F102: Life Insurance
Chapter 5: Health and care insurance products – Income
protection (IP)
Introduction




Benefit: Provide regular pre-determined level of income whilst ill (does not
directly cover medical costs)
o Benefit is in the form of regular income (short or long-term payments
during period of incapacity)
o Benefit can also be seen as a form of temporary annuity that continues
until recover, death or retirement (which ever one occurs first)
o PH may also convert the regular income to become lumpsum.
o Policy document should clearly define the situation or circumstances
that need to exist in order for the benefit to be paid out. (this is to reduce
fraud) and also define when benefit will be terminated, these include:
 Unemployment
 Redundancy
 Early retirement
 Reluctant to return to work.
o Policy will not have a value on surrender or maturity.
 The sum at risk under IP product is very large compared to the
regular premiums.
 Once expenses and expected claims are taken into account
there is little surplus left to build up the asset share
Term: Policy is usually written as a long-term policy
o Policy allows for PH to be unable to work recover and then fall into
period of incapacity again.
o A claim does not terminate the policy.
Premium: The initial premium paid is based on the benefit design and various
rating factors
o Premiums and benefit may be level or increasing at a fixed rate of
relative to a price inflation index (salary inflation)
Purpose of the cover:
o A product is said to be attractive if it is:
 Clear on its purpose
 Has an appropriate charging structure,
 Has affordable premium levels to customers.
o To replace income for the insured life whilst unable to work due to
accident or illness and cannot earn an income.
 Policy usually kicks in after 3-6 months of incapacity in order to
reduce over insurance.
 State benefits may be available; however, these are likely to be
insufficient.
Income stream is designed to meet PH’s major expenses such as
monthly loan servicing costs.
 These also include mortgage protection.
 Benefit is structured to cover both interest and capital
repayments.
o Can be used to cover premium payments. This is usually offered as a
rider benefit because premiums are small.
o Locum Protection
 Purchased by professionals for income protection on each other.
 For business which depend on each other to provide complete
services to their clients.
 Benefit provides salary and other employment costs of a
temporary staff replacement.
o Perceived needs by customers:
 Many people are not aware of the risk/implementation of it and
so are not concerned by it
 Believe that state benefit will be sufficient. In ST benefit may be
related to income but LT it may not as it is designed to maintain
minimal acceptable standard of living
 Individuals may be bad at estimating the size of the risk they face.
Target market:
o Employers who are keen to pass financial responsibility for sick
employees to an insurer after limited period of invalidity.
o Self-employed individuals
o Individuals who do not have provision through employer.
Simplicity vs complexity
o The concept is simple and appealing (factors that make the product
attractive)
o The risk management process (such as policy rules involved) may make
the product a little complicated.
o Claims definition (situation or circumstance that leads to a claim) may
make the policy hard to understand.
o


Product features
This section considers the different features that might be included in an income
protections. These factors are meant as a risk management tool and may complicate
the product.
General policy conditions


Wording of for the following policy conditions may make the policy complex:
lapses, recovery, death, retirement, partial recovery. However, you need to
ensure robust policy design and wording in order to reduce any potential risk.
The Insurer needs to take the following measures to reduce risk:
o Ensure that the general policy conditions are clear.
 Conditions should clearly reflect the true intentions of the insurer.
 They need to give some cushion against adverse events which
insurer has no control over.

Should be simple and unambiguous. In order to reduce policy
claims dispute which will be in favour of the insured and not the
insurer.
Benefit definition (amount)





The benefit amount should be defined in policy terms
o Not always linked to salary may also be expressed as a cash amount
rather than % of salary (this will lead to annual review of benefit which
can be costly in terms of admin expenses)
Benefit limit needs to be applied in order to ensure that they are incentives for
the insured to return to work.
o This can be done by expressing the benefit in terms of salary at the time
of claim
o Or expressing the benefit in terms of state benefit at the time of claim
Replacement ratio is defined as the ratio of post-income to pre-claim income
net of tax in both cases.
o Ratio needs to reflect reduction in disposable income after incapacity.
o IP benefits in some places are taxed the same as income. The tax
treatment of the benefit has a direct effect on the replacement ratio.
o This is seen as an indicator of the claims experience. The higher the
income ratio the lower incentive to return to work and the worse the
morbidity experience is likely to be.
o Limits should be applied to encourage individuals to return to work.
o Maximum replacement ratio can be seen as a way of managing risk.
Over-insurance refers to a higher than appropriate replacement ratio. This can
arise in the following manner:
o Over-insurance from outset
o Salary not keeping up with benefits (benefits increasing by a ratio
greater than salary increases)
o Reduction in the tax levied in IP products
o Multiple policies or receipt of other non-disclosed sources of income
while sick
o Ways to reduce over-insurance: Robust policy design through the
following:
 An appropriate maximum benefit formula scale which includes
maximum replacement ratio, strict limitations for high salaries in
excess of specified limits, overall maximum benefit limit or
deductions for any other benefits such as state benefit
 Quality training for those conducting the sale (reducing incentive
to over insure)
 Regular reviews to ensure level of benefit is still appropriate.
 Policy conditions which highlight actions to be taken in place of
over-insurance.
Escalating benefits and premiums
o IP policies can be level. Where benefit paid in sickness remains constant
as specified and does not increase out of claim.
Benefits may also increase at a certain rate usually at published prices
such as earnings index.
 Should the benefit escalation rate be high it may be a problem
trying to get assets which will match the liability.
 Insurers usually restrict the increase rate to a fixed rate.
o Benefits may also increase at a different rate in and out of claim (this
increases complexity of the product)
 Escalation rate is the same in and out of claim. This is a common
design.
 Benefit increases out of claim but remains constant in claim
(benefit and premium increase each year but once claim
commences it remains constant). This encourages PH to go back
to work. This design is not so common.
 Smaller escalation rate in claim compared to out of claim.
 Some escalation rate in claim, little or no escalation rate out of
claim.
 If benefit escalates out of claim premiums will also escalate
Proportionate or rehabilitation benefits
o Rehabilitation benefits may be provided to those who go back to work.
This is done to encourage PH to go back to work.
o Can also offer a reduced benefits to PH who go back to work in a
different occupation or reduced capacity.
o Rehab benefits may also include personal support, advice and
counselling attractive.
Waiver of premium
o Most policies include the conditions that premiums are waived during
periods when benefits are payable.
Benefit definitions
o Waiting period is a period following commencement of policy during
which no claims a paid.
o Deferred period is in initial claims period during which no benefits are
paid. They usually make premiums more attractive.
 Reasons why policies have non-zero deferred periods is:
 Integrate with employer-supplied benefit.
 Reduce cost of claim to insurer
 Reduce insurer’s administration cost
 Meet true customer needs. (wont want to submit claim for
non-severe illness
o Linked claims period is an incentive for policyholder to return to work
where the differed period is waived should PH be incapacitated again
within a certain period of returning to work.
Expiry age or term is the age at which benefit stops, this is usually the retirement
age. In mortgage business it will be the term of the loan.
o Policies may be written for an exact duration in years.
o




Claims definition
The following terms may be used to define the situation or circumstances which a
claim will be payable:


Occupation definitions
o The PH’s occupation has an effect on the product design in terms of the
way the product is priced and the claim payment.
o Effect of occupation on price charged:
 IP rates are usually depended on the PH’s occupation.
o Effect of occupation on the claim payment:
 This is usually used to define a valid claim such as:
 Inability to perform own occupation. This has a great
financial impact to the insurer.
 Inability to perform own occupation and any other
occupation by education status or training.
 Inability to perform own occupation for an initial period of
claim followed by inability to perform any occupation
thereafter.
 Inability to perform any occupation. This offered to
occupations which carry the most risk. Although this can
be seen as unfair
Alternative incapacity criteria
o Occupational claims definition may be unsuitable for those not in paid
employment.
o The following tests are used to assess the impact of illness or disability on
the PH’s ability to perform tasks required by an occupation or required
in day-to-day life:
 Activities of daily living (ADLs)
 MTWTF-D (Mobility, Transfer, Washing, Toileting, Feeding
and Dressing).
 Benefit commencement will be based on failure of the
insured to be able to undertake the above unaided.
Mental capacity may be taken as an overriding test of
mental capacity.
 Functional assessment tests (FATs)
 Activities of daily working (ADWs)
 Personal capability assessment (PCA)
Other policy conditions
There may be conditions in the Policy wording that requires the PH must inform insurer
of any changes in occupation and residence/location.

Occupational changes
o Policy may require PH to notify insurer should the insured change
occupation with the intention of modifying the premium if necessary.
o Claims definition are usually defined in terms of occupation.

Residence and location
o Policies make no allowance for residence or location of the PH.
o Risk does vary with residence or location. The insurer will look at balance
of risk within its book in determining premium levels without explicitly
charging loading in premium.
Chapter 6: Health and care insurance products Critical
illness (CI)