Unlocking the mystery of renewal pricing for benefits plans
BY Paul Boundy, vice-president business development, Group Benefits, Sun Life Financial | February 10, 2011
Health costs have been increasing at a “higher-than-inflation” rate for some time, so it’s no surprise that premium costs for group benefits plans often increase each year. But for your cost-sensitive small business clients, these premium increases can be a significant concern.
That’s an issue to you because you’re on the front line explaining the renewal rates to them. While rate increases can seem a bit like a mystery to clients, the fact is that there’s a very established process in place to determine a group plan premium each year.
Here’s an overview of the many factors insurance companies consider that influence the premium renewal rates for your small business clients.
Cover those costs
When an insurance company sets a premium renewal rate for small business clients, it’s trying to do two things:
- Cover its claims costs, plus expenses. When setting renewal rates for the small business client base as a whole, insurance companies want to cover expected claims payout costs plus expenses. These expenses include taxes, advisor commissions, overhead, plan administration and a relatively small component for insurer profit.
- Keep premium rates as stable as possible. If insurance companies charged premiums based on the claims payout experience for each small business client, the premium amounts would be highly volatile from year to year. For this reason, insurance companies use a variety of methods to average out costs over a wider pool to ensure that the premium rates for small businesses are reasonably stable from year to year.
The two main methods used to provide better cost certainty for small business clients are pooling certain types of claims, and, for other types, applying a “credibility rating” to the actual claims experience of each plan.
Pooled claims explained
For benefits where the incidence of a claim is low, but the potential payout is high – namely life insurance, long-term disability insurance and short-term disability insurance for very small plans – claims are pooled with other policyholders and are not charged directly to any one plan sponsor. This means that claims for the one group plan do not directly impact rates.
By using the performance of the insurer’s block of business as the main basis for life and disability rates, insurers can minimize volatile swings in premiums for each group plan from year to year.
However, rates for each separate group plan are reviewed each year before renewal and adjusted if needed to reflect changes in the demographics of the plan (such as aging, employee male/female mix, occupations, and salary changes).
Credibility and experience-rated benefits explained
For the health and dental portions of a plan, insurers will typically consider a group plan’s actual claims experience. However, the degree to which this claims experience affects the premium will depend on something called a “credibility factor” that’s used in the calculation.
How credible or believable the claims history is depends on the number of insured employees and the number of years of claims history available. For example, a plan with a pool of 40 employees will have a higher credibility factor than a plan with only five employees. This means that premium rates for smaller plans will not be as affected by the yearly fluctuations in their claims, and their rates will instead be based more on the manual rates of the insurer.
In terms of looking at the claims history over several years, insurers consider the current year as more credible and give it a higher weighting than prior years. For example, the current year might be given a weighting of 75%, while prior years may only get a weighting of 25%.
Other factors that can impact rates
There are a number of other factors that can impact premium rates from year to year – and insurers need to include an estimate of what that impact will be in order to ensure that the premium will be sufficient to cover claims costs and expenses. These additional factors include:
- The higher cost of existing products and services
- Newer more expensive drugs
- The increasing use of existing products and services
- Public plans (Medicare) shifting services to private plans
- Changes in legislation that impact health care
- Changes in taxes
- Changes in interest rates (see box below)
These additional factors (if they occur) are considered in all small business premium renewals.
Three basic truths of underwriting
Whether setting initial plan rates or setting rates on renewal, insurance companies will always factor three truths of underwriting into their premium calculations.
- Insurance costs increase with age. As we age we may require more medical services, and our risk of becoming disabled or of death increases. So insurance costs increase as well.
- Female premiums are higher than males for all benefits with the exception of life insurance. This is because females tend to have more claims than men. However, because of their longer life expectancy, life insurance is less costly for females.
- When interest rates are low, premiums increase. Insurance companies are required to hold reserves to fund claims that are not yet known – and for promised payments such as long-term disability claims. Interest on reserves, and on cash flows, generate income, so when interest rates are low, less income goes into the reserve – and greater premiums are needed to fund them.
So if a small business client experiences a significant change in their workforce, premium costs could change depending on the impact of this change on their workforce demographics.
Method behind the mystery
While there are many factors that go into setting rates each year – and calculations can be complex – your small business clients should be assured that these factors are consistently applied from year to year. While no client welcomes a rate increase, a little background knowledge of why an increase has occurred can go a long way to providing a positive group benefits plan experience for all.