Opinion & Analysis
Richard Walsh:ABI asked to issue guidance on index linking for IP
25 Sep 2019
At the last IPTF meeting we had a discussion about index linking of IP insurance and its effect on premiums and you will have seen the Cover article and the In For A Penny article published on 25 September.
Theoretically it should be simple, whether we are considering a guaranteed premium or reviewable premium policy. Many customers will want to review their level of cover if they have a change of circumstance eg they move to a higher or lower paid job. However for those in a settled job with a reasonable expectation of increased wages over time the simplest way of ensuring adequate cover is to inflation proof their cover using one of the official indexes from the Office of National Statistics, eg the Consumer Price Index (CPI), Average Weekly Earnings (AWE) or the Retail Price Index (RPI).
One would then expect the level of premium to increase by the same percentage as the increase in cover. However for many insurers this in not the case because it also takes into account the likelihood of making a claim due to the increase in the customer’s age – typically with the indexation multiplied by two, although this does vary. This moves us into murky territory. Below is a table of how indexation works for different types of policies.
|Type of premium
|A – Guaranteed premiums with level cover||B – Reviewable premiums with level cover||C- Guaranteed premiums with index linked cover||D- Reviewable premiums with index linked cover|
|Premium stays the same?||Yes||No – increased at each review.||No – increased either by the rate of inflation OR by rate of inflation + a factor for age||No – increased either by the rate of inflation OR by rate of inflation + a factor for age. Plus an additional amount at each review|
|Level of cover stays the same?||Yes||Yes||No – increased by rate of inflation||No – increased by rate of inflation|
|Premium is reviewed eg each year after first five years?||N/A||Yes||N/A||Yes|
First we need to ask the question – is it justified to increase the rate of indexation for age for guaranteed premium index linked policies when the guaranteed premium has already had rising age taken into account? I suppose you could argue that the risk rate of additional sum assured is dependent on age. The same question would apply to policies which have an age based premium escalator. Clearly there is a difference in view given that different insurers do different things. Risk and age is a pretty predictable variable. Given the small costs involved it seems to me that there are two potential solutions. Either insurers absorb the costs and simply increase premiums based on the index increase or a maximum additional percentage is adopted across the industry eg 2%. Maybe some smart actuary can work out what a reasonable figure is?
This brings us to the question of predictability vs non-predictability and reviewable rates. For a customer with an index linked reviewable rate policy two factors will impact on their premium at review time. First the indexation link as above and second the review increase (or decrease). A trip down memory lane for me! In 2006 the ABI issued detailed guidance on “Practical Aspects of Unfair Contract Terms for Non-investment Protection Policies with Reviewable Premiums”. Here is a typical wording on one insurer’s website for IP:
“When you apply for your policy we will work out the premium you need to pay based on a number of assumptions. We then review these assumptions on an ongoing basis and if we need to change our assumptions then we will look at the premium you pay to see if it needs to change. This means your payments are not guaranteed to remain the same for the whole of the term of the policy.
The premium you pay will not be changed within the first 5 years, after that we can change it. Your premium could then go up, go down, or remain the same.
Any change in premium will be in addition to any inflation-linked changes in your premium if you have chosen inflation-linked cover.”
The ABI Guidance was produced with legal advice and consultation with the FOS and the FCA (FSA as was) and includes detailed information on what insurers need to do to justify increasing premiums at the review date. However it does not cover IP (only term life and CI) but the principles are the same. In essence a division between predictable change or unfair increases (eg to increase profits) and unpredictable changes (“valid reasons”). Here is what the guidance says on them:
“It is for individual insurers to determine and set out the valid reasons which could cause the insurer to exercise the unilateral right to change the premium. The list must be complete but not overly long. Examples of valid reasons might be: medical advances which affect the insurer’s expectation of future claims; any event outside the insurer’s control that the insurer expects to have an impact on future claims which the insurer could not reasonably have foreseen when the assumptions were last reviewed.”
So where does this leave us. In my view the ABI should look to simplify and produce commonality on additional indexation charges and at the same time revisit the guidance on reviewability so that it includes examples for IP. Or to put it more bluntly – update the Statement of Best Practice which was last updated in 2005. The overall aim should be transparency for consumers and advisers. As for right now, advisers should seek to get the best possible rates for any additional indexation charges for their customers.