Factors Affecting Claims | Group Insurance Rate Making

Factors Affecting Claims

As previously mentioned, equity requires that rates reflect those factors that result in different claims experience for different groups. Although there are variations among insurance companies, the following factors are used by most insurance companies to determine rates for life, disability income, medical expense, and dental insurance: the sex, age, geographic location, occupation, and income of group members; the size of the group; and the length of time that rates will be used.

Sex. The sex of insured persons is taken into account for determining rates for life, disability income, medical expense, and dental insurance.

Age. Age is also used as a rating factor for life, disability income, and medical expense insurance. Dental insurance rates usually do not take age into consideration.

Geographic Location. At one time, geographic location was a rating factor for medical expense and dental insurance only. However, an increasing number of insurance companies are using geographic variations for determining life and disability income insurance rates. For these latter types of insurance, rates may not be determined separately for a wide variety of locations. Rather, the insurance company may have only two or three rate schedules, with each schedule applying to several different geographic locations on the basis of past claims experience.

Occupation. Occupation is virtually always reflected in both group term life and accidental death and dismemberment insurance rates. It may also be reflected in disability income, medical expense, and dental insurance rates, but the number of groups for which it is of concern is relatively small. Consequently, some companies ignore it as a rating factor but may not write such coverages when certain occupations are involved.

Income. At one time, the income level of group members was commonly used as a factor in establishing disability income, medical expense, and dental insurance rates. Currently, income level is still a factor in determining dental insurance premiums, but it is more likely to be an underwriting consideration in disability income and medical expense insurance.

Size. The size of a group also affects rates because the proportion of the premium needed for expenses decreases as the size of a group increases. All manual premium rates are based on an assumption that the size of a group falls within a certain range. If the size of a group varies from this range, an appropriate rate adjustment is made to reflect this differential. In addition, many insurers reserve the right to rerate a group during the period of the contract if the group changes in size by a certain percentage. This is particularly important in an era of downsizing and mergers.

Time. A final factor considered in the calculation of rates is the length of time for which the rates will be used. This is a concern primarily for coverages that involve medical and dental claims, which over time will be expected to increase in severity because of inflation. In inflationary times, monthly rates that are guaranteed for three months can be lower than those guaranteed for one year.

Frequency of Premium Payment Period
Because group insurance premiums are usually paid monthly, this is the period for which rates are generally determined. When premiums can be paid less frequently (such as annually), they are usually slightly lower than the sum of the monthly premiums for the same period of coverage.

Calculation of Manual Rates
Manual rating involves the calculation of the manual premium rates (also called tabular rates) that are quoted in an insurance company's rate book. These manual rates are applied to a specific group insurance case to determine a final premium rate (sometimes called an average premium rate) that then will be multiplied by the number of benefit units to obtain a premium for the group.

There are three different manual rating methods. However, if identical assumptions are used, each method should result in approximately the same premium for any given group. The first method determines separate manual premium rates for groups with certain characteristics that an insurance company feels will affect claims experience. A second approach establishes a single standard manual rate that is adjusted in the premium-calculation process to compensate for any characteristics that deviate from those of the standard group. A third method merely combines the first two approaches and considers some factors in determining the manual premium rate and other factors in determining the final premium rate.

The first step in the calculation of manual premium rates is the determination of the net premium rate, which is the amount necessary to support the cost of expected claims. For any given classification, the net premium rate is calculated by multiplying the probability (frequency) of a claim's occurring by the expected amount (severity) of the claim. For example, if the probability that an employee aged 50 will die in the next month is .0005, then the monthly net premium for each $1,000 of coverage is .0005 × $1,000, or $.50. Because premiums are collected before claims are paid, the insurance company adjusts this figure downward for anticipated interest earnings on these funds.

In general, insurance companies that write a large volume of any given type of group insurance rely on their own experience in determining the frequency and severity of future claims. Insurance companies that do not have enough past data for reliable future projections can turn to many sources for useful statistics. Probably the major source is the Society of Actuaries, which regularly collects and publishes aggregate data on the group insurance business that is written by a number of large group insurance companies. Other sources of information are industry trade organizations and various agencies of the federal government.

The second and final step in the calculation of manual premium rates is the adjustment of the net premium rates for expenses, a risk charge, and a contribution to surplus. Expenses include commissions, premium taxes, claims settlement costs, and other costs associated with the acquisition and servicing of group insurance business. The risk charge represents a contribution to the insurance company's contingency reserve as a cushion against unanticipated and catastrophic amounts of claims. The contribution to surplus or net worth represents the profit margin of the insurance company. While mutual companies are legally nonprofit, they, like stock insurance companies, require a contribution to net worth that is a source of financing for future growth.

From the standpoint of equity, the adjustment of the net premium rate is complex. Some factors, such as premium taxes and commissions, vary with the premium charge; however, the premium tax rate is not affected by the size of a group, whereas the commission rate decreases as the size of a group increases. To a large degree, the expenses of settling claims vary with the number, and not the size, of claims. It costs just as much administratively to pay a $10,000 claim under a group life insurance plan as it does to pay a $100,000 claim. Certain other costs tend to be fixed regardless of the size of a group. For simplicity, some insurance companies adjust, or load, their net premium rates by a constant percentage. However, other insurance companies consider the different patterns of expenses by using a percentage plus a constant charge. For example, if the net premium rate is $.60, this might be increased by 20 percent plus $.10 to arrive at a manual premium rate of $.82 (that is, $.60 × 1.2 + $.10). Because neither approach adequately accounts for the difference in expenses as a result of a group's size, another adjustment based on the size of the group will be made in the calculation of the final premium rate.