1. Group LTD Pricing Issues SOA Spring Meeting, Dallas, Texas May 30, 2001 Session 48
Rick Leavitt - Smith Group
Delaine Hare - Fortis Benefits
Dave Fitzpatrick - The Standard

2. The economy, circa 1998-2000 Decline in unemployment
Interest rates started to rise
Rising Index of Leading Economic Indicators

3. LTD industry, circa 1998-2000 Improving LTD profits
Positive results, but is ROE strong enough?
But it beats the early 90’s
Deteriorating STD profits
Suddenly losses!

4. Where’s the cheese?
Who got the cost savings resulting from managed and integrated disability?
The carrier????
The employer????

5. The economy, circa 2001 Stock market has stumbled
Unemployment starting to rise
Interest rates falling
Index of Leading Economic Indicators is on the rise
Consumer Confidence falling

6. Agenda Manual rating pitfalls Competitive pricing pitfalls
Measurement & accountability

7. Manual rating pitfalls
Rick Leavitt
Smith Group

8. How Useful Are Your Manual Rates?
1. Do they accurately predict claim costs?
2. Are they adjusted for current risk dynamics…Unemployment? Discount Rate?
3. Do your underwriters use them?
4. Do you track sold to manual rates?

9. Common Pitfalls: Inforce vs. New Sales
For Example:
Current Rate Block Change
Segment A: 33% -10%
Segment B: 33% 0.0%
Segment C: 33% 10%
Estimated Rate Impact: 0%
In Reality:
New Rate Sales Change
Segment A: 60% -10%
Segment B: 30% 0.0%
Segment C: 10% 10%
Actual Rate Impact: -5%

10. Common Pitfalls: Rate Variables are Dependent
Consider an example
Current Factor Actual Cost
Own Occupation: 24 Month
Unlimited
Industry: Doctors
Lawyers
All Other
24 Mo Unlimited
Variables are Doctors 30% 70%
Dependent Lawyers 50% 50%
All Other 80% 20%

11. Common Pitfalls: Rate Variables are Dependent
Hypothetical Example:
Results of Own Occupation Study
Pricing Factor Observation
Unlimited
24 Month Own Occ
Do you need to adjust the Own Occ factor?

12. Common Pitfalls: Changing Dynamics Over Time?
Three Year Study shows rate is right on…
What is appropriate for 2001?

13. Smith Group Comparison of Filed Manual Rates
12 Top Companies
Sample Calculations on over 1000 Representative Cases
Manual Rates Calculated as Publicly Filed

14. Smith Group Comparison of Filed Manual Rates:

15. Smith Group Comparison of Filed Manual Rates: Variation of Individual Companies

16. Smith Group Comparison of Filed Manual Rates: Variation of Individual Companies

17. Smith Group Comparison of Filed Manual Rates: Industry Factors

18. Smith Group Comparison of Filed Manual Rates: Area Factors

19. Delaine Hare Fortis Benefits
Pricing pitfalls
Delaine Hare
Fortis Benefits

20. Recipe for top line growth
Discount 10% for “value” contract
Discount 10% for early intervention
Discount 10% on “good cases”
Discount 5% for packaged LTD/STD
Guarantee the rates for 3 years
Value contract - improvements by the product development shop
Early intervention - improvement by the claims shop
Good cases - improvement by the underwriting shop
Package sales - improved efficiencies
Where in all of this did the distribution system improve?

21. …and the bottom line Have you been too aggressive?
If so, can you recover?
Renewal is a double-edged sword
One big increase - can you afford the poor persistency?
Layered increases - can you afford the good persistency?
Do you try to recoup past losses? (“You can’t make up your losses if the policy leaves.”)
Do you just try to get back to square one? You’ll never be satisfied with your overall returns if you keep making mistakes on new business.
Traditional actuarial pricing models target the desired return over the life of the policy. It may not be reasonable to try to recoup losses on your mistakes after the fact. But if your business model has embedded mistakes, you’ll have trouble hitting your return objectives.

22. Watch your tail
Better claim management improves claim closures at early durations
What happens to closures at later durations?
Is your reserve tail as strong as it used to be?
It’s like a balloon - you push down on the front end of the reserve, and the tail pops up on you.

23. Simple reserve illustration
For relative comparison only
Not an opinion on what is an appropriate pricing discount
Sensitive to termination rate assumptions
Valuation table, age, sex, etc.

24. Manage the early claims...
45 year old
20% better term rate for 24 mo.
Same term rate after 24 mo.
19% cost savings
Base
Example
Improved

25. …without managing the old
45 year old
20% better term rate for 24 mo.
20% worse term rate after 24 mo.
9% cost savings
Base
Example
Improved

26. Watch your assumptions
Improved claim management & stronger contract
Did they add to your margins?
Did you give it all away?
Was it as big as you thought?
Some cases may not benefit at all
Could have been making hay while the sun was shining.
Perhaps our customers took the hay we made (and then some?)
Perhaps some of the hay was actually weeds.

27. Table 95a / Basic 2000 Table
Concerns expressed over appropriateness of this table
Termination rates in later durations appear to be overstated
Reserves may be deficient

28. Value of early intervention...

29. …is relative

30. Claim Manager of the Year
The award goes to… Nobody!!!
Starvation effect
Elimination period is akin to a deductible
Nothing controls incidence like loss of income
When you add STD coverage, what are you replacing?
Have we enabled more LTD claims by emphasizing a need for STD?
Which provides more incentive to RTW during the STD period:
60% to $500/week
60% to $1,385/week
Line between STD & LTD is arbitrary. We may expect claims to close at the STD/LTD transition - does the claimant share that expectation?

31. What is a “good case”?
Manual rates already reflect the “good” plan design & “good” industry
Is “good” experience really credible?
Have we enabled more LTD claims by emphasizing a need for STD?
Which provides more incentive to RTW during the STD period:
60% to $500/week
60% to $1,385/week
Line between STD & LTD is arbitrary. We may expect claims to close at the STD/LTD transition - does the claimant share that expectation?

32. Persistency & profitability
Blue line is target rate - the long-term run rate - this rate may not be known to you when the case is sold - or maybe your underwriter rolled the dice on their risk selection
Red line is actual charged rate pattern over the policy lifetime - losses emerge early, and you react to them with a series of increases
First 4 years, the area between blue and red represents your losses.
After 4th year, area between red & blue represents your gains
Can you keep the group long enough to make your return over the life of the policy?
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7

33. …during a recession Drop in interest rate raises the bar
Higher unemployment may raise the bar
Have we enabled more LTD claims by emphasizing a need for STD?
Which provides more incentive to RTW during the STD period:
60% to $500/week
60% to $1,385/week
Line between STD & LTD is arbitrary. We may expect claims to close at the STD/LTD transition - does the claimant share that expectation?

34. Measurement & accountability
Dave Fitzpatrick
The Standard

35. Calculated (Manual) Rates
Group Aging and impact on rates? (recession and baby boomers)
Aging census one year can increase claim costs 5-10%
Multiple year rate guarantees?

36. “You can’t manage what you can’t measure.”
“What gets measured gets done.”
Bill Hewitt, 1991

37. Successful Measures of Sold-to-Calculated Rates
Actual-to-Expected Analysis
Can easily be aggregated at underwriter/rep /plan level
Can help in pricing vs. loss ratio analysis only
Provides a measurable target that is easily understood

38. Reasons Why Rates May Vary
Underwriting Considerations
Mistakes
Experience Rating
Credibility
Underwriters may discount loads
Change in census from proposal to effective date

39. Return on Equity (ROE)
Formula for Underwriters to ensure attainment of ROE targets
ROE = Net Income/(Average Equity)
Equity = Required surplus (STAT reserves - GAAP reserves)

40. Return on Equity (ROE) An elegant formula: Equity =
where C0 = Asset Risk - Affiliated Amounts
C1 = Asset Risk - All other
C2 = Insurance Risk
C3a = Interest Rate Risk
C3b = Health Credit Risk
C4a = Business Risk
C4b = Health Adm Exp - Business Risk

41. Return on Equity (ROE) Pros and Cons of an elegant formula:
Impressive to look at and discuss
Difficult to challenge
Hard to explain
Not understood by underwriters and many normal actuaries

42. Return on Equity (ROE) An example of a much simpler formula:
Equity = 30% of annualized premiums +
30% of case reserves
Possible to approximate to fit individual company’s equity requirements!

43. Return on Equity (ROE) Pros and Cons of a simple formula:
Easy to understand and explain
More likely to be used by underwriters
Convenient to periodically review
Approximates equity to the satisfaction of most normal actuaries
Percentages may vary by company
Can be further refined as % of premium

44. Industry/Occupation Variations
One role of the underwriter is to assign the “best” occupation class
Individual DI has some lattitude in assigning which might result in 5-20% difference
Group occ factors are combination of industry/occupation assignment

45. STD - What’s Up!
JHA Profitability Survey reports STD profits are negative
Lack of concrete evidence that managing STD reduces LTD claim costs
Brings into question the assumed savings of integrating disability
Probably caused by aggressive acquisition pricing or assumed expense saving

46. Group Insurance Handbook
Maximize participation - preclude individual selection
Voluntary/contributory LTD violates these two principles
Most selection can be priced and/or controlled
100% participation on a rich plan design may not be a good thing (gross-ups).

47. High Maximum Benefits Less pressure in recent years
Impact of bonus and incentive compensation
Selection may be controlled through EOI
Evidence is your friend
Doesn’t need to be an inconvenience
Free cholesterol check

48. “If you aren’t getting the results you want, ask the magic question, ‘What is being rewarded’.”
Getting Results, Michael LeBoeuf

49. Manual Rating - Quality Assurance
Field Office Managers/Reps Accountability
Combination of office loss ratio and sold rates in relation to manual
Actual loss ratio tied to predetermined target
Positive or Negative!

50. Bottom-line Accountability
Sales reps/Office Managers tied to target loss ratios and sold-to-calc ratios
In year 2000, positive and negative compensation impacts were offsetting, but significant at the individual level.
Percentage of reps received higher compensation due to favorable sold-to-calc ratios was somewhere near moiety

51. Pricing - Reserve Analysis
Measuring results requires appropriate reserve analysis
Incurred But Not Reported Reserves
Reported Reserves
Actual-to-expected Termination Rate Study - theoretical elegant
Actual reserve runouts better

52. Reserve Analysis
“The whistles and bells don’t cost much during good economic times.” Rick Leavitt, Las Vegas
“Reserve runouts on IBNR and reported reserves are better during good economic times.” Dave Fitzpatrick, Dallas

53. Reserve Analysis
IBNR reserves and reported reserve runouts fluctuate over time for many reasons (incidence rates, claim management, RTW offsets, SS awards/denials, re-opens, economy, replacement ratios, mortality)
IBNR range without adjusting - 40% of reserve
Reported range without adjusting - 12% of reserve

54. Rate Filings
Required in several states prior to use (FL, WA, CO, ND, NY)
Inability to gain timely approvals may impede progress in improving profitability