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The life industry isn’t working

Life is full of examples of human behaviour that point to the need for collective action to counteract the destructive self-interested actions of the individual. JM Keynes pointed out that while the man who feared being made redundant and saved more of his income was acting rationally, if everyone did this, the recession would be longer and deeper than was necessary – hence Keynesian economics.

Even in financial services, we can find self-interested actions worsening the collective outcome. How paradoxical that life assurance, one of the ultimate expressions of the benefits of sharing risk, is one such case.

To illustrate this, I ask you to join me in a thought experiment. It starts in 1960, when a set of 10,000 people aged 30 buy 25-year term assurance policies. They each fill in a four-page application form and over 90 per cent are accepted at normal rates. Over the following 25 years, a few of them die – fewer than the life assurance companies anticipated, enabling them to show a greater profit than they expected.

Fast-forward to 2011, when another set of 10,000 people aged 30 buy 25-year term assurance policies. They each fill in a 20-page application form and only 40 per cent of them are accepted at normal rates, the rest pay higher premiums depending on their size, gender and personal and family medical history.

Over the next 25 years, the pool accepted at normal rates will deliver a fairly predictable outcome – fewer of them will probably die than the insurance companies currently expect. But the various pools underwritten at different rates will show much more variable outcomes. Because the pools are smaller, a few more or less deaths than expected within the next 25 years will tilt the outcome towards losses for the insurers in some cases and super profits in others.

As for the costs, the expected mortality of the entire group of 10,000 in 2011 will, as it was in 1960, be paid for by the whole group of 10,000. But who is paying for the costs of the 20-page application forms, the complicated underwriting, the multiple applications, the medical reports and the advisers’ time? Strip out the effects of mortality and technology on reducing premiums, and what we see is that between 1960 and 2011 the life assurance industry has loaded a pile of extra costs on to its customers.

Of course, some individuals are winners and some are losers from what has happened. But that does not mean it is right to describe today’s process as fairer than what happened in 1960. On the contrary, for society as a whole, the outcome is worse. Collectively, we pay more for the same cover (excluding mortality gains) – and a lot of previously insurable people now cannot get cover at all.

The industry has made something simple into something unnecessarily complex, because it was in the interests of companies to create ever more marginal distinctions in their underwriting process in their attempts to offer lower premiums to one group or another. It is a race to the bottom and if it continues, we can expect the proportion of people underwritten at normal rates to be 10 per cent in 2030. That daft projection shows the folly of the whole process because it implies the elimination of risk-sharing.

And how do we escape from this not at all merry-go-round? You tell me.

Chris Gilchrist is director of Churchill Investments and editor of The IRS Report


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There are 14 comments at the moment, we would love to hear your opinion too.

  1. The Financial Services industry is so scared that it will fail completely unless it starts thinking and acting more about the needs of clients and less about pleasing the regulators – whose only purpose in life is to make a job for themselves.

  2. Blair Elaineson 10th May 2011 at 2:19 pm

    The industry keep the mask of complexity over everything and the regulator keeps that mask glued to the face of the industry, every attempt they make to simlify backfires. If they would leave to market forces then the simplest solution would have won through years ago, assclowns from the regulator, buffoons from the life companies, numpties from the general public,!

  3. You can say the same about the whole bloody industry. In an effort to “improve” clients monetary safety and starting with FIMBRA we have managed to “bolt-on” a completely new industry of regulation which has to “leech” of the sales organisations that existed before. Crime semms to be getting bigger and more frequent as do invoices from the various “Quango`s” we have allowed to proliferate. Not long now till the internet takes over and the general public start guessing what to do with their money. What a farce.

  4. Simple???…. Financial Services???….. Never

  5. I have thought for a long time how ludicrous it is that underwriters decide that someone should be charged a 50% or 100% loading. If an applicant really is a higher risk than average then why insure him/her at all. And how such rough-and-ready loadings without any true regard for the actual increase in statistical risk ?

    Of course, we have to treat every client fairly (ha,ha). So we need to get rid of ALL cross-subsidy in the protection industry – everyone needs to be assigned their own individual risk premium. Eventually, there will be no pooling of risk and the insurance industry (and insurance products) will become redundant altogether.

    We all know that whatever future the finan
    cial services industry faces, there will be yet more regulation, more compliance, more self-interested quangos and more costs for the public to bear.

  6. Given that this micro-underwriting is now a part of doing business with life companies, how is it that those same companies are not standing up to the regulators as they force through the preposterous EU legislation that will forbid premium calculations on the grounds of gender.

  7. Peter Maynard 10th May 2011 at 3:09 pm

    This argument doesn’t entiirely stack up although it’s true that back in 1960 the risk questions on the app would have been two pages at most. As we know, now there are MANY more pages, although that’s partly as a result of more space for the answers. But that’s nothing to do with cost.

    Underwriting IS a lot more complex, and it’s true that fewer lives are accepted on normal terms. The increased stratification and differential pricing of risk is maybe a moral issue that can be debated another time.

    But back in 1960 most policies were with-profit endowment or whole life, so mortality experience was of little consequence to insurers – it was investment returns that counted. Today, on the other hand, it’s all pure risk buisness – where mortality/morbidity is key to profit – written on rates that are a fraction of what they were in 1960. So underwriting has to be effective. And it is; actually more so than in 1960.

    So how can insurers have loaded in cost to consumers’ detriment? Yes it’s true that commission has gone up by a huge amount, but it’s also true that life companies are much more efficient than they once were.

    The real cost burden comes from regulation. If that were stripped ou, and adviser rewards reduced because their job would be easier, how much could term rates fall still further?

  8. Peter Maynard 10th May 2011 at 3:16 pm

    Anonymous, are you serious or a troll?

    ” If an applicant really is a higher risk than average then why insure him/her at all.”

    You want to deny people cover because their health is impaired or whatever? Most of us think that covering as many as possible is what we’re here to do.

    “And how such rough-and-ready loadings without any true regard for the actual increase in statistical risk?”

    The risk pricing process isn’t perfect (far from it) but the majority of ratings ARE statistically based. It’s a requirement of the Disability Discrimination Act and, more important, we owe it to customers to apply fair terms.

  9. This is like comparing a 1960 Mini with a 2011 Mini, we have moved on, the world has changed beyond all recognition, some life offices are more efficient.

    What has changed? What were the premiums like in 1960? What is the cost of terminal illness benefit?

  10. Roger Edwards 10th May 2011 at 4:16 pm

    Whilst what you have said about the increasing complexity of the application process since the 1960s and the different risk pools that have been created, I do not think it necessarily follows that this is a more expensive process – it would have been had we been stuck with 1960s technology – i.e. no digital media, and only relying on paper processes and land line phone.

    But technology has kept the costs of doing business down – even if it has led to more complexity.

    And when it comes to Life Insurance premiums – the base line premium is cheaper than it has ever been in history – so even those who are being loaded could still end up paying proportionately less then they would have in the less complex 1960s.

  11. Chris,
    not in the wider consumer interest but this is how capitalist systems work! In particular service industries. You could just as easily be talking about car insurance, mortgages or even paying for financial advice. Somebody realises that if they can cherry pick the most lucrative pieces of business they will make more profit.

    This usually happens because somebody breaks ranks or there is a new entrant to ‘shake things up’.
    It is a race to the bottom, eventually participants will be forced out or fail if they get it wrong. This is followed by consolidation and maturity and the whole process starts again.

    Just have a look at car insurance, but why should you and I (mature careful driving record I’m guessing) contribute to a risk pool inhabited by the ultra high risk under 25 year old males? The social impact on the other hand is that age group driving around uninsured because they can’t afford it. (One insurer quoted Vauxhall Corsa third party Salford, male under 21 last month £36,000 pa), considerably more than they earned.

  12. I don’t believe it. I’ve finally seen a comment from Evan Owen that I completely agree – backed up by hard facts from Mr. Edwards.

  13. people people let us not fight but unite to make this industry whole again

  14. Make it whole again? I have a dream.

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