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The Actuary The magazine of the Institute & Faculty of Actuaries

Scaled benefits a balanced view

Current critical illness policies pay the full sum assured for all of the listed illnesses. There have been calls recently to vary the sum assured according to the severity of the illness suffered or surgical procedure undergone. The logic of these ‘scaled’ benefits is to produce a more exact match benefit and need, thereby reducing windfall gains and anti-selection, and also lowering premiums. These are all laudable aims, but will scaled benefits really improve the situation?

Matching benefit and need
The article will concentrate on matching benefits and needs and the related problem of ‘windfall’ benefits, since these are often quoted as a problem with current product design and the introduction of reason-scaled benefits. ‘Mild’ heart attacks are a good place to start, since these are the most common type of ‘windfall’ discussed, but the same reasoning can apply to many other diseases.
Consider the situation of two people with a scaled benefit critical illness policy. Both experience a ‘mild’ heart attack (with little long-term disability resulting) and the benefit paid is 50% of the full sum assured. The first person may want to return to full-time work shortly after the event, while the second individual might prefer a long period of convalescence, followed by part-time employment. Policyholder one would be happy with the reduced benefit because he enjoys the rigours of the workplace and is eager to return. The second policyholder would rather avoid the stress of full-time work, concerned about a second attack, but the scaled benefit dictates his reaction to his illness it tells him that his heart attack was not serious. The raison d’être of critical illness insurance provision of the financial flexibility to react to a critical illness has been lost. It is very difficult to match benefit with need, since each individual’s needs are very much their own. It is important to remember that there would be nothing wrong with paying each person 100% of the sum assured the heart attack was not anti-selective behaviour and the covered event would have been included in the pricing.
What is meant by the phrase ‘windfall’? I would define ‘windfall’ in the context I often hear it discussed as ‘something which, if it happened to you would be devastating, but if it happens to someone else is nothing to worry about’! The oft-quoted ‘mild’ heart attack is a misnomer. I remember attending a presentation by Marius Barnard, the pioneer of critical illness insurance in South Africa and world-famous heart surgeon. At one point in his presentation he said there was no such thing as a mild heart attack. It is not a phrase you hear used by those who have suffered a heart attack only those who haven’t.
To look at the issue more quantitatively and less emotionally, it is useful to examine the ratings that would be applied at underwriting stage on a life policy taken out by someone who has had a ‘less serious’ heart attack. ‘Less serious’ is defined as an attack where there is a full recovery, no further symptoms, a return to full-time employment within six months, resting and stress ECGs within normal limits in layman’s terms, ‘mild’.
Our underwriting manual categorises heart attacks according to severity. The least serious, as described above, is class 1. This type of heart attack is pretty unusual the vast majority are class 2 and upwards. The loadings given in table 1 are for someone aged 4049, a typical age for a critical illness claimant, and assume no other complications, such as hypertension.
A typical mortality rate for an unrated insured life for this age group would be around 1‰. Therefore, in the years immediately following the least serious form of heart attack, the sufferer is experiencing mortality of 12 to 13 times the normal level. It is difficult to describe a payment in such circumstances as a windfall.
Remaining with heart conditions, the view is often expressed that angioplasties and bypasses should not qualify for the full sum assured, ie that they are not critical. Such arguments are often justified by referring to time off work as somehow being the relevant criterion for determining the severity of the illness. This is unlikely to be the opinion of a cardiologist who is able to look past the length of absence from work or type of operation undergone and instead focus on the clinical need for the operation, ie the underlying disease, as well as the effect on quality of life, mental state, and the threat of more serious illness in the future. It is interesting that our underwriting manual would give similar ratings to those just seen for heart attack for someone who has undergone either a bypass or a two-vessel angioplasty. The treatment is only palliative, it is not a cure and the person remains ‘ill’ and at risk of premature death.
Which ‘scale’?
If scaled benefits are going to be introduced, what will the ‘scale’ actually be? It may be instructive to take a current list of 30 or so illnesses and classify them into three categories: critical, moderate, and ‘emotional’. Where would one place multiple sclerosis perhaps in the moderate category, since life expectancy could be 20 years or so following diagnosis? What about blindness surely less ‘critical’ than MS, and with little effect on expected mortality, so perhaps in the ‘emotional’ category? A discussion with the claims underwriters and/or CMO at this point would be useful and is likely to bring home the point that it is important to consider not only the life-threatening aspect of the covered diseases, but also their impact on quality of life and emotional state. Critical illness insurance provides ‘living benefits’ and as such, quality of life and emotional state are important factors when considering how the benefit will actually be used or the nature of the ‘need’ that is being met. It is likely that following this exercise and considering ‘need’ in this much wider sense, most diseases would fall under the ‘critical’ column.

Will scaled benefits reduce anti-selection? Probably, to the extent that the incentive for non-disclosure is reduced. But it was seen above how the ‘mild’ heart attack can actually happen in a non-selective way and how most covered events would be classified as critical. Additionally, the claims experience seen to date on critical illness business shows no particular problem with anti-selection. There is no doubt that it does exist and very early claims are seen, particularly from breast cancer and MS, but the overall experience appears to show greater positive selection than that seen in mortality business.
Scaled benefits last for the term of the contract. Most anti-selection occurs following policy inception. Any anti-selection that does occur could therefore be better tackled through a moratorium (nil claims period) or better still, via improved underwriting questions.

Added complexity
Having considered the issue of scaled benefits in some depth, it is doubtful that their introduction would have the effect that many imagine. Benefits may not match needs any better, since those needs are very much individual. Taking a wider definition of ‘needs’ to encompass quality of life and emotional state, the argument becomes even less convincing. Windfall benefits don’t need to be removed, since they don’t exist to any large extent. Anti-selection could be tackled better in other ways and, in any case, is not a particular problem. Cost savings would be small, since most diseases are ‘critical’ anyway.
What scaled benefits would add, however, is complexity complexity in the areas of underwriting, claims, administration, product design, and pricing. Perhaps the most important area where complexity will have a negative effect will be at point of sale. It is important to remember that the public isn’t interested in insurance. Complexity is a big turn-off at sales stage. The current simplicity of the product is a big plus point why change it?
Scaled benefits may have a place, however, in the high sum assured market. Because of the mismatch of benefit and need, sums assured tend to be limited to £1m for personal cover and £2m for business covers. Higher amounts have been written, although these remain rare.
Some of the reasons given earlier may not apply to this market sector. There may be more incentive to return to work for this group of people than for the average person. The argument about financial flexibility post-claim may also be less relevant for wealthier individuals. They are more likely to understand the scaled benefits product and the reasons behind it.
There is therefore a possible place for scaled benefits in the UK market. If used for the high sum assured segment, they may add real value in allowing higher benefits to be offered. Their use elsewhere, however, is likely to lead to reduced sales levels with no obvious benefits in return.