Aviva looks at how trustees can assess the benefits of medical underwriting in bulk annuities.
Over the course of the last decade or so, medically underwritten annuities have become commonplace in the individual annuity market. Allowing customers to receive a retirement income specific to their life expectancy, medical underwriting is fast becoming the norm in this market.
But what of the world of Bulk Purchase Annuities? Recently, demand for medical underwriting has been on the increase here, too. But should we expect a steady trickle of cases or a veritable epidemic?
A more accurate diagnosis
Following on from the individual annuity market, the reason for choosing a medically underwritten BPA is to give a more accurate assessment of a scheme's overall longevity risk. In some cases, this will result in a lower price for the trustees than a traditional bulk annuity.
But how are trustees to know whether collecting this data will provide a lower price? In trying to determine this, they have to deal with a number of issues:
• Bulk annuity contracts require disclosure of all relevant information.
Insurers require trustees to disclose all information they have regarding the health of the members to be covered by the contract. Trustees need to be careful where any informal knowledge of a member's health may be seen to blur the lines with collecting individual medical information.
• Insurer pricing of longevity for traditional bulk annuities is extremely granular.
For instance, the difference in longevity between members with different postcodes or occupations could be greater than the difference between a member having had a heart attack or not.
• Not all insurers price the difference between a traditional and medical underwritten bulk annuity the same.
This means that when an insurer talks about a reduction to traditional BPA pricing, it is important to understand whether that insurer is active and/or competitive in the traditional market, or whether it is benchmarked against something less relevant.
The wrong treatment for smaller schemes?
These issues would seem to support the view that it's difficult for trustees to be certain their membership is in worse health than an insurer may assume. Given this, is there a size of scheme which lends itself to medical underwriting?
A common theory is that smaller schemes are best suited. But conversely, it could be argued that it's the smaller schemes which stand a greater chance of increased premiums.
Aviva have used our own experience to produce the following graph representative of the actual distribution of health (which would be found after individual underwriting) of members who would look to have the same characteristics before individual underwriting.
On the left, we see scheme members in the worst health with the lowest life expectancy. The graph has a long tail as there are a high number of different health impairments which can cause a wide range of life expectancies.
On the right, we have the members in the best health. Much less of a tail here, for the simple reason that there's an upper limit to how healthy a person can be.
For an individual member, the most likely outcome is to have a health status on the green line (the mode of the distribution). As the number of members increases, the overall outcome tends towards the average (or mean of the distribution), shown by the red line.
So therefore in extremis if we look at just a single member, the most likely outcome is to be on the green line, i.e. you would see a slight increase to the traditional BPA price which is based on ‘average' mortality - or the red line.
This suggests that in the case of small schemes, a greater number of schemes will see a slight price increase to compensate for the few who see large price reductions.
To be prescribed cautiously
Finally, it's worth remembering that underwriting is an additional process which needs to be factored in. It could increase timescales by six to 12 weeks which, in itself, may run the risk of problems being caused by changes in market conditions. Focus also needs to be given to ensure costs of data collection are kept to a minimum.
The medical underwriting bug is catching. Only time will tell how great an impact it will have within the Bulk Purchase annuities market. At the very least it may prove a worthwhile route where it is obvious that a scheme has a characteristic which will not be picked up by traditional pricing, such as exposure to a harmful working environment. The skill will be in determining which schemes this applies to.
Whether a scheme uses medical underwriting or not, let's hope for a healthy outcome for all concerned.
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