Risk pooling for members, central to the ongoing sustainability of insurance, is potentially at risk of being unwound as members exploit the system by buying cover that they are not entitled to.
Like playing the house at a casino, players will always look for even the slightest advantage to tilt the odds in their favour. In a casino card game like blackjack, counting cards creates an edge by giving the player more information. It isn’t illegal but casino’s try and spot counters and ban them from playing to ensure their house advantage remains intact.
Similarly, in life insurance, having more information than the house can provide an edge. This information asymmetry is known as anti-selection and like a casino, if enough members took advantage, a small change in odds could detrimentally impact all the remaining members.
This risk is not theoretical. Group insurance continues to offer consumers in ill-health an opportunity to access sizeable insurance cover without underwriting. Inconsistencies in advised insurance also allow selection against the insurers. For example, seven insurers could respond with seven different answers on the same advised case of an applicant with Type 2 Diabetes.
The life insurance industry also does not have a mechanism to monitor cover levels across multiple insurers and there are real examples of policyholders claiming significant amounts across more than one provider. Practically, today, consumers can still double down at different tables at different casinos.
There is an increasing google trend of consumers searching for the term ‘pre-existing condition’. The growing use of social media forums and information availability provides consumers sometimes with more information than even the insurers assessing the risk. Global medical testing is now available and these results are not globally linked up to one single patient system. Adding to this, availability of policy information no longer requires writing or phoning the insurer (or digging up your policy) but the product disclosure statements can be reviewed online and immediately, across multiple providers. They are taking out life cover when they shouldn’t technically be able to access it.
With PYS already implemented and PMIF due for implementation next April, one of the key challenges for insurers and reinsurers relates to the potential for a disproportionate number of members with favourable information on their health to opt back in.
Life insurance is fairly unique relative to other insurance types in that it has a very low incidence rate (on mortality for example, the probability of a 40-year-old dying is of the order of 0.1 per cent or 1 per mille in actuarial speak). It also has very high sum of insureds, averaging around $300,000 for group insurance lump sum risk. This is in contrast with motor insurance where there is a 15 per cent probability of a claim and just under $3000 average claim size.
As a result, it takes a surprisingly small number of extra claims to negate a portfolio’s profitability. Just five extra claims of $100,000 or one large extra claim of $500,000 on a 20,000-person scheme could increase the claims cost by 25 per cent for that group. Extending this, it might take only five extra claims on a block of $50 million to reduce profits by 5 per cent. Picking on one illness only, there are an estimated 50,000 deaths from cancer expected in 2019, highlighting an example of the risk that members in poorer health are more likely to be the ones opting back in.
There is a common misconception that insurance removes this risk but all insurance delivers is a deferral of the cost impact into the next rate change – ultimately members pay. If one extra claim of $500,000 significantly impacted the cost for the other 19,999 members of the scheme, then trustees must manage this risk for the collective best interests of members.
The underlying product design assumptions that we’ve used for the last 20 years have also shifted in that the link between work and illness is different, with consumers able to continue part time working while sick. Similarly, the link between financial impact and illness has also fundamentally changed, with many illnesses able to be treated quickly and allowing return to work. Stage 1 cancers do not financially impact consumers the same way as they used to historically. Lastly, we are moving into the consumer expectations age where the spirit of the policy is becoming more prevalent. Declining claims is becoming increasingly difficult and there is likely a move away from use of pre-existing conditions or disclosure monitoring at claims stage.
Group insurance is changing as a result of the legislation. We are moving closer to an opt in model for new members than the traditional opt out. Despite views on whether this in itself is good for members, that horse has bolted. Funds and insurers need ensure that the unintended consequences are carefully considered for all members, in particular challenging the historic thinking and techniques on anti-selection and managing the sustainability of their risk pools for the benefit of all members.
Ilan Leas is managing director at Retender, the risk specialist.