Author: Nick Johnson
7 July 2014
In past blogs I've talked about Netflix, freebies and popcorn. Trivial stuff. If you're expecting more of the same today, you're about to be surprised.
This week, I've been pondering death. More specifically, how to put a price on death (I'm still an actuary after all). Hang on, let me explain...
Is accuracy always a good thing?
I’ve been debating the merits of medically underwritten bulk annuities with a fair few advisers lately. Traditionally, bulk annuities are underwritten based on some broad factors, such as members' postcodes and occupation – and an assumption that schemes would have a range of healthy, normal and poorly members. This includes an inherent assumption that we would be right on average for the schemes we win.
Now we’re starting to use members’ medical information to underwrite – and price – bulk annuity schemes more accurately. Of course, a more accurate price doesn’t always mean a better price. Let’s say, for example, your scheme members turn out to be a bunch of health junkies. In this case, the price will likely go up – and naturally, that’s a concern.
With the current approach, trustees are asked to decide whether to go down a traditional buyout route or an enhanced buyout route. They may suspect that their membership is unhealthy, but they often make this assessment against the broader population. They won’t know the true impact of underwriting until medical data has been collected and analysed by the insurers, relative to the factors they would use in traditional pricing. In many ways they are being asked to take a gamble based on little or no information.
And then there are the practicalities. Collecting scheme members’ confidential medical information requires a new process (assuming you can convince them to give it to you). Designing and setting up that new process burns precious resources. And for what? A more accurate price. You see the problem here.
Why medically underwrite bulk annuities, then?
Full disclosure: until about six months ago I was a little sceptical of medical underwriting for bulk annuities. Now, generally speaking, I'm very supportive. So what’s changed my mind? Well, I have three basic hypotheses in mind:
- Individual medical information is a much better indicator of life expectancy than demographic assumptions.
- In a world where superior underwriting information is available, insurers who choose to ignore it risk offering an inferior price compared to insurers who take full advantage of it.
- Done the right way, it absolutely can be practical and cost-effective to collect members’ medical information. Especially for schemes with fewer than, say, 200-300 members.
Now, the individual annuity market shows us that hypotheses 1 and 2 are practically no-brainers. You just have to look at how the enhanced annuity market has developed, and the fact that there’s no answer you can give on the common quote request form (industry standard medical underwriting form) which could result in clients getting a lower retirement income. It can only go up.
Change is coming
I'll admit my third point is open to more debate, but that‘s rapidly changing.
Firstly, through use of enhanced transfers, pension increase exchanges and early retirement exercises, trustees have both accepted and proved that it’s perfectly possible to get scheme members’ cooperation when you need it.
Secondly, the small number of bulk annuities that have been medically underwritten to date suggests that members are willing to provide medical information. They just need to be asked in the right way, as part of a well-managed process.
Thirdly, there are a number of companies set up to help schemes gather members’ medical information in an efficient and cost-effective way.
A third way?
Clearly some trustees may have strong views on their membership and be of the firm opinion that medical underwriting is or is not for them. If this is the case, then we are more than happy to follow their desired route.
However, we don’t think it’s right to force trustees into a gamble over which route they take. At Aviva, we like to take a more practical approach to things. We don’t believe we should ignore the medical underwriting route – but also recognise that, for many schemes, underwriting will provide little benefit and may actually increase prices. Instead, we’re suggesting a third way. By working with schemes we can benchmark traditional buyout pricing. This means we can identify and target types of member for whom medical underwriting may produce pricing benefits, making clear both the potential for upside and downside before working intelligently towards a trade.
Calling all sceptics: will you accept my challenge?
For those who want to ignore medical underwriting: I’d put it quite simply: Pandora's box is open. Some schemes have chosen medical underwriting already. More are considering it. Momentum is building.
Some reluctant insurers are still hoping the lid of the box won't be opened too far. But in a market where price limits many schemes’ de-risking ambitions, and medical underwriting provides many a solution, I’m not sure that’s a realistic expectation.
Over the longer term, I firmly believe the market will move towards the approach used in the individual market: if you don’t provide medical information, you will simply pay a higher price. However, this will take some time to materialise and in the short to medium term I don’t think it’s reasonable to ask trustees to make the hard choices blindly. Clearly, we can’t give you the best of both worlds – but we can help you make a sensible choice, with greater understanding of the size of the risk and potential up and down side of your choices.
So to my challenge: if you are struggling to see how to navigate the yes/no decision on underwriting your scheme, give our third way a go. I’m hoping that, like me, you may become a convert.