With the critical illness market in a state of turmoil, the search is on to find the next generation of successful products. Neil Reynolds looks at two possible solutions
Success in the critical illness (CI) market is likely to be measured by two overriding criteria - marketability and risk management. There needs to be a product which people will buy, but there also needs to be reasonable protection for the providers of the life offices' and reinsurers' capital by not exposing them to unnecessary risks. Either of these criteria on its own makes for an unsuccessful product; achieving the right balance is crucial.
In a series of two articles, we examine some possible product designs that aim to tackle these challenges. This article looks at the disability underpin and scaled benefits.
The disability underpin
Perhaps the best way to protect the life office against the ever-advancing pace of medical advances is to insure the sickness of the individual rather than a set of ancient claims' definitions. The premise here is to add an additional claim criterion - the underpin - to the current product. So, in addition to meeting the claim definition of one of the covered diseases, there must be a certain degree of underlying illness or disability present before a claim is valid. This would also be an effective way of restricting those "windfall" benefits we often hear about.
Such a development benefits the life office since only serious claims are paid. More importantly there is an in-built 'hedge' against medical advances as there is still the requirement to be disabled before the benefit becomes payable. It could be that a fixed disability underpin becomes more difficult to fail as time goes by and medicine improves. Therefore, rather than medical advances being a potential disaster for claims experience, they could become an aid to product profitability.
It could also be argued to benefit policyholders since premiums are not wasted paying less serious claims. Additionally, the product automatically keeps itself up to date since the main driver of claims is the disability underpin rather than the individual claim definitions themselves. This product variation would therefore appear to have much to commend it.
So, how should a suitable disability underpin be constructed? One approach would be to include it within the definition of the individual illnesses. For example, looking at the current Association of British Insurers' (ABI) stroke definition: "A cerebrovascular incident resulting in permanent neurological damage. Transient ischaemic attacks are specifically excluded."
It would be relatively easy to add activities of daily living (ADL); activities of daily work (ADW) and functional assessment tests-based wording. The current definition may appear to have a disability underpin, as there is a requirement for permanent neurological damage. However, damage could be permanent, but very small and the situation is analogous to that surrounding heart attacks and troponins.
While such an approach may be suitable in the case of stroke, it is not feasible to apply a blanket ADL criterion to all covered diseases since some would not result in the failure of ADLs. Many forms of cancer, for example, while being of clear severity, would not result in ADL failure. The two-stage claims process could also be problematic.
The alternative of tailoring a disability underpin to each individual illness would be a massive task just when the industry had settled on standardised claims' definitions through the ABI's Statement of Best Practice. It would also result in the definitions being even less clear to consumers than is currently the case with obvious consequences. A further problem with the use of an ADL/ADW disability underpin is that it brings us into the realms of the disease with the most problems at claims stage - total and permanent disability (TPD).
TPD is notoriously difficult to price due to the lack of available claims data and appropriate surrogate data. The CI sub-committee of the Continuous Mortality Investigation (CMI) Bureau is now gathering claims data split by type of claim. However, with only 62 TPD claims for males and females combined for 1999 - the latest year's data available - it will be many years before that can be used for pricing.
A more serious problem exists with TPD however, as a stand alone variant - it doesn't sell. There is limited appeal to the man in the street, assuming he can understand the cover and trust in the two-stage claims process, to buy a product when he probably doesn't know anyone of working age who is permanently disabled. Similarly, the distribution channels are likely to be less than enthusiastic. We end up with a triumph of risk management over marketability - a product which manages the risks to the capital providers pretty effectively, but which doesn't provide a healthy profit to them since sales would be negligible.
Nevertheless, there may be some applications for such a product. It does provide a large degree of future-proofing against medical advances. It may even be offered on a guaranteed premium basis if reinsurers feel the long-term trend in permanent disability is likely to be downwards. This could allow decent profits to be made if pricing is at today's level of disability.
There is also the cost saving. If a hybrid product is launched paying 50% of the sum assured on diagnosis as at present and the remaining 50% if failing three ADLs six months later, the premium could be reduced by 25-30%. This may be an attractive proposition in some market segments, but such a product is a long way from CI as we know it. Product development needs to bear this in mind.
Scaled benefits
Scaled benefits, where the sum assured depends on the severity of the illness suffered, are another possible means of reducing the risks in the product since less serious illnesses only qualify for a lower payout. Some proponents argue that they also produce a better match of benefit and need. This is true to some extent, although it needs to be remembered that needs in a "living benefit" product are very much individual. The underlying premise of CI insurance, the provision of the financial flexibility to react to a serious illness, is diluted in a scaled benefit product.
Similarly, it is alleged that windfall benefits are reduced with a scaled benefit product. Again there is some truth in this, but it is instructive to consider what is meant by "windfall". Angioplasties are often referred to as non-serious events (by those who haven't had one) with the length of time spent in hospital somehow being used as an appropriate severity criterion. This ignores the fact that the treatment is only palliative and the risk of premature death remains. Heart attacks, too, are sometimes referred to as minor by the casual observer who probably wouldn't be as relaxed about their own cardiac death.
This brings us onto choosing an appropriate scale. Where, for example, would multiple sclerosis be categorised? What is the criterion for assessing severity? Is it effect on life expectancy, quality of life, emotional state or something else? What about blindness, which has an immaterial effect on mortality? Is this less serious than cancer? What about deafness - isn't there a case to be made that blindness is more severe than this? These are all issues that need to be answered - and explained at point of sale - if a scaled benefit product is developed.
There is certainly logic in the scaled benefit approach, but the practical difficulty of choosing the scale should not be underestimated.
There could be a place for scaled benefit products in tackling anti-selection. Current CMI results show worrying signs of anti-selection in the early years following policy inception. Positive selection would result in claims' experience in the early years being lower than in the later years due to the beneficial effects of underwriting. Here the situation is reversed (at least for males), indicating possible anti-selection at early durations. It is too early to say whether this reflects the true position, and data for later years is currently being analysed by the CMI.
Scaled benefits could help here, assuming someone is likely to delay policy purchase only for less serious events. However, the diseases causing problems here are multiple sclerosis and breast cancer, each of which is likely to be paid out at a high level of sum assured. Also, scaled benefit solutions to tackle anti-selection are rather blunt since they are in place throughout the contract term.
Scaled benefit products also add complexity to the market. The main area where complexity is added is at point of sale. It is vital to remember that the general public is simply not interested in insurance. The current simplicity of the product is a huge plus point and should only be amended with great care.
Scaled benefits may have a place, however, in the large case market where sums assured are restricted. Some of the points above may have less relevance in this market sector. There may be more incentive to return to work for this group of people than for the average person. So the argument about having the financial flexibility to react to a critical illness could be less relevant. Financial flexibility may be less of an issue for wealthier individuals in any case. They are also more likely to understand the scaled benefits product and the reasons behind it, so the point-of-sale issues are less of an obstacle.
There may therefore be a place for a scaled benefit product in the market. If used for the high sum assured sector, it could add real value in allowing higher benefits to be offered while better managing the risks for the life offices and reinsurers. Its use elsewhere, however, while having many positive factors, still requires the tackling of some very difficult issues, not least of which is the availability of a market.
COVER notes
• Having a disability underpin can protect insurers from medical advances, helping to keep premiums down. But blanket claims criteria may be hard to apply to different conditions.
• Scaled benefits could produce a better match of benefit and need and keep costs down. But choosing a scale of cover would be difficult to advise on at the point of sale.
