One of the greatest threats facing life insurers is anti-selection (also called adverse selection or negative selection). Anti-selection occurs when an underwriting information deficit allows a higher-risk group (such as smokers) to purchase life or health insurance at the same price a lower-risk group (non-smokers)
ANTI-SELECTION AND ASYMMETRIC INFORMATION
1. “Asymmetric information is present whenever actors on one side of the market have better information than actors on the other, and this information is important to the outcome of the exchange.
2. In situations of asymmetric information where high-risk customers (those in dangerous jobs or high risk lifestyles) have information that the insurer doesn’t have about some aspect of the transaction, it is likely that the high-risk customer will purchase life insurance.
3. The less-informed party (the insurer) cannot fully distinguish the “good” risks from the “bad,” and the “bad” or riskier parties to the insurance contract tend to sign on to the contract more frequently than the “good” risks.
NON-DISCLOSURE
1. Non-disclosure is the failure to provide information material to underwriting. More than 50% of health non-disclosure is probably accidental or unintentional. Anti-selection occurs when a condition is fully disclosed to the extent required by the insurer but the insurer does not make use of the information.
2. Anti-selection is caused by inefficiencies and/or blind spots on the part of the insurer, which are then exploited intentionally or otherwise by the applicant
3. Inefficiencies refers to the situation where an insurer is aware of a risk posed by a condition, and seeks disclosures pertinent to evaluating that risk but does so in a way that is ineffective in exposing the risk in the majority (or a significant minority) of cases. This can be the result of poor product design or poorly formulated disclosure questions,
4. In the case of a disputed claim in these situations, the regulatory authority will almost always take the consumer-friendly position that it is up to the insurer to ask the questions it needed to ask and that the cost of any misunderstanding should be borne by the insurer.
IMPACT OF ANTI SELECTION
1. The members of the high-risk group receive higher claims payouts, and are more costly to the insurer;
2. Because they pay a relatively low price, members of the high-risk group purchase additional insurance;
3. The insurer, to cover losses, raises rates for everyone;
4. The low risk customers abandon the company and seek coverage at a lower price elsewhere.
5. Price rises and more conservative product design affecting all applicants, in
particular those least able to afford insurance.
6. A more cautious approach to the acceptance of higher risk lives.
7. At a macro level, more people reliant on personal savings or state support due to high premium.
8.Cost inefficiencies - More claims, the wrong kind of claims (the risk pool may not be designed for certain claim types)
9.Pricing inefficiencies - Price may not reflect marginal costs leading to individuals selecting the wrong health plans on a benefit-cost basis
10. Diversification inefficiencies - Desirable risk spreading is lost as insurers tailor their offerings to deter the sick and attract the healthy
ROOT CAUSE OF ANTI SELECTION
1. The cause may be systemic or due to the actions of individual applicants.
2. Systemic anti-selection may arise from poorly worded questions, or poor product design.
3. Anti-selection due to the actions of individual applicants can be caused because some applicants deliberately fail to disclose information, but is more likely to be caused by genuine misunderstandings.
4. Policyholder loyalty is low / switching plans is easy and cheap
5. Risk from premium rating includes Premium terms set for several years and no ability to adjust premiums according to individual experience
6. Social Trends
i. Pre-existing conditions are not covered and claim will be declined. More products allowing certain pre-existing conditions – will impact pricing and assumptions.
ii. Health only seen as an issue in old age – Demographic vs Insured population breakdown is skewed.
7. Common Regulatory Issues
i. Normally pricing for a product is fixed for few years from when the prices are filed. Insurers are playing catch-up
ii. Health club memberships – NO DISCOUNTS on third party products
MANAGING ANTI SELECTION
1. A number of steps to minimize the potential for incidental non-disclosure and anti-selection
i. Amending application forms to ask clearer questions.
ii. Record better answers.
iii. Scripted tele-underwriting to replace traditional interviews. Trained interviewers phone applicants to clarify and elucidate disclosures on the application form. T
iv. Use of automatic underwriting engines with detailed reflexive questions
v. More questioning on Alternative and Complimentary Medicines
2. Underwriting Processes
i. Consider claims trends or uncommon spikes in utilization at the time of issuance/ renewal
ii. Modifying policy terms upon renewal – exclusion of hospitals/ treatments, deductibles etc.
iii. For Group policies, share periodic reports on utilisation with clients with suggestions to address claims costs
3. Claim Processes
i. Vertical integration for greater claims control
ii. Audit for fraud control or operational control
4. Capital Management
i. Sufficient capital to meet the liabilities
ii. Economic capital allocated to the insurance class
INNOVATION
1. Use of detailed rating factors
i. Hospitals clubbed into different networks depending upon cost
ii. Lifestyle choices – drinking, eating, smoking, fitness habits
iii. Occupation, industry, postal code, body mass index, pulse rate, blood pressure, gender, history of diseases in family, marital status
2. Experience based pricing and benefits
i. Rewarding past behavior by cumulating bonuses for defined benefit policies
ii. Pay as you go premium with frequent resets based on activity monitoring
iii. Discounts/loadings based upon monitoring of activities
iv. Combining exposure based rating with experience based rating using credibility theory. More applicable for group policies
THOUGHTS
1. The key point at which anti-selection has been detected is at the claims stage, in particular through the investigation of early and suspicious claims.
2. Insurers need to keep a close eye on the source and type of new business as it is proposed, and be able to detect and explain any trends. information has been proven to have been withheld, then the claim amount would be adjusted or the insurer would refuse to pay the claim.
3. The delayed detection, and the out-of-band claims profile anti-selection encourages insurers to increase premiums, which in turn drives away lower-risk customers, causing a spiral of declining profits.
4. For successful underwriting, the ideal would be having both infinite marketplace information available in real time and the organizational capacity to respond. In this way both inefficiencies and blind spots could be eliminated.
(Source: Munchre, actuariesindia)
