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2.2 Pricing health insurance Most of the discussion in the previous section also applies to pricing health insurance. However, there are some additional considerations and issues which make pricing health insurance especially challenging.
Expected claims costs are computed using a combination of morbidity rates, claims incidence for each benefit category, and claims amount distribution by benefits category – claims must be separated in the database because this will enable separate pricing of each benefit category. Claims costs should ideally be segregated by age, gender, and geographic location. For this purpose, there is nothing which compares to an extensive and consistent database to estimate claims distributions.
Incidence rates are dependent on the insureds’ utilization rates and utilization trends – and these can change significantly in a very short time. Utilization is dependent on prevailing characteristics of the insured, including their overall health, access to services, understanding of how to use services, the dignity with which services are provided and many other factors. For example, VimoSEWA introduced a child benefit in its hospitalization plan in
2002. In analysing the experience, it was observed that there was an increase in the number of families participating in the child health coverage and the increased participation decreased average utilization rates (see Table 27).
252 Microinsurance operations
raised from 65 to 69, and if a death benefit of US$50 for the member’s children aged 90 days to 21 years were added?”, and so on. Such complex questions may arise during the business planning stages of a microinsurance programme or may be raised by the management at any time – a good model can be used to test these types of scenarios.
The model should use the current database for evaluating key parameters.
For example, demographic profiles, incidence rates and lapse rates should be updated before running the model. The expenses of the organization based on past experience and on the microinsurance business plans should be loaded into the model.
The output of a quality model includes prospective income statements, balance sheets, and cash flow statements. These outputs are indicative in nature and one must be careful to limit their interpretation. Generally, the user adjusts the premium rates and product features until the projected statements look reasonable.
4 Conclusions The key messages in the chapter are as follows:
– Pricing microinsurance products is very technical and requires assistance from an actuary.
– The actuary has to consider the whole package – target market, product design, marketing and communication, administration and claims service – to set an appropriate premium. These parameters must be monitored periodically to anticipate changes in pricing.
– Accurate pricing begins with a quality database. The database should be designed by an IT professional with inputs from an actuary to ensure that the data are relevant for pricing purposes.
– Data, like any other resource, must be carefully managed.
– Health insurance is more difficult to price than life insurance. Rates should be reviewed every six to 12 months because utilization and inflation trends can change rapidly.
– Microinsurance modelling techniques can be used to price products more accurately, produce business plans and detect developing trends.
3.6 Risk and financial management Denis Garand and John Wipf1 The authors appreciate the technical suggestions and edits provided by David Dror (Social Re) and Carlos Martínez Gantes (DKV Seguros).
Sound financial management is one of the most important requirements for long-term success in the insurance business. It is an especially complex task because the bulk of an insurer’s assets are used to back future benefits that are payable contingent on the occurrence of insured events.
Many microinsurers – particularly those with roots in the development community – fall short of having an adequate level of financial and risk-management skills. Many of these, however, offer only short-term, lowerrisk products, although a few carry higher-risk, long-term products (see
Chapter 2.2).The aim of this chapter is to provide a brief overview of the major financial management issues that the insurer must master, as well as to offer practical and important financial management suggestions specific to microinsurance. In particular, this chapter discusses: 1) the risk of insurance, 2) capital requirements, 3) reserves, 4) reinsurance, 5) investment management and 6) profit distribution.
1 The risks inherent in insurance products Insurance is the business of risk management and therefore requires a thorough understanding of the nature and degree of the various risks present in the products being offered. Most of these risks are also inherent in microinsurance products. For microinsurance to be sustainable, four major categories of risk have to be managed and understood. The quantification of these risks is the basis for determining the actuarial reserves and the amounts of capital required for the long-term sustainability of a microinsurance programme (see Box 49). The four major categories of risk are: 1) pricing inadequacy, 2) asset depreciation and default, 3) interest rates and investment mismatch and 4) general contingencies and management.
In this chapter, actuarial reserves are assumed to reflect the actuarial present value of expected liabilities2 less actuarial present value of expected premiums inclusive of the appropriate margins as determined by a pricing actuary.
These reserves are assumed to be reflected as a liability on the balance sheet.
Furthermore, to simplify the discussion, the term “capital” here includes retained earnings, surplus, claims fluctuation and contingency reserves, guarantee funds deposited with regulators, etc. It includes all assets over and above those funding the actuarial reserves. Capital is assumed to be accessible in the event of deficiency in actuarial reserves.
1.1 Pricing risk Pricing is such an important topic that Chapter 3.5 is devoted to it. As pointed out in that chapter, pricing requires an accurate projection of the claims expected to be incurred, preferably based on specific experience data.
Many microinsurance programmes have inadequate and inappropriate data and therefore have difficulty obtaining an accurate projection of claims, which could lead to an erroneous pricing of their products. In other words, a lack of experience data exposes these programmes to a pricing risk. As discussed in Chapter 3.5, a good MIS together with a well-managed database enables the pricing actuary to derive the expected claims cost and other pricing components. The chapter also describes the specific data elements that must be included in the database.
It is important to understand that actual mortality and morbidity costs vary by age, gender, region, socio-economic status and other parameters. In the absence of good data and in places where the demographic profile of the target market is not well understood, microinsurers that charge level rates to all participants in life and health insurance schemes are exposed to a significant pricing risk since this practice requires an inherent assumption regarding the risk profiles of the target market. Removing exposure to erroneous risk profile assumptions would necessitate premiums being fixed according to age, sex and other parameters.
For simplicity and popular marketing appeal, or due to legal requirements such as in South Africa, most microinsurance programmes price on a community basis, which means that all risks within a specific scheme are charged the same premium. Consequently, the microinsurance scheme is exposed to a
much greater pricing risk since both the current profile and the future trends in the target population’s demographics become major factors in the expected claims. Even more importantly, the participation rate becomes a crucial determinant of success because it, in turn, affects the demographic profile of the participants (a subset of the target population) and the aggregate risk exposure.
In general, a low participation rate will result in much greater risk exposure since older and higher-risk individuals tend to enrol first and participate more readily. Conversely, a higher participation rate generally means that a larger proportion of lower-risk individuals are also participating. This is clearly demonstrated by VimoSEWA’s experience, where the mortality rate declined from 19 per thousand in 1998 to five per thousand in 2004 (see Table 26 in Chapter 3.5). This positive trend is largely the result of the organization expanding from 30,000 to more than 100,000 lives covered, and this wider participation involving an increase in younger members.
One of the most common pricing risks for microinsurers is deriving a community rate for group products based on an average age of a group, rather than basing it on the actual age-sex demographic profile of the group.
The mortality rate for the average age of a group, for example, is a poor substitute for the weighted average mortality rate since the latter measure takes into consideration the demographic profile of the group.
For instance, the average age of the 8,500 members of Kasagana Ka (KSK), an MFI operating in Manila, is 39.95 with 98.67 per cent women. The mortality rate for KSK using an average age of 40 is 2.292 per thousand per annum, while using the more appropriate weighted average mortality rate based on the MFI’s age-sex profile results in 3.395 per thousand. Since the expected mortality rate using the average age is just 67.5 per cent of the weighted average mortality rate, if the average age were used as a basis for deriving the level rate for a compulsory life product, for example, the product would be significantly under-priced.
Although mortality rates usually vary by region,3 the geographic parameter is much more important for many risks covered by non-life insurers. In health insurance, for example, not only do morbidity rates vary by region, but more significantly, access to treatment, manner of treatment, and costs of treatment can vary greatly between hospitals.4 Regional claims costs vary for other products as well, such as those offering protection against natural disasters.
3 This fact is generally accepted by most actuaries and due to numerous factors such as diet, living conditions, lifestyle, cultural practices, livelihoods, access to medical treatment, etc.
4 In some countries such as in India, expected claims costs are higher in urban areas than in many rural areas partly due to increased incidence resulting from better access.
Risk and financial management 257 Even if all the correct information were available for projecting claims, actual claims patterns usually change from the expected pattern assumed by the pricing actuary. Since higher than expected claims could severely impair the insurance programme, a certain amount of capital is required in case the underlying risk is underestimated. While this pricing risk is generally present in all insurance programmes, it is much greater for microinsurance since the risks are not as well understood by the actuaries.
Another significant pricing risk for longer-term life and savings products is the assumed interest rates. Projected claims, other benefits and expenses are discounted to their present value using assumed prospective interest rates – the lower the assumed interest rates, the higher the present value of future costs reflected in the premium rates, and vice versa. The pricing actuary may sometimes assume an overly optimistic interest rate to lower the present value of claims and the resulting net premium rate. This error, however, could jeopardize the programme later on when the assumed interest rates are not achieved. On the other hand, the actuary could be overly conservative and assume too low an interest rate, thus making the price uncompetitive.
Either way, the interest rate assumption results in a significant pricing risk for longer-term products. This and other pricing risks need to be backed up by extra capital.