If you sell group long-term disability insurance, you want to work with an insurer that takes a flexible but sensible approach to risk analysis.
One problem is that some of the carriers you work with may be using an outmoded approach to analyzing your requests for increases in maximum disability benefit levels.
You call about Passaconaway Sprockets, a manufacturer that wants to increase its in-force LTD maximum to $15,000, from $10,000, to cover its CEOs recent salary increase.
The underwriter dutifully calls up the groups census, averages the top 3 salaries, checks the benefit percentage and finds the average benefit. If the average benefit of those top 3 is $15,000or close enoughthe underwriter will agree to the request and you will be happy. If it isnt, the underwriter may decline, and you may use forceful, colorful language to explain why the underwriter ought to change the decision, or else.
Some underwriters will give in and grant the request. Others will hold firm. Others will get their supervisors, managers or reinsurers to approve or decline.
The story stays the same from insurer to insurer, from year to year. The other thing that stays the same is the Top 3 test.
So, what is the Top 3 test and why should you be worried about it?
The Top 3 test is supposed to protect insurers from an inadequate spread of risk. In theory, a measure of the top 3 salaries gives the insurer an idea of where the maximum should be placed. Unfortunately, in todays market, the growing difference between what top executives earn and what other employees earn often weakens the reliability of the Top 3 test.
Lets look at one example of a case that exposes the limits of this popular test:
A 200-life group requests a $20,000 maximum. Top salaries are $650,000, $400,000 and $175,000. The average is $408,333. If the monthly benefit is 60%, the average monthly benefit for the top 3 is $20,416. The group “qualifies” for the $20,000.