Group LTD Pricing Issues SOA Spring Meeting, Dallas, Texas May 30, 2001 Session 48 Rick Leavitt - Smith Group Delaine Hare - Fortis Benefits Dave Fitzpatrick.

Group LTD Pricing IssuesSOA Spring Meeting, Dallas, Texas

May 30, 2001Session 48

Rick Leavitt - Smith Group

Delaine Hare - Fortis Benefits

Dave Fitzpatrick - The Standard

The economy, circa 1998-2000

• Decline in unemployment

• Interest rates started to rise

• Rising Index of Leading Economic Indicators

LTD industry, circa 1998-2000

• Improving LTD profits– Positive results, but is ROE strong enough?– But it beats the early 90’s

• Deteriorating STD profits– Suddenly losses!

Where’s the cheese?

• Who got the cost savings resulting from managed and integrated disability?– The carrier????– The employer????

The economy, circa 2001

• Stock market has stumbled

• Unemployment starting to rise

• Interest rates falling

• Index of Leading Economic Indicators is on the rise

• Consumer Confidence falling

Agenda

• Manual rating pitfalls

• Competitive pricing pitfalls

• Measurement & accountability

Manual rating pitfalls

Rick Leavitt

Smith Group

How Useful Are Your Manual Rates?

1. Do they accurately predict claim costs?

2. Are they adjusted for current risk dynamics…Unemployment? Discount Rate?

3. Do your underwriters use them?

4. Do you track sold to manual rates?

Common Pitfalls: Inforce vs. New Sales

For Example: Current Rate Block Change

Segment A: 33% -10%

Segment B: 33% 0.0%

Segment C: 33% 10%

Estimated Rate Impact: 0%

In Reality: New Rate Sales Change

Segment A: 60% -10%

Segment B: 30% 0.0%

Segment C: 10% 10%

Actual Rate Impact: -5%

Common Pitfalls: Rate Variables are Dependent

Current Factor Actual Cost

Own Occupation: 24 Month 1.00 1.00

Unlimited 1.10 1.10

Industry: Doctors 1.50 2.00

Lawyers 1.20 1.10

All Other 1.00 1.00

24 Mo Unlimited

Variables are Doctors 30% 70%

Dependent Lawyers 50% 50%

All Other 80% 20%

Consider an example

Common Pitfalls: Rate Variables are Dependent

Hypothetical Example:

Results of Own Occupation Study

Pricing Factor Observation

Unlimited 1.10 1.26

24 Month Own Occ 1.00 1.02

Do you need to adjust the Own Occ factor?

Common Pitfalls: Changing Dynamics Over Time

Three Year Study shows rate is right on…

What is appropriate for 2001?

85

90

95

100

105

110

115

1998 1999 2000 2001

1998 19992000 2001 ?

Smith Group Comparison of Filed Manual Rates

• 12 Top Companies

• Sample Calculations on over 1000 Representative Cases

• Manual Rates Calculated as Publicly Filed

Smith Group Comparison of

Filed Manual Rates: Distribution of the Ratio of Manual Rates

0%

10%

20%

30%

40%

50%

1 1.5 2 2.5 3 3.5 4 4.5 5

Max/Min

Max/Avg

Avg/Min

Smith Group Comparison ofFiled Manual Rates:

Variation of Individual CompaniesCompany A versus the Average

0

0.5

1

1.5

2

2.5

0 0.5 1 1.5 2 2.5

Average Manual Rate

Co

mp

an

y A

Ma

nu

al

Ra

te .

Smith Group Comparison of Filed Manual Rates:

Variation of Individual CompaniesCompany B versus the Average

0

0.5

1

1.5

2

2.5

0 0.5 1 1.5 2 2.5

Average Manual Rate

Com

pany

B M

anua

l Rat

e .

Smith Group Comparison of Filed Manual Rates: Industry Factors

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

Ag

ricultural,

Min

ing, O

il and

Co

nstru

ction

Manufacto

ring

Transportation

Wh

olesale T

rade

Retail T

rade

Ban

king

Mo

rtgage

Secu

rity Bro

kers

Insuran

ce

Insuran

ce

Real E

state

Investm

ent

Ho

tels/Person

al

Ad

vertising

Data P

rocessing

Miscellan

eous

Do

ctors Offices

Health

Services

Legal Serv

ices

Edu

cational

Social Services

Eng

ineering

Go

vern

ment

Smith Group Comparison of

Filed Manual Rates: Area Factors

0.75

0.85

0.95

1.05

1.15

1.25

MA

NJ

NY

PA MD

VA

NC

GA

FL TN

OH

IN MI

WI

MN

IL MO

TX

CA

WA

Pricing pitfalls

Delaine Hare

Fortis Benefits

Recipe for top line growth

• Discount 10% for “value” contract

• Discount 10% for early intervention

• Discount 10% on “good cases”

• Discount 5% for packaged LTD/STD

• Guarantee the rates for 3 years

…and the bottom line

• Have you been too aggressive?

• If so, can you recover?

• Renewal is a double-edged sword– One big increase - can you afford the poor

persistency?– Layered increases - can you afford the good

persistency?

Watch your tail

• Better claim management improves claim closures at early durations

• What happens to closures at later durations?

• Is your reserve tail as strong as it used to be?

Simple reserve illustration

• For relative comparison only

• Not an opinion on what is an appropriate pricing discount

• Sensitive to termination rate assumptions – Valuation table, age, sex, etc.

Manage the early claims...

0.0

0.2

0.4

0.6

0.8

1.0

0 24 48 72 96 120 144 168 192 216 240

Months of duration

l(x) Base

Improved

• 45 year old• 20% better term rate for 24 mo.• Same term rate after 24 mo.• 19% cost savings

…without managing the old

0.00.10.20.30.40.50.60.70.80.91.0

0 24 48 72 96 120 144 168 192 216 240

Months of duration

l(x) Base

Improved

• 45 year old• 20% better term rate for 24 mo.• 20% worse term rate after 24 mo.• 9% cost savings

Watch your assumptions

• Improved claim management & stronger contract

• Did they add to your margins?– Did you give it all away?– Was it as big as you thought?– Some cases may not benefit at all

Table 95a / Basic 2000 Table

• Concerns expressed over appropriateness of this table

• Termination rates in later durations appear to be overstated

• Reserves may be deficient

Value of early intervention...

LTD without benefit of early

intervention

LTD with benefit of early

intervention

…is relative

LTD without benefit of early

intervention

LTD with benefit of early

intervention

LTD with no STD coverage

in front

Claim Manager of the Year

• The award goes to… Nobody!!!

• Starvation effect– Elimination period is akin to a deductible– Nothing controls incidence like loss of income– When you add STD coverage, what are you

replacing?

What is a “good case”?

• Manual rates already reflect the “good” plan design & “good” industry

• Is “good” experience really credible?

Persistency & profitability

85%

90%

95%

100%

105%

110%

115%

Rate Charged Profitable Rate

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

…during a recession

• Drop in interest rate raises the bar

• Higher unemployment may raise the bar

85%

95%

105%

115%

125%

Rate Charged Profitable Rate

Measurement & accountability

Dave Fitzpatrick

The Standard

Calculated (Manual) Rates

• Group Aging and impact on rates? (recession and baby boomers)

• Aging census one year can increase claim costs 5-10%

• Multiple year rate guarantees?

“You can’t manage what you can’t measure.”

“What gets measured gets done.”

Bill Hewitt, 1991

Successful Measures of Sold-to-Calculated Rates

• Actual-to-Expected Analysis

• Can easily be aggregated at underwriter/rep /plan level

• Can help in pricing vs. loss ratio analysis only

• Provides a measurable target that is easily understood

Reasons Why Rates May Vary

• Underwriting Considerations

• Mistakes

• Experience Rating

• Credibility

• Underwriters may discount loads

• Change in census from proposal to effective date

Return on Equity (ROE)

• Formula for Underwriters to ensure attainment of ROE targets

• ROE = Net Income/(Average Equity)

• Equity = Required surplus + (STAT reserves - GAAP

reserves)

Return on Equity (ROE)• An elegant formula:

Equity =

where C0 = Asset Risk - Affiliated Amounts

C1 = Asset Risk - All other

C2 = Insurance Risk

C3a = Interest Rate Risk

C3b = Health Credit Risk

C4a = Business Risk

C4b = Health Adm Exp - Business Risk

k

} )VAdjustedompany C - VCGDT (1987

] )()( )( )C(C {*[yieldsmoney new

x100

24

23

22

2a3140

tbpSPIA

xt

bba CCCCCA

Return on Equity (ROE)

Pros and Cons of an elegant formula:

• Impressive to look at and discuss

• Difficult to challenge

• Hard to explain

• Not understood by underwriters and many normal actuaries

Return on Equity (ROE)

• An example of a much simpler formula:

Equity = 30% of annualized premiums +

30% of case reserves

Possible to approximate to fit individual company’s equity requirements!

Return on Equity (ROE)

Pros and Cons of a simple formula:

• Easy to understand and explain

• More likely to be used by underwriters

• Convenient to periodically review

• Approximates equity to the satisfaction of most normal actuaries

• Percentages may vary by company

• Can be further refined as % of premium

Industry/Occupation Variations

• One role of the underwriter is to assign the “best” occupation class

• Individual DI has some lattitude in assigning which might result in 5-20% difference

• Group occ factors are combination of industry/occupation assignment

STD - What’s Up!

• JHA Profitability Survey reports STD profits are negative

• Lack of concrete evidence that managing STD reduces LTD claim costs

• Brings into question the assumed savings of integrating disability

• Probably caused by aggressive acquisition pricing or assumed expense saving

Group Insurance Handbook

• Maximize participation - preclude individual selection

• Voluntary/contributory LTD violates these two principles

• Most selection can be priced and/or controlled

• 100% participation on a rich plan design may not be a good thing (gross-ups).

High Maximum Benefits

• Less pressure in recent years

• Impact of bonus and incentive compensation

• Selection may be controlled through EOI

• Evidence is your friend

• Doesn’t need to be an inconvenience

• Free cholesterol check

“If you aren’t getting the results you want, ask the magic question, ‘What is being rewarded’.”

Getting Results, Michael LeBoeuf

Manual Rating - Quality Assurance

• Field Office Managers/Reps Accountability

• Combination of office loss ratio and sold rates in relation to manual

• Actual loss ratio tied to predetermined target

• Positive or Negative!

Bottom-line Accountability

• Sales reps/Office Managers tied to target loss ratios and sold-to-calc ratios

• In year 2000, positive and negative compensation impacts were offsetting, but significant at the individual level.

• Percentage of reps received higher compensation due to favorable sold-to-calc ratios was somewhere near moiety

Pricing - Reserve Analysis

• Measuring results requires appropriate reserve analysis

• Incurred But Not Reported Reserves

• Reported Reserves

• Actual-to-expected Termination Rate Study - theoretical elegant

• Actual reserve runouts better

Reserve Analysis

• “The whistles and bells don’t cost much during good economic times.”

Rick Leavitt, Las Vegas - 2000

• “Reserve runouts on IBNR and reported reserves are better during good economic times.”

Dave Fitzpatrick, Dallas - 2001

Reserve Analysis• IBNR reserves and reported reserve runouts

fluctuate over time for many reasons (incidence rates, claim management, RTW offsets, SS awards/denials, re-opens, economy, replacement ratios, mortality)

• IBNR range 1993-1998 without adjusting - 40% of reserve

• Reported range 1993-2000 without adjusting - 12% of reserve

Rate Filings

• Required in several states prior to use (FL, WA, CO, ND, NY)

• Inability to gain timely approvals may impede progress in improving profitability