The risk factors used to determine premium rates for risk insurance

Col Fullagar explains the risk factors employed to determine premium rates for risk insurance.

The marriage of insurers and actuaries is one of the great enduring relationships of the last several hundred years.

It is the actuary who wields such mysterious power behind the scenes, crunching the numbers to ensure the insurer’s business operates profitably.

If an actuary performs their role well and their assumptions are borne out within their predicted margin of error, when an insured event occurs the benefit amount can be paid from the claims pool without compromising the insurer’s profitability.

To ensure the claims pool remains healthy, actuaries review the particular type of insurance to be offered, assess the various ‘personal’ and ‘environmental’ risk factors and calculate premiums rates for the various categories of insured persons.

The personal risk factors taken into account include the age, sex and smoking status of the life insured. The environmental risk factors include earnings rates, expenses, mortality (death) and morbidity (disability) rates.

The assessment of risk associated with an individual is often initially based on the information provided within the insurer’s application form. If, however, the applied-for benefit amount is sufficiently high, insurers have a range of mandatory medical requirements that they request.

These mandatory requirements include such things as:

• medical examinations;
• blood tests; and
• electrocardiograms (ECGs).

This additional information enables the insurance underwriter to check for any health issues unknown to the insured, and the risks associated with anti-selection can be mitigated.

The prescribed benefit level at which mandatory medical information is requested is generically called the non-medical limit.

One of the more subtle environmental risk factors the actuary considers is the impact of non-medical limits and the obtaining of additional medical information on the viability of the insurer’s claims pool.

While the effective operation of non-medical limits is important for the insurer, from the client’s perspective it will delay application completion and from the adviser’s perspective it is often viewed as yet another hurdle to get over when writing risk insurance.

To bypass the perceived issues associated with non-medical limits, some advisers have taken to splitting the applied-for cover between more than one insurer so that the benefit amount is under the non-medical limits of each insurer.

But advisers would see the practice as meeting their duty of care to the client, since they could reduce the delay in application completion and avoid other issues associated with the obtaining of additional medical information.

In fact, in some circumstances, the practice constitutes a very appropriate component of the insurance recommendation.

While this may appear to solve the problem for the client and the adviser, it can have unexpected and more insidious impacts in other areas.

To assess when the practice is and is not appropriate, a more considered approach is suggested. Below are some matters that might be considered.

Price pressure

Actuaries make various risk assumptions when calculating premium rates.

To the extent that one of these risk assumptions is that mandatory medical information will be obtained when applied-for cover exceeds the pre-set non-medical limits, a deliberate action by the adviser and/or the client to avoid providing this information creates an element of anti-selection — which may in turn lead to an adverse claims experience resulting eventually in upwards pressure on premiums.

There is of course a temptation to say ‘not my problem’, however, one actuary when asked to estimate the impact widespread avoidance of non-medical limits might have on premium rates responded by saying the increase could be as high as 20 per cent.

An increase in this way would not only affect new applications but in-force policies as well. Mitigating this is the fact that a reduction in mandatory medical requirements will reduce life office expenses, which in turn will result in a downward pressure on premiums.

Non-medical limits include applied-for cover

While one reason for avoiding non-medical limits is to speed up the application completion process, this goal may not always be achieved.

Under the client’s duty of disclosure, it would be necessary for the client to respond positively if the question “Are you applying for similar cover elsewhere?” was asked in the application.

In calculating non-medical limits, some insurers not only take into account cover being applied for with them, but also cover in-force or being applied for with other insurers.

Even if this does not occur at the automatic level, it is likely a prudent insurance underwriter would take into account in-force or applied-for cover when considering what non-mandatory medical information to request.

If this occurs, splitting the cover might not achieve the desired outcome as the client may still be required to undergo additional medical tests.

Also, if underwriters become aware that a particular adviser is habitually avoiding non-medical limits in this way, they may be tempted to call for a spot check medical or personal medical attendants report (PMAR) in order to rebalance the anti-selection scales.

Product selection

The role of the adviser, in part, is to identify and recommend an appropriate risk insurance product solution for the client.

If, in order to avoid compulsory medicals, it was necessary or it may be perceived as having been necessary for the product selection process to be compromised, the adviser may be placed at some personal risk — particularly if the client was in some way disadvantaged.

The questioning of the appropriateness of product selection could occur at the time of the original application, at the time of claim, or at any time during the life of the policy — and the questioning may come from the client, another financial adviser or any of a range of other third party advisers to the client.

The above could call into question adviser actions for other cases, not just those associated with the avoidance of non-medical limits, which, naturally, could have dire consequences for the adviser and the adviser’s business.

Delays in application completion

If applications are lodged with multiple insurers, statistically, there is an increased risk of at least part of the total applied for benefit amount being delayed if one insurer is slower in completing their component of the cover.

The chances of this occurring increase considerably if the underwriter for one insurer decides to request additional information (eg, a PMAR) and the other insurer(s) become aware and wait until this information is received and then request a copy.

Even if the other insurers are not aware, should the additional information be some form of medical test such as lipids or an x-ray, the matter of what action needs to be taken under the client’s duty of disclosure may arise.

The client may seek to ascribe responsibility to the adviser if any problems that arise cause the client to suffer a loss.

Mitigating this, of course, is the fact that the application may have been delayed had a single application been lodged with one insurer.

Duty of disclosure

If the client was collaborating with the adviser in avoiding compulsory medical requirements because the client had reason to believe they may have a yet undiagnosed medical condition, this would need to be disclosed by the client under their duty of disclosure.

Faced with this disclosure, the insurer would likely request the medical information anyway.

Again, a mitigating factor would be the difficulty of proof (eg, if the client did not mention their apprehension to anyone).

If the client, following the advice of their adviser, intended to avoid non-medical limits by applying for cover on a ‘staggered basis’ (ie, subsequent insurance would only be applied for after the earlier application had completed), once again the client’s duty of disclosure may require that this be revealed.

The staggering of cover would certainly lead to additional delays in the total amount of necessary insurance starting, which again gives rise to risk exposure for the adviser.

Again, if an adverse medical condition was revealed, the perception of the insurer may be that anti-selection was being engaged in even if this was not the case. Proving innocence in this situation is not always an easy matter.

Financial adviser influence

There is a tendency for advisers to place material components of their business with a small number of insurers. By doing so, advisers are able to build up an improved relationship with the underwriters of those insurers and thus improve the chances of favourable acceptance terms for their clients.

The recognition that the total amount of cover an adviser places with a particular insurer influences the underwriter’s decision has even been mentioned in the judgement passed down in a recent court case.

The splitting of applications to avoid non-medical limits may reduce the impact of adviser influence.

Statements of Advice

Because of the potential impact the splitting of cover could have on the provision of advice, there would seem to be merit in disclosing the details of what is being done and why to the client. This may best be done within the Statement of Advice (SoA).

If avoiding non-medical limits by splitting cover led to a material increase in the total premium, for example, if one insurer’s rates were higher than another and multiple policy fees were being charged, an appropriate justification would again need to be included in the SoA.

If the justification was frequently and consistently along the lines of ‘the client is too busy to attend for medicals’ or ‘it would be inconvenient to the client’, the validity of the justification could be called into question either then or at some future date.

At the same time, however, it may be that a client working overseas is returning to Australia for a brief period and it would be impractical for that client to attend for compulsory medical examinations.

In this case, the justification of ‘inconvenience’ is valid. The adviser might speak to several insurers, alert them to the client’s dilemma and seek their co-operation in assessing split applications.

Client health risk

A case could be made, either legal or moral, that by avoiding the compulsory medical examination (which equates to a ‘free check-up’), the client is running the risk of not identifying unknown medical conditions. As a result the client’s health may be put at risk.

If a medical condition was subsequently discovered, the client may again seek to lay blame on the adviser for any loss that arose as a result.

The ‘laying of blame’ does not have to be justified nor does it have to lead to any legal action; but any gossip could lead to material damage to the adviser’s reputation or loss of clientele.

To avoid this risk, there may be a temptation to arrange for the client to have the medical after the insurance is in place; however, by suggesting this, the chances increase that the adviser and the client may be perceived as acting with complicity against the insurer.

The undertaking of post-application completion medicals could even lead to situations arising that might be viewed as a breach of the duty of disclosure which, in turn, might place the validity of the cover in jeopardy.

Claims complications

A primary purpose of putting insurance in place is to ensure that, when a claim occurs, the claim proceeds can be passed on to the client as quickly and easily as possible.

The use of multiple insurers may simply shift problems from the front-end when the application is lodged to the back end with an increased risk of claim delays, complications and inconvenience.

Delays may occur if each insurer requires their own forms to be completed. They may require their own claim requirements, or the process might be slowed if the insurers try to work together in a co-ordinated way.

Complications may also occur if different policy conditions and claim eligibility criteria apply between each insurer, for example:

• benefit offsets, which insurer offsets first; and
• policy definitions, where it is possible that one insurer may admit the claim and another may not.

All this will mean greater inconvenience for the client and the adviser.

Changes to non-medical limits

If the practice of avoiding non-medical limits became widespread it is likely that more or all insurers would:

• change their non-medical limit rules such that cover being applied for with other insurers was taken into account;
• reduce their overall non-medical limits; or
• increase their premiums to offset the anti-selection risk.

This would potentially affect all advisers and their clients.

Adviser and client credibility

The insurer’s and even the client’s perception of the adviser may be damaged if the adviser is or is perceived to be acting an a way that could be construed as ‘devious’ or ‘clever’ which could in turn colour the perception of the adviser’s actions in other areas.

If any non-disclosure or an unknown pre-existing condition was subsequently found, the credibility of the client and/or the adviser may be seriously damaged in the eyes of the insurer.

It may be that the credibility of other advisers who appropriately recommend the splitting of cover in isolated situations is damaged because they are inadvertently perceived in the same way as those who make a practice of medical avoidance.

Summary

There may be other issues associated with the practice of deliberately avoiding non-medical limits that have not been considered within this article.

While at first glance, this practice may appear to be well intentioned and client-focused and thus in line with the adviser’s duty to their client, this may not necessarily be the reality or the perception.

It is not the role or purpose of this article to say whether the practice of avoiding non-medical limits by way of splitting cover between insurers is good or bad, appropriate or inappropriate — that is the role of the adviser.

It is, however, the purpose of this article to assist advisers in making an informed decision for each client by taking into account the potential impact on:

• the individual client;
• the adviser’s portfolio of clients;
• clients generally if the practice became widespread;
• the adviser’s business; and
• the adviser.

Actions in isolation for the right reasons do not always translate to right actions if they become widespread or unconsidered.

Col Fullagar is national manager for risk insurance at RI Advice Group.