Premium guarantees demystified
It is important in the FAIS environment that a financial advisor explains a premium guarantee to clients. When products offer premium guarantees, it means that during the guarantee period a life insurance company is unable to increase the premium or reduce the corresponding cover. A premium guarantee therefore "protects" policyholders from a premium increase for a certain period of time.
Importance of a guarantee period in a financial needs analysis
The financial advisor must not only consider the length of the guarantee term, but must also be comfortable with a company's guarantee philosophy as this philosophy will influence the likelihood and extent of possible premium increases at the end of the guarantee term.
Some advisers might regard the guarantee term as irrelevant as they may have a view that the policy will not be needed for the full period or that the policy might be replaced beforehand. There are some risks associated with this approach. If policyholders become uninsurable and their policy premiums are adjusted at the end of the period, they will be unable to replace their current policies. The policyholders will then be forced to pay the higher, possibly unaffordable premium.
Future legislation may also impact on the replacement of policies, making it difficult to replace them. It is therefore important to take possible future increases into account during financial planning.
Equal premium guarantees?
Some insurance companies use a cross-subsidy model and offer one standard guarantee to all their policyholders, whereas other insurance companies offer a choice to their policyholders, i.e. a longer guarantee period at a correspondingly higher price. Only one insurance company offers an individually calculated guarantee period for each client. This philosophy is consistent with the individual calculation of the premium and as a result, this enables the offering of some of the longest guarantees in the market.
What happens at the end of a guarantee period
Life insurance companies use certain assumptions when they calculate premiums, i.e. expected claims, expenses and investment returns. When, at the end of the guarantee period, actual experience/reality differs from these assumptions, a life insurance company may need to review the premiums being charged. In practice, the most important factor when considering the need to review premiums at the end of a guarantee period is actual claims.
A healthy risk pool is important
In order to significantly reduce, or even avoid the probability of a premium review and a possible escalation of premiums, it is vital that an insurance company maintains a healthy risk pool. Certain insurance companies use some of the following strategies to ensure this:
* Upfront underwriting
If a policyholder is underwritten at inception, it ensures that the correct premium is charged for each client.
* Product features that reward healthy living
Through certain product features, policyholders are made aware of possible health problems, which they should then address. Life insurance companies use these product features to reward policyholders for maintaining a healthy lifestyle. This leads to a better claims experience from this pool of clients.
* Personal risk rating
This ensures that an appropriate premium is charged and that clients' premiums are not being cross-subsidised. It is consistent with the individual premium guarantee calculation method.
There is also a guarantee term extender available in the market that offers policyholders an opportunity to further increase the length of the guarantee period on qualifying life policies.
