Does this mean such a policy has to be written as non-life business since the insurer has an option to terminate the cover? The answer is no. If a policy has reviewable coverage, then considering this point alone, the contracts could still be written as long-term business.
Clearly the marketing of such a product needs careful consideration. Clear communication is vital - particularly at the point of sale. It is important that the policyholder understands the reasons for having reviewable coverage.
To help ally any suspicion of small print issues, safeguards need to be put in place, and be visible in product literature, to guard the policyholder against the life office acting unfairly. Such measures could include:
&149;A requirement that any change to coverage is purely as a result of medical advances, rather than, for example, poor claims experience.
&149;A requirement that new definitions introduced are in line with those used for new business.
&149;A similar requirement for the actual diseases covered.
&149;Altering the definitions to the most recent ones produced by the Association of British Insurers' Critical Illness Working Party.
&149;Ensuring the policyholder realises that changes are being made to all policies, not just to his or hers.
If cover is reviewable then it is necessary to charge premiums that reflect the cover being offered at the time. This means premiums will need to increase with age rather than be level. This should not be a particular problem and may well be an advantage in improving initial affordability, although there are clear systems, administration and illustration implications. Selective lapses are a possibility, but these can be managed through an active customer retention program and clear communication at point of sale. In the Australian market, where premiums increase with age, selective lapses are not viewed to be an important issue.
Reviewable cover
It is necessary to consider and communicate the claims issues that arise when definitions are changed. If a definition is tightened, for example, there needs to be the utmost clarity for the policyholder as to what is the current coverage of the policy. Particular problems are most likely to arise if claims' definitions are altered around the time of individual claims being assessed. Processes need to be put in place to manage such situations and clear communication with policyholders is absolutely vital.
In fact, the reviewability of coverage can, and should, be turned around and marketed as an advantage. This is achieved through positioning the product as always being up to date. So whatever happens in terms of medical advances or new diseases, the policyholder is always covered against serious illnesses while avoiding unnecessary payments of benefits (and higher premiums) for less severe conditions. This need not be restricted to new illnesses emerging. Extra diseases, which already exist but have not previously been covered, could be added to new products.
Customer contact
Reviewability also brings customer contact. Benefits include cross-selling, up-selling and data cleansing. Overall an intelligent customer relationship management programme can provide an opportunity to engage customers, hopefully leading to further sales opportunities, but at the very least, protecting the in-force business - an area often neglected in the pursuit of the important next sale.
Therefore, while marketing and claims challenges exist in such a product, they can, with careful thought, be minimised. It should be possible to convince the prospective policyholder of the logic and the benefit of the approach. Hopefully this would also extend to the IFA or salesperson, who while currently reluctant to consider these products, need to recognise that the current generation of fully guaranteed products is a dying breed.
The reviewable product, in terms of its structure and how it presents to the consumer, is the closest thing we have to the existing product. It is also vastly safer and therefore deserves serious consideration. Another way in which guarantees can be removed is from the premium rates, leaving only the coverage guaranteed throughout the policy term. However, this is a less than perfect solution, both from the life office's point of view and the policyholder's.
From the life office's and reinsurer's points of view there is the risk of selective lapses if premiums are increased significantly. There are also the wider issues to consider such as systems' time, costs and priorities as well as competitors' actions. Although these issues also arise if the policy coverage is reviewable, there is more scope to keep the premiums unchanged for these policies since the ability to review the definitions instead of the premiums provides additional scope for manoeuvre. It is also questionable whether, in practice, premiums could be reviewed to the extent necessary to cover any 'shocks' in claims experience.
From the policyholder's point of view, the issues about being locked into a set of ageing claims' definitions remain. There is no ability to update the cover over time. Yes, if the positive medical advances prevail over the negative, premiums will drop, but surely the point of the policy is to provide the right cover rather than wrong cover cheaply.
Renewable cover
Renewable plans are written in the majority of cases for terms of five years, after which the policyholder has the option of continuing cover by exercising the renewal option. The policy then issued is written on the premium rates current at the time and covers the illnesses and definitions available to new business. Therefore the renewable product is always up-to-date.
Guaranteed rates are also available as long as the contract term is not too long; around five years is the maximum offered by the reinsurers. There will be premium increases every five years due to ageing, but initial premiums will consequently be lower and guaranteed until the next five-year anniversary. Each renewal also brings the opportunity for customer contact for the life office and client contact for the intermediary. There is a risk management issue inherent in renewable contracts - that of anti-selective behaviour at policy renewal. This can lead to only those more likely to claim actually renewing their cover, meaning that normal premium rates will be inadequate. Renewal option loadings are charged to allow for this.
However, this aspect of renewable contracts could be mitigated in two ways and lead to renewal option loadings being reduced. First, the reason for purchase is important here. Renewable products have been taken out where cover is definitely needed for the first five years, say, but may or may not be needed after that. The situation is different, however, with much of the CI business sold today where there is a clear need for cover for the full policy term, for example, to protect a loan. Second, renewal could take place automatically, with an opt-out provision. Such an approach is viable if cover is required for a known term.
Overall therefore, the product automatically renews provided that cover for the full term of the mortgage is always up-to-date. With guaranteed premiums, customer contact is enhanced and anti-selection is limited. Renewable contracts would seem to have much to commend their increased use in today's marketplace.
Neil Reynolds is a director at Mercer Oliver Wyman
COVER notes
&149; Reviewable definitions would keep cover up-to-date with medical advances, but strict measures would need to be put in place to safeguard policyholders' interests.
&149; Renewable plans would also keep cover up-to-date and enhance customer contact, but may lead to anti-selective behaviour at policy renewal.
