Preferred underwriting as a competitive tool
Risk transfer and pooling form the backbone of life insurance, as these factors allow the insurer to cover claims out of a common pool. However, in order to maintain some degree of equity among individuals exhibiting different mortality risks, insurers have classified and charged insured lives according to statistically credible and well-accepted characteristics, through the process commonly referred to in the industry as underwriting. In South Africa, most companies vary standard terms according to age, gender, smoker status and socio-economic class (a combination of income and education).
In South Africa, blood tests are required for almost all underwritten policies, primarily due to the high prevalence of HIV in the country. As a result, insurance companies have the opportunity to test blood for cholesterol and cotinine, which determines smoking status, in addition to testing for HIV. At the same time as the blood is drawn, both blood pressure and Body Mass Index (BMI) can also be recorded. Most insurers currently only use this information to determine whether the client will be accepted at standard rates or whether the premium will be loaded.
‘Preferred underwriting’ is a common underwriting approach in the United States and Canada that looks primarily at various risk factors such as blood pressure, BMI, cholesterol levels, family history and motor vehicle reports (driving record). The use of these factors aims to stratify the standard risk pool fairly and accurately. Preferred underwriting therefore makes use of much of the same information generally collected in South Africa to split the standard rates pool of lives into those clients who are eligible for lower premiums, due to being better risks, and those who require higher premiums, as they are worse risks. This is commonly done in North America for most life cover policies, but the concept of preferred lives can theoretically also be applied to, and may have an even more significant effect on other forms of cover, such as disability and critical illness (dread disease).
The first form of preferred underwriting was the introduction of lower rates for non-smokers in the 1960s. In South Africa, for a given product with a specific underwriting process, this has already become part of standard rates, as these rates have already been set by age, gender, smoker status, occupation, income and education. This allows approximately nine-tenths of applicants to be accepted at the standard rate, with the remainder either rated or declined.
At its most elementary level, the ‘preferred lives’ concept divides a standard sex and smoker-distinct class into more sub-classes through the use of additional rating criteria which are objectively defined and measured and are known to be predictive of relative mortality. The extreme application of the preferred life insurance concept results in a unique rate charged to a particular individual based on that individual’s unique mortality risk profile. As long as death remains haphazard, the principle of insurance is left intact. By removing any existing mortality cross-subsidy in the insured pool, this ultimate preferred life insurance represents the philosophical opposite of charging all insured lives an identical rate. In effect, such insurance promotes complete insurance equity as opposed to complete insurance equality.
The preferred lives concept can also in certain circumstance be considered likely to encourage healthier and safer lifestyles, an effect that had previously been noted within the much smaller group of rated insured lives. However, in reality the preferred lives concept was not introduced for the principal benefit of encouraging healthier lives but rather used as a way to reduce premium rates for better risks in a highly competitive insurance market.
It appears that the continued development of preferred life insurance is inevitable as the insurance industry continues to gain knowledge and experience about the link between various conditions and mortality, and due to further pressure from increased competition in the industry. From a consumer perspective, it may be argued that preferred life insurance is welcomed because it represents a fairer pricing system, as it sets rates using a more accurate assessment of a life’s relative mortality risk.
By: Grete Kritzinger (pictured), Business Development Executive, RGA Reinsurance Company of South Africa Limited
