Some Pointers On Pricing Large Case LTD For Profitability

Many group disability carriers continue to struggle to find an effective way to hit target profit margins in the large case, experience-rated LTD market.

The issues, and the struggle, have importance to anyone in the market, whether buyer, producer or insurer.

Among the things plaguing group LTD carriers today are: the lack of solid manual rates, inaccurate risk exposure information, and unknown variables underlying the risk. Only when these factors are understood can a company profitably price group LTD, paving the way for a healthy and vigorous industry.

The challenge is that any one of these factors can be influenced randomly and unexpectedly, making pricing LTD a significant challenge. Lets look at the key variables affecting LTD profitability. They are: exposure information; experience data in pricing; and marketplace competitiveness.

Getting accurate exposure information, and in turn calculating an expected claim cost, can be tricky business. But estimating future claim costs based on historical experience can be even trickier.

Naturally, the idea behind experience rating is to rely on historical claim costs to project future claim costs. And when historical experience differs from expected (i.e. manual claim costs), it is “believed,” to a certain degree, based on how credible the case is. The challenge is understanding all of the pricing impacts.

Lets look at an example. Well take a hypothetical 3,000-life case, and we will use Monte Carlo simulation techniques. These techniques assess random influences on pricing scenarios. In our example, we will use these techniques to show how LTD claim costs are distributed unevenly around the average (mean). This is why pricing LTD requires expertise.

The graph below shows the random nature of LTD loss distribution. It also shows the significant range of losses possible around the mean. In reality, actual claim costs will never be exactly equal to expected claim costs; sometimes they will be more, but more often they will be less.

The concept to understand is that in a product like LTD, more often than not, the losses will be less than expected. However, this will be offset by the years when claim costs are greater than expected losses. This pattern will occur, regardless of whether there is any change in the underlying risk of the group.

What actually happens is, the occasional larger loss is paid for by slightly better than expected losses in the majority of years being reviewed.

Similar pricing issues have had a tremendous impact on another industry–the property and casualty industry. This was brought to light by the events of Sept. 11, 2001. As Warren Buffet, chairman of Berkshire Hathaway, put it in his letter to shareholders: “All of us in the industry made a fundamental underwriting mistake by focusing on experience, rather than exposure, thereby assuming a hugerisk for which we received no premium.”

In this case, he is talking about terrorism risk. But the LTD industry, on a smaller scale, may be guilty of the same thing. By over-weighting experience through high credibility, and often ignoring very bad experience as a fluke, the industry is potentially underpricing the risk it is assuming.

Here are some things LTD carriers can do to improve things:

–Insist on an accurate, up-to-date, census from in-force and potential customers. Exposure is king.

–Develop accurate manual rates that underwriters can trust to represent the basic underlying risk on a case. To do this, perform base table studies and segmented experience studies where possible.

–Underwrite the real reasons why a case should or could run differently than the manual rates. For instance: look at financial underwriting; communicate with the claims department about how the employer is impacting risk results; and obtain experience on more subjective types of claims.

–Track differences between sold rates and manual rates.

To summarize, the LTD industry does face pricing challenges that could affect the entire market. But the challenges can be overcome by adopting some of the measures suggested here. These include: using a solid manual rate system, obtaining accurate risk exposure information, and having a good understanding of the variable risk factors that impact pricing.

Andre Baillargeon, FSA, MAAA, is a disability actuary at JHA, Inc., Portland, Maine. His e-mail is abaillargeon@jhaweb.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, May 13, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.