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A small but important claws... or Schrödinger’s cat is (dead &) alive and well

Author: Nick Johnson

26 August 2014

You might remember that I blogged recently about Aviva’s view on medical underwriting for bulk annuity transactions.

For those who didn’t read it, or need a refresher on our view, we fully support the provision of additional data (be it medical or otherwise) to help us better understand the likely longevity of scheme members. However, we offer a word of warning that this data can lead to price increases as well as reductions and that trustees should go into such transactions with eyes wide open to the possibility of a downside as well as an upside.

This risk was brought to mind sharply this week when I was handed a brochure from one of the companies marketing underwriting services to trustees. Now, I am generally supportive of organisations which provide support services in this area. Collecting sensitive health data from pension scheme members can be a complicated and emotive issue, so having an experienced third party to assist makes a lot of sense. It should also bring advantages of consistency of collection and auditability – qualities which insurers find attractive.

However, I was somewhat concerned that this brochure made no mention of the following:

  1. Collecting medical data could lead to a higher price than standard bulk annuities, as well as a lower one.
  2. It could also limit the number of insurers willing to quote for the scheme.
  3. The decision point on whether to go for a medically underwritten or standard BPA is effectively the point at which you decide whether to collect medical data and NOT once you have analysed the results.

So where does the cat come in?

The importance of point c) shouldn’t be overlooked. Traditional bulk annuity providers are understandably concerned about the risk that trustees will only choose the traditional route if they have information to suggest that their members are healthier than average. For this reason they have largely adopted a process of excluding schemes where the ‘selection’ has occurred. In Aviva’s terms – and we’re not alone in this – we have a clause which requires that the trustees can only accept a standard quotation if they confirm they have not sought any medical information.

In many ways, this is a modern day version of Schrödinger’s Cat. (Yes, that does give me an excuse for the bad pun in the title. And yes again, the guy who’s forever telling you that understanding bulk annuities isn’t rocket science is about to tell you why they’re like quantum physics...)

Schrödinger’s cat explained

Physicists seem to like cats. Those of us of a slightly nerdy persuasion might have seen the ‘Quantum Cheshire Cat’ mentioned on the BBC website recently. Here’s the lowdown on its older cousin Schrödinger (though you’ll probably change the explanation by observing it...)

https://www.youtube.com/watch?v=IOYyCHGWJq4

The very act of looking at the possibility of getting medical data fundamentally determines the state for the bulk annuity. Hence the reference to every physicist’s favourite dead-and-alive moggy.

From this point forward, the bulk annuity is more than likely to be treated and priced as if all members are healthier than average, with analysis of the data being provided used to (hopefully) reduce the price.

As far as I’m aware, Aviva is currently the only company that has written both medical underwritten and standard bulk annuities, so we are pretty agnostic to which route trustees choose. However, we are also committed to making sure trustees make decisions in the full knowledge of the facts. So while I know that companies’ marketing material is designed to point out the benefits of their particular service, I think there is also an obligation to point out the limitation and risks as well.

Which means it’s time to let the cat out of the bag, as well as the box.

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