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The Actuary The magazine of the Institute & Faculty of Actuaries
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Q x A = E

W hen discussing critical illness (CI) our
actuaries frequently use a formula similar to the following:
qx(1Skx)+Six
This formula sets out our high-level pricing model for accelerated CI. A formula that makes more sense to our non-actuaries is QxA=E quality multiplied by acceptance equals effectiveness. We use this formula in GE’s change management toolkit, and in a product development context to help us understand the dynamics of a successful product. There is no rocket science behind the formula, but it is a vital consideration which our industry consistently forgets. This article is an attempt to run through some of the key issues with CI using this formula. We will use the following definitions:
– Quality means a product we can confidently price profitably and administer.
– Acceptance will cover meeting customer need (customers include both salespeople/independent financial advisers (IFAs) and policyholders).
– Effectiveness is profitable, high-volume sales.

Customer need
A year ago GE Frankona Re carried out some research into CI as part of its ‘Future of critical illness’ project. We sent detailed questionnaires to three specific groups of people:
– IFAs;
– direct offices; and
– some of our own staff.
The first question addressed customer need. Virtually all IFAs told us CI was a great product because it met a key customer need. Conversely, nearly all the direct offices and our own staff suggested the biggest problem with CI was that it did not meet customer needs. Many respondents suggested income protection insurance (IP) was a much more important needs-based sale.
There tends to be a cynical view in the marketplace that IFAs have less of an understanding of the products, and true customer need, than do providers. Perhaps tongue in cheek, people claim IFAs are overly influenced by commission rates, or just sell the product that is easiest to explain and involves the least underwriting problems. However, when our survey questions asked about what works and does not work with the CI product, IFAs had a clear handle on where the product succeeded and where it failed their clients. Each had direct experience of a policyholder who had received a £250,000 cheque which paid off the mortgage, and some more problematic cases where a claim had been declined.
These IFAs do understand their customers’ needs. These are not theoretical needs thought up in a brainstorming session, but the needs seen by the IFA, taking account of the client’s circumstances and the product’s affordability.
As mentioned above, the survey showed many within the industry would put IP insurance before CI as far as protection needs are concerned. If you can maintain the customer’s pre-disability income when that customer is unable to work, then you have covered the customer’s biggest need. The ability of CI to pay off the mortgage in one lump sum or help with some lifestyle changes is great, but the customer could continue to pay their mortgage if they were still receiving an income. IP gets a big score for quality under our formula, but sadly does badly in the acceptance category. The product deemed by many not to meet the customers’ needs, CI, is selling like hot cakes, even in 2003 during a period of premium increases. This product is certainly not perfect but it has the attention of IFAs and the mortgage-buying public, giving a resounding ‘thumbs up’ from the market.
It is accepted that some CI sales have not been right for the customer, but we should be prepared to accept market demand as a true performance indicator of whether a product meets a consumer need. But has CI gone too far in attempting to satisfy this need, and become what many commentators have termed a lottery-style product? Well, in places maybe it has. Angioplasty and some of the less ‘critical’ claims triggers have perhaps crossed this line, largely owing to diagnostic and treatment advancements making identification and intervention much easier, and less risky, than before. As an industry we are concerned about paying ‘windfall cash’ to people who have not suffered a critical event. Let us look at part of our formula once more and check this out from both sides of the equation.
Quality
Obviously we need the product to be attractive to the customer, but we are looking to provide insurance cover. Unless we are covering critical events, the product will become more of a lottery ticket. Assuming we have this balance right, can we price the risk? There are some definitions it is difficult to price accurately, such as angioplasty. Here the policy pays out on the undergoing of a procedure, rather than the diagnosis of a specific disease. Our ability to track future incidence rates is therefore hampered by the uncertainties of future medical science, and NHS funding. The main illness-driven definitions, such as heart attack, stroke, and cancer can be priced with sufficient research into future trends, given enough credible insured lives data to accurately price on a disease-specific basis.
Are we happy paying for a valid heart attack claim when the policyholder returns to work three months later, with the mortgage paid off? We do not see any policyholders upset that they have had their mortgage paid off, regardless of whether their heart attack was a major or a minor one. For these customers the insurance company has done its job a success story! Some in the industry have cried foul, saying this is not what the cover was designed to do, but wasn’t it? The policyholder has been fortunate enough to recover from this heart attack, but he has an underlying disease process that will not disappear. He may want to pay off the mortgage so he can work part-time, or increase his pension contributions so he can retire early if his condition deteriorates. This is meeting a customer need, and one the policyholder appreciated at the point of sale.
We defined acceptance as insurance meeting a customer need if sales trends are anything to go by, this has clearly been achieved.

Guaranteed and reviewable rates
There has been much discussion recently about whether it is possible to price CI with long-term guarantees. A number of reassurers have decided they cannot price these guarantees accurately. This has significantly affected available market capacity.
From the customers’ perspective, this issue is less to do with a desire for guaranteed rates, and more to do with their nervousness about reviewable products, due to a lack of understanding. Many of the unknowns surrounding reviewable products can be addressed at the point of sale, providing an opportunity for the consumer to weigh up the suitability and affordability of each product. These questions would include:
– Will my premiums increase in the future?
– If they do, when, how often, and will I be able to afford them?
– If I cannot afford premiums in the future, will I have an alternative?
– If company A’s reviewable premium is 5% lower than company B’s which is best value to me?
A guaranteed rates product would indeed address these uncertainties. That said, reviewable products have a place in the market, offering a generally cheaper product, but with premiums being reviewed intermittently. To date, the acceptance of reviewable CI has been limited, outside protected sales channels, such as tied agents and direct sales forces. IFAs appear to be strongly in the guaranteed premium camp and it may transpire that customers and IFAs will always prefer a guaranteed product, as long as the price differential does not stretch too far.

Evolving definitions
You go to a bookmaker and place a bet on a horse. Your horse wins. You return to the bookies to pick up your winnings, only to find the bookmaker changed your horse for another when he realised too many people had won.
Evolving definitions products allow for both premium and claims definitions to be reviewed. The review could change the wording of the definition (eg redefining what a valid heart attack is) or add or remove the claims trigger itself. It is difficult to express in words quite how great this feature is for risk managers, but how poorly this product would score on customer acceptance.

The future
In conclusion, let us start taking customer needs more seriously. We should be taking greater notice of the salespeople, particularly IFAs, and not discount their view out of hand.
There is only one person who can define customer need: the customer. The customer wants value for money, an understanding of what they are buying, and security. Security comes not just from having cover, but knowing how much it is going to cost and whether this may change.
Our Q¥A=E analysis tells us that IFAs and customers alike have a genuine, understandable need for guaranteed rates. Let us not discount their need just because the industry has concerns over whether we can price accurately. Equally, we should not kid ourselves that concepts such as evolving definition products better serve customer needs. Nobody is going to market a product which they cannot profitably price (Q), but the successful son of CI will be the product that gets the highest acceptance score (A), thereby achieving profitable, high-volume sales (E).
Whatever your views on this, the fact remains that CI is a hit. We should be looking to build and improve on the product, but we need to ensure the salespeople and customers understand what we are trying to achieve, and we need their input before trying to develop successors to CI. In addition we must work on understanding why the buying public have such a low acceptance of IP insurance.

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