In the vast realm of employee benefit brokers, general agents, carriers, plan administrators and third-party administrators, you probably have heard the term “voluntary benefits” at some point. This in-demand product segment has demonstrated continued secular growth, so it is no surprise various market participants are interested and investing in this market. Yet, for many insurance professionals, these products, their risk management elements and the table stakes can seem an enigma.
What exactly am I talking about here? Often, confusion begins with the nomenclature alone—and for good reason. In the employee benefits world, the term “voluntary benefits” (or “worksite,” “supplemental” or “enhanced” benefits) is understood as employee benefits that are:
- Completely optional to the employee
- Entirely or mostly paid for by the employee through payroll deduction
This definition can apply to a wide range of traditional benefits such as group life, disability, dental and vision insurance. However, when referring to voluntary benefits today, the emphasis is often on “growth” products, which fall into one of three categories:
- Supplemental health insurance. This category includes accident, critical illness, cancer and hospital indemnity.
- Supplemental life insurance. This category includes term life, universal life or whole life coverage.
- Nonmedical or noninsurance products. This category includes identity theft protection plans, pet insurance and pre-paid legal service plans.
While brokers today are interested in all three categories, from a product profile and risk management perspective, this article will focus on supplemental health benefit insurance products—the third category of benefits does not contain bona-fide human insurance products. While some element of network contracting, service and business risk exist with such lines, these agreements typically are structured for a renewing term under which time the carrier is insulated from pricing risk itself. In addition, supplemental health products may be sold to individuals or retirees outside of the workplace; these channels represent substantial premium in the marketplace but are not addressed in this article.
Supplemental Health—Understanding the Products
Supplemental health products have a few key defining characteristics:
- The plans are limited benefit contracts, providing benefits only for specific medical events defined in the contract.
- They do not have a coordination of benefits provision with medical insurance.
- There is no component of provider network reimbursement; benefits are paid on a first-dollar basis directly to the employee.
Often, the claims adjudication requires some amount of medical documentation to be provided, but the turnaround can be as short as one or two days. The employee can then use this cash how they see fit—it is not restricted for specific use of medical care alone.
Out of all voluntary benefits, supplemental health products have enjoyed the largest growth rate of new business premium. For example, annual growth for critical illness is expected to be more than 10 percent in 2019. Employee exposure to out-of-pocket medical costs and the employer’s need to offer a comprehensive suite of benefits to employees at low or no cost typically drives the growth of this product.
Accident insurance is payable in the event of an accident resulting in injury to the insured. Accident insurance is distinctly separate from traditional accidental death and dismemberment (AD&D) coverage because it covers a broader range of accidental injuries at varying amounts. Coverage may exclude accidents in the workplace to reduce price and carve out benefits normally covered by workers’ compensation.
The benefits within an accident insurance policy can be structured as either an extensive schedule of fixed indemnity benefits or simply can be based on medical expenses incurred for accidental injuries up to a fixed limit (e.g., $5,000). Most products filed in the past decade have been structured as a fixed schedule design, with a long list of benefits ranging from services like x-rays or emergency room admission to specific injuries such as torn ligaments or bone fractures.
Cancer and Critical Illness Insurance
Cancer and critical illness insurance are both defined broadly under the National Association of Insurance Commissioners (NAIC) type of insurance for specified disease limited benefit coverage. The distinguishing feature between cancer insurance and critical illness insurance is the range of illnesses covered under each plan. While cancer insurance is, as it sounds, limited to various forms of cancer, critical illness insurance covers a broader range of illnesses such as heart attack, major organ failure, stroke, end stage renal disease and coronary artery disease with bypass surgery.
Like accident insurance, there are variations in how benefits are paid out under cancer and critical illness insurance. Benefits may be payable either upon diagnosis of a covered illness, which is typically paid as a lump sum benefit, or for treatment related to that condition. Treatment-oriented product designs can either pay based on a fixed benefit schedule with specified services, or based on incurred medical expenses, sometimes within specific categories of services (such as chemotherapy or surgery). Lump sum critical illness diagnosis plans are the most popular type of coverage in the group market, as they are the simplest to administer and have the broadest appeal to consumers.
Hospital Indemnity Insurance
Indemnity plans generally pay based on a fixed schedule of benefits for specific medical services or types of inpatient confinement. These services can be for treatment of both accidental injury and/or sickness. The plans can be categorized into two subgroups:
- HSA-compatible hospital indemnity. These plans are limited to fixed per diem confinement benefits for inpatient hospital or intensive care confinement. These plans are “permitted insurance” under the tax code and represent most sales in the large group market.
- Non-HSA-compatible hospital indemnity. These plans include a larger schedule of inpatient and outpatient procedures including surgery, physical therapy, physician services and nursing facilities.
Risk Management Issues
Supplemental health products all have shared characteristics from pricing, valuation and risk management perspectives. While the covered losses are related to medical events, they have other features such as commission structures and continuation provisions that may resemble life products. Furthermore, while claim costs can be derived from medical data, public health care databases or medical journals, actual experience in the industry is affected by various offsetting forces in terms of underwriting risk. It is important for any risk manager in this space to closely monitor emerging experience for signs of anti-selection, poor participation, low persistency or outright fraud.
Anti-selection and Participation
In voluntary plans, there is an element of anti-selection risk as individuals with either specific knowledge of their own medical circumstances or a lifestyle with a higher risk of a claim are more likely to enroll than other individuals. This may include those who regularly participate in high-risk activities such as mixed martial arts, or someone with a prior history of cancer.
While older policies may have included exclusions for known or pre-existing conditions, or administered simplified underwriting, competition in the market, technology capabilities and customer expectations have limited underwriting in the past four to five years. This includes both guaranteed issued underwriting for actively at-work employees along with the removal of most pre-existing condition exclusions. This alleviation of underwriting protections, coupled with the fact that these plans typically have employee participation in the 10 percent to 25 percent range, necessitates regular monitoring and in-force management. To the extent participation is low, there exists more room for individuals to anti-select against a specific benefit and for such anti-selection to affect overall loss ratios.
Finally, as portability provisions routinely are included in the design of these products, there is a long-term liability component of risk to the extent that covered individuals can continue coverage after leaving their employer. In the industry, portability often is offered at the same rates as employees; however, typical observed rates of exercising portability are very low, leading to a large degree of anti-selection. For certain coverages that have increasing claim costs, such as hospital indemnity and critical illness, portability creates an additional reserving risk concern in that prefunding of claims may not be enough to cover the high incidence of hospitalization and illnesses that occur at older ages.
Commission Structure and Persistency
For many types of supplemental health products, the industry norm is independent distribution through either “voluntary” brokers who specialize in these types of products or traditional benefit brokers who may outsource enrollment to a firm or general agent who is an expert in these products. As such, high first year commissions are common and amount to 50 percent to 70 percent of the first year’s earned premium, with renewal compensation schedules in the 5 percent to 15 percent range. It is worth noting that level commission structures are more common on hospital indemnity than accident, cancer and critical illness policies.
To offset this loss in the first year under generally accepted accounting principles (GAAP) accounting, insurance companies will defer the excess of first year commissions over ultimate commissions, as well as some portion of other acquisition expenses, to be amortized over the lifetime of the policy. Much like traditional life products, this creates an important exposure to early duration lapses, as policies need to remain in force for four to five years to hit pricing targets for profitability.
This is an increasing concern in a group market that is flooded with new competitors and consolidation of distribution. In the past, voluntary brokers marketed products separately from benefit brokers, and the changing of a medical or group disability carrier or broker every two to four years wouldn’t necessarily impact the persistency of the voluntary plan. However, in a market with more carriers offering voluntary benefits and a greater number of traditional brokers distributing them, this may no longer be the case. Having either a single broker in charge of both core benefits and voluntary benefits, with the added element of a highly competitive market, could result in all benefits being switched to a new carrier with the changing of the broker of record. In this environment, the average duration of a group may decrease.
Wellness or Preventive Care Benefits
Often included as a benefit within all types of supplemental health coverage, wellness benefits pay a nominal benefit (e.g., $50 or $100) when a covered person undergoes a defined form of preventive care. Contracts in the market vary on this definition. Some carriers’ products require the insured to undergo a specific set of covered tests, whereas other products will pay a benefit for a routine annual primary care exam by a physician.
Since the utilization of wellness benefits depends more on the individual behavior of the covered population rather than their actual medical underwriting risk or lifestyle factors, these benefits are particularly challenging to price. Several other variables affect the actual frequency of claims, including:
- An insured’s awareness that the benefit is included within their plan
- Ease of starting the carrier’s claim adjudication process
- The level of documentation required for proof of loss
As carriers continue to market the efficiency of online claim submission capabilities and simplified claim processes, consumer behavior may change as insureds find it easier to file a claim. Furthermore, the emphasis on wellness and preventive screening within a company’s employee benefits plan undoubtedly will impact experience. Preventive care is now covered at 100 percent by Patient Protection and Affordable Care Act (PPACA) compliant medical plans, and employers have introduced numerous initiatives to make annual screenings more accessible to their employees through wellness fairs, on-site biometric screenings and other incentives.
It is critical that carriers marketing these benefits monitor loss ratio or claim incidence on such wellness benefits regularly and separately from the core benefits of the voluntary plans themselves. Wellness benefits reach a strong credibility threshold much more quickly than other benefits. Additionally, these types of benefits are more volatile over time, since the experience is driven more by technology and consumer behavior than underlying medical risk itself.
Claim costs for accident insurance in the commercial group market traditionally are assumed to be level for a given population. This implies the incidence of accidental injury for a working age, actively at-work population is largely the same across age groups. As the manual claim costs do not vary by age, base accident insurance products usually do not generate an active life reserve. This makes the product quite favorable from a return-on-capital perspective, as a lower after-tax profit margin is required to meet a given level of return. However, profitability is very sensitive to lapses. Other challenges when predicting morbidity include:
- Occupation/industry. The occupational hazards involved with an insured population are strongly indicative of expected claim costs. Most companies include a rating factor for Standard Industrial Classification (SIC) codes ranging between 85 percent and 130 percent of normal claim costs. In some cases, while the industry of the group may be known, it may not be clear as to the portion of high-risk occupations to be insured, such as for city governments, which include both administrators and first responders.
- Covered dependents. Covered children are a major component of overall family claim costs for accident insurance products. As these plans are offered on the traditional four-tier basis (often to align with medical), the assumption of the number of covered children per family becomes a significant component of pricing.
- Standard workplace protocol. Although accidental injury rates can be predicted by industry and family size of the population, some public sector employers or union groups may have specific protocols related to on-the-job injuries, such as seeing an on-site physician, which can result in higher than expected medical service utilization.
Competitive pressure over time has led to carriers including a greater number of illnesses under the plan, with most market plan designs now including between 16–30 or more covered conditions. These plans include coverage for advanced neurological conditions like Alzheimer’s disease and Parkinson’s disease; less severe conditions like carcinoma in situ or benign brain tumors; and loss of bodily functions such as blindness and deafness. There is less population data available for these types of conditions than there is for heart disease or invasive cancer. As such, these benefits may be priced with greater conservatism than more common illnesses.
Premium rates for such products typically are age banded, but the rate can either be locked in from the age of the insured at time of issue (issue age by age or issue age banded) or can increase as the insured ages (attained age by age or attained age banded). Tobacco use is a common rating factor in some plans, with higher rates charged to tobacco users. Many carriers also include industry and group size as a rating factor. For example, there is clear medical evidence for a higher rate of certain cardiovascular disease for particular industries, such as service and wholesale trade. Unlike accident insurance, children contribute very little to claim costs since the incidence of most covered conditions is very low for younger people.
The pattern of claim costs by age for heart attack and cancer follows a steep, increasing slope for most working ages. Termination ages in such contracts are either very high or do not exist due to a one-year pricing term. As such, issue age rated critical illness and cancer coverages priced under a long duration contract generate significant active life reserves, which gives them a very different rate-of-return profile than accident or hospital indemnity. Portability rates and long-term persistency play an important role, as persistency into retirement ages can have a dramatic impact on projected claims. Decreasing long-term lapses result in higher incurred claims in later durations, increasing the overall loss ratio of the block. Therefore, to ensure a block is performing as priced, it is important to regularly review both emerging loss ratio experience and persistency of the block in comparison to pricing assumptions.
Attained age plans, on the other hand, are priced for the morbidity in each age band and do not generate active life reserves. The earnings profile of these plans is much more like accident insurance, with the exception that the average premium per employee will be driven by age demographics due to the premium structure.
Hospital indemnity products have claim costs that can vary by age group, but premiums either can be age banded or priced to a single rate for all ages. The sickness component of the product often includes maternity care. As such, there is risk for anti-selection, because planned surgeries or maternity care are often covered under such plans. This anti-selection problem is worsened by unwillingness by brokers and groups to introduce some form of medical underwriting. To keep costs sustainable, additional risk protection is included in the design of these contracts.
- Termination ages typically are lower for hospital indemnity than for accident insurance.
- Pre-existing conditions limitations are more prevalent than in other lines of coverage.
- There are waiting periods that apply universally or that specifically carve out confinement due to normal maternity without complications.
- Portability may be limited (i.e., to three or five years) when available.
Since anti-selection is a significant element in experience for hospital indemnity plans, and participation is relatively low compared to a normal medical plan, it is recommended that insurers use caution in affording significant rate guarantees. Additionally, group rating at renewal is important to incorporate for this product line, as there is substantially greater variability in year-to-year claim costs based on the behavior and enrollment of the underlying group’s population.
This article is intended as a high-level overview. Additional considerations, such as renewability provisions, fraud and other items, are important to the supplemental health insurance market, and in-force management typically includes a robust policy and procedures program. It is critical for actuaries, underwriters, brokers and plan administrators to understand the unique characteristics of this growing and important market so it continues to be a successful insurance solution for the end consumer.
Copyright © 2019 by the Society of Actuaries, Schaumburg, Illinois.