Tim Gosden assesses how increased underwriting sophistication can benefit customers
The urge to compare underwriting practices in the enhanced annuity and life protection markets is a strong and obvious one. Over the last decade or so, the protection arena has been transformed by slicker methods of assessment and acceptance of risk, resulting in drastic reductions in processing time for business applications.
Key to this improvement has been matching the underwriting skills to the most suitable cases and also developing data capture techniques that allow appropriate medical information to be made available to underwriting staff as quickly as possible.
However, while the underlying philosophy for life underwriting has been developed over many decades, enhanced annuity underwriting could be described as relatively immature. The first enhanced product, a smoker annuity, appeared in 1995 but although the market has been slow to develop it now looks set to take off as insurers strive to improve their pricing sophistication. There are also clear distinctions between life and annuity products in that the underwriting of the annuity relies on the customer disclosing as much information as possible to improve their pension. Also unlike life protection an annuity, once established, can't normally be changed or surrendered. This makes it even more important for full and accurate disclosure of information at point of sale.
Historically, disclosure of medical information has been a problem for underwriters because consumers often feel uncomfortable and often not sufficiently knowledgeable about such matters. Underwriters also appreciate that advisers often do not feel confident in their knowledge and deciding on what information is and isn't relevant. Without this confidence, it becomes more difficult for advisers to prompt or encourage their customers.
This is where an effective and well-designed disclosure form could help. There is no doubt that enhanced annuity providers have made great progress in developing the industry common form for collecting medical information.
However, while the form itself continues to be refined, most underwriters would probably share the view that, from a risk assessment perspective, many enhanced annuity offers are made on sub-optimal underwriting information collected at point of sale.
Uplift or not?
A good example could be where a potential annuitant discloses a history of high blood pressure, and takes two different drugs daily. Underwriters will find themselves presented with scenarios like this on a regular basis for cases coming through the industry form or bespoke provider and IFA medical questionnaires.
Supplied with this information alone, it is difficult, if not impossible to quantify the severity of the diagnosed condition, hypertension, as often no additional data is provided (such as a recent blood pressure reading) to support the assumption that a significant reduction in life expectancy is likely. Yet enhancements are granted on this basis.
However, inaccuracies and lack of relevant information at point of sale are only part of the story. The way the underwriting results are then assessed to determine the rate, often compounds these issues.
How much uplift?
In the enhanced annuity market, advisers, and indeed customers, want quick decisions and a slick process and to an extent this has driven enhanced annuity underwriting - as it has life underwriting. In response, automated underwriting systems have evolved that generally operate on a point score to determine severity. The scores then fall into bands that determine the level of enhancement.
The problem here is that a combination of inadequate disclosure and a pricing strategy that uses a limited number of bands can result in customers with more serious conditions ending up with the same annuity as someone suffering from something far less serious.
For example, underwriters would agree that most diabetics should qualify for an enhanced rate of some degree. The issue here isn't whether there is increased risk of early mortality, but how to quantify and price that risk.
In terms of quantifying the risk, a slightly overweight, yet well-controlled diabetic with no significant complications, presents a completely different risk to the diabetic who doesn't regularly monitor blood sugars, and has diabetic renal disease, nerve damage, and vision impairment.
There are two issues here: The first issue is disclosure because in order to assess the risk properly the underwriter would need to know about complications and markers such as glycated haemoglobin (HbA1c).
The second issue is pricing. Whether this information is supplied or not these diabetics could end up in the same pricing band and the same annuity rate even through the risk is completely different.
Yes, insurance is about averaging and pooling of risk but the question is whether this is really treating these customers fairly? The burning question is also whether providers operating this strategy will find it sustainable in the longer term from a profitability perspective?
Ultimately, the position any underwriter wants to be in is to be able to quantify, with a reasonable level of confidence, the perceived risk that justifies an increase. There is no doubt that enhanced underwriting will continue to evolve and there are already signs that providers are moving away from banding structures.
There will come a time soon where advisers and customers gradually accept the need for a more detailed disclosure, because they will realise that it is in their long-term interests to give one. With appropriate data capture techniques employed there is no reason why this should slow down the application process.
Ultimately, those providers who can balance an effective service proposition with a sophisticated risk assessment process, that allows a fair and truly representative annuity offer to be made, may emerge as the market leaders.
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