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Critical illness - Return of premium: a double-edged sword

par Caroline Phémius | August 20 2003 03:50PM

The return of premium guarantee may be energizing critical illness insurance sales, but is it bad for insurers’ long-term health? Some believe the return of premium guarantees are too generous and poorly priced, much the same way term-to-100 was a few years ago.

“Looking at what’s happening today in the market, I am worried that in some cases this guarantee is not adequately priced relative to the risk it represents,” said Benoît Miclette, Director of Living Benefits at Munich Re, the dominant reinsurer in the sector. This error in judgement may undermine the product’s long-term profitability, especially with the 10-year to 15-year contracts.

“Critical illness insurance is a recent product,” Mr. Miclette noted. “With such a short history, it is difficult to evaluate the number of people that will cancel their policies. The return of premium guarantee is a risk comparable to T-100 in the sense that the lapse rate is crucial to the profitability of the product.”

Insurers usually protect themselves from the risk of generous guarantees by assuming that a portion of policyholders will cancel their policies over time. These cancellations then release them from some of their obligations.

The only problem is, when policyholders learn that they are purchasing an especially advantageous product, the chances of them dropping it decreases sharply. This shift may falsify actuaries’ forecasts, similar to the case a few years ago of substantially under-priced T-100 policies.

Win-win situation

The return of premium (ROP) feature is when insurers pay back all the premiums at the end of the contract if the policyholder did not make a claim. Many say that this guarantee puts the policyholder in a win-win situation.

Most companies routinely offer to refund premiums to the estate if the policyholder dies before the contract expires, without having received critical illness insurance (CI) benefits. This guarantee is less risky because it can be priced based on mortality tables.

Advantageous for the customer, the ROP has become one of the main selling points of CI, brokers say.

Recently compiled Canadian CI sales results compiled by LIMRA International reflect this trend. During the first quarter 2003, 67% of CI policies sold included the guaranteed ROP rider.

The ranks of insurers that offer a return at expiry are growing steadily. Since January, Canada Life is offering a premium refund for its T-75 and T-100 contracts after 10 or 20 years.

Insurers on guard

Denis Belliard, Manager Product Development at AXA Assurance, agreed that the ROP at expiry is risky, given that the calculations to establish the cost of this guarantee rest on the assumption of withdrawal.

AXA is not taking chances. “We take into account statistics on CI in Europe and we share the risk with a reinsurer,” Mr. Belliard noted.

Great-West Life also considers the ROP a risky add-on to the product. Marcel Martin, Director of Marketing and Living Benefits, revealed that he followed the herd. “We had no choice but to offer the ROP to remain competitive. If the market hadn’t pushed us, we wouldn’t have done it.”

Mr. Martin added that it is important to ensure that the price of the guarantee adequately covers the risk represented by the ROP.

At Manulife Financial, 57% of sales in the first quarter 2003 include a ROP rider, mentioned Teresa Walkey, Living Benefits Product Manager for the company.

Ms. Walkey said the ROP is a big seller at Manulife. She considers that the ROP principle may be dangerous if some insurers offer such guarantees to the detriment of the number of illnesses covered. Ms. Walkey is worried that insurers will push their clients “heavily towards the ROP rather than the protection offered.”

The company chose to emphasize the importance of coverage above all and is trying to relegate the ROP to the backburner. To quote one of its promotional arguments: “Would you give up your fire protection in your household insurance to have a money back guarantee?”

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