Tuesday, September 27, 2005

Asking the Wrong Questions (Part 2)...

In Part 1, we broached the subject of rate increases.
Insurance underwriting refers to the practice of obtaining and then evaluating information about the current health of the prospective insured. Of course this starts with the information on the application, but it may also include doctors’ records, or even a physical exam. All of this gives the underwriter a decent “snapshot” of the applicant's current health.
But as the insured ages, so does that underwriting information. In the case of an individual, claims are paid, health conditions arise or worsen, new medications are prescribed. In the case of a group, in addition to those health factors, the make-up of the group also changes over time. The result of all of these changes is that the initial information, on which the rates were based, become obsolete (i.e. “stale”), and this because the risk has changed, the premium will also.
Now, take that same principle, and apply it to a block of business (in other words, a large group of policies). As the group ages, and as claims are paid, and as the overall health of the group declines, rates increase. At first, this isn’t necessarily a terrible thing; after all, we’ve come to expect some increases along the way. But as year after year brings increase after increase, people “trade in” their old, expensive policies for a newer one, with cheaper rates (remember, the new policy will benefit from new underwriting, and will generally be less expensive).
That is, the healthy individuals (or groups, as the case may be) will find other coverage. But if your health has really declined, then you may have no choice but to stay put. And you’re not the only one in that boat: maybe that block of business has a LOT of unhealthy folks in it. So the claims mount up, and fewer and fewer insureds are left in the original “pool” of those who signed up. Welcome to the vicious cycle we call the Death Spiral.
As my colleague Bob Vineyard notes in the comments section of that post, there’s another factor, as well: age (band) changes. Just getting older affects our premiums. Some companies rate people based on their actual age each year, while other lump folks together in age bands. There’s really no “better” or “right” way, each has its own pro’s and con’s. If you’re rated by “attained age,” then your rate only goes up a relatively small amount, but it does this every year. If your carrier bands people, then your rate doesn’t change because you turned 42. But you’ll be hammered when you hit 45. Your choice.
Okay, so we’ve asked and answered the right questions. Now, what to do about that rate increase. Stay tuned for the exciting conclusion in Part 3.
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