Is the increasing use of medical underwriting in bulk annuity pricing now inevitable? Costas Yiasoumi examines how MUBAs have affected the pensions industry
The article 'Evolution or revolution' (The Actuary, June 2014) introduced the innovation of using medical and lifestyle information to price bulk annuities. 'Slicing and pricing: medical underwriting' (The Actuary, August 2015) explained how medically underwritten bulk annuities (MUBAs) can be used to 'top slice' the largest pensioners in a pension plan to de-risk concentrations of longevity exposure. So, the question is, where to next?
Over that time, MUBAs have grown from circa 3% of all bulk annuity transactions under £100m in 2013, to circa 10% in 2014 and to over 25% in 2015. There have also been two MUBA transactions greater than £100m, one of £206m and one of £230m. Trustees of over 75 pension plans have purchased MUBAs, representing over £2bn of premium since 2013.
Is the increasing application of medical underwriting in bulk annuity pricing now inevitable or will it recede into the actuarial history books as an interesting but temporary innovation?
Why does this matter?
MUBA growth has been fuelled by (a) the attractive pricing that has been seen by trustees and advisers, and (b) the ease with which MUBAs can be used to insure small sub-groups of large liability pensioners via 'top slicing'.
There are thousands of defined benefit pension plans on the road to annuitisation - for many, MUBAs may enable this sooner and at lower cost.
So tell me why medical data make a difference?
A key ingredient for pricing is life expectancy. The more confident an insurer is in its life expectancy assumption, the lower it can price a bulk annuity versus an equivalent pension plan with the same life expectancy, but with less insurer confidence in that assumption.
That doesn't mean other data is ignored. Pension amounts, postcodes, industry type and so on are still used, but medical and lifestyle data adds an extra dimension to traditional pricing methods.
For a single pensioner annuity, the benefit of that medical and lifestyle data can be enormous and probably swamps all other competitive differentiators between insurers. But the impact diminishes as the number of pensioners being insured increases until it is no longer a major competitive differentiator - that is, the 'law of large numbers' kicks in.
Does that mean medical underwriting is a 50/50 game?
Yes and no.
Without prior knowledge of a pension plan's health profile it is 50/50 as to whether the membership is more or less healthy than "average". But importantly, as explained above, by virtue of having knowledge of the health profile of the membership there is more confidence in the resulting life expectancy assumption.
Add these two aspects together and the net result is lower pricing on average - so better than 50/50 overall. Pension plans with poorer health characteristics attain even lower pricing; those with much better health characteristics receive higher pricing. Cross subsidies are reduced but this means a wider variation of pricing between pension plans.
The healthiest pension plans may have been better off purchasing a traditional bulk annuity (and traditional insurers would be better off not writing such plans!).
In this context, health is measured relative to the average for the relevant socio-economic group. So a white collar pension scheme is "healthy" if that is versus the average health for a white collar socio-economic group.
What number of pensioners is the sweet spot?
There is no definitive answer.
Small pension plans are particularly suited to MUBAs for the reasons described above, and will find ready attention from insurers concentrating on MUBAs.
Medical underwriting is highly unlikely to be a dominant factor for transactions covering, say, 1,000 pensioners. But the precise biting point cannot be certain. It will depend on factors such as industry type, homogeneity of the membership, member ages, as well as the relative strength or weakness of the other competitive factors for pricing. Even where medical underwriting might generally be expected to offer a better deal versus traditional pricing, that might not always be the case (and vice versa) as the specifics of each transaction will vary.
The largest MUBA transactions have covered a few hundred members - the likelihood is that a practical maximum benchmark size will develop over time within the industry, based on the experiences from actual transactions.
What about top slicing?
Even the largest pension plans have potential to use MUBAs.
Most pension plans have a skewed profile of pensioners; the ex-CEO in a £5 million pension plan representing 20% of liabilities or the 100 largest pensioners in a £1 billion pension plan representing 10% of liabilities.
Before MUBAs "top slicing" (insuring the pensioners with the largest pensions) was uncommon. Medical and lifestyle data offers significant extra underwriting insights to traditional rating factors meaning a more refined life expectancy calculation. In all types of insurance, more data = less uncertainty = sharper pricing.
A single top slice MUBA or progressive layers of top slicing MUBAs can be an effective way to insure liabilities. There have been various top slice transactions by small and large pension plans with premiums of up to £230m.
This is all very complex - how can trustees decide whether to request medically underwritten pricing?
The good news is, there is a way.
The decision on top-slicing might be slightly more complex. This is because if trustees undertake a top-slicing transaction they may be asked to supply the underwriting information from that transaction to insurers quoting on subsequent future bulk annuity tranches. Those insurers may take this into account in their pricing especially if the period between the transactions is not long. If that original underwriting data showed that those members were particularly healthy that may lead to a higher price for subsequent future tranches.
What about insurers that do not use medical data?
This is where things start to get interesting. At present, there is polarisation between those that use this method for pricing bulk annuities and those that do not. Over time, if medical underwriting becomes more and more prevalent, the differentiation may blur.
There is no doubt that the growth in MUBAs has been beneficial to the pensions industry. Based on the cost savings typically reported to date, UK pension plans have collectively saved tens of millions of pounds in bulk annuity premiums since 2012.
How prevalent MUBAs become in future remains to be seen. However, should the usage of medical and lifestyle data in pricing continue to generate lower premiums, as it appears to have done to date, usage will hopefully continue to rise as it should do in any well functioning market.
Further reading: 'The Good, The Bad and The Healthy', The Pensions Institute, January 2016, www.pensions-institute.org/reports/GoodBadHealthy.pdf
Costas Yiasoumi is director of defined benefit solutions at Partnership Assurance