Risk Management Program Of Dip
The figure above is a summary of important issues disability insurance providers are facing that has to do with managing their risk exposures. First is the demographic risk that refers to the inability of the insurer to accurately determine whether the applicant’s life is estimated within a healthy or disabled parameter. This risk largely pinpoints the possibility of insurer misquoting quoting the insurance policy either of the two.
In effect, the Enhanced Life Annuity (ELA) that is usually deferred is likely become mis-priced if the mistake is incurred (Levantesi & Menzietti). Scenario analysis is used to measure this type of risk as well as mortality and/ or morbidity projections which can show any trends on how and to what extent lifestyle is changing. Life expectancy, values of important metrics and disability trend has useful information that insurers can use to reduce demographic risks.
When this is completed, insurers can allocate their assets to productive investments and particularly to ideal applicants depending on their profile. The second on the list mimics the condition that faces the US Social Security. This Department recently reported rising costs in disability system driven by what is referred as “perverse” incentives (cited in National News 2007). The explanation is simple. Claims for disability have higher benefits compared to early retirement. This makes the former superior alternative in cases of early retirement inflicted by injury.
As disability benefits cease when the claimant decided to work again, there is less motivation to go back to work even if the injury is bearable and going back to work is viable. Evidence of this is observed when it is recorded that 60% of applicants are approved through their appeals from an initial refusal of their application by the Department (cited in National News 2007). In effect, the Department is exposed to a risk where productive labor is induced to be idle which is not good for quality of life of workers and the economy at large. The third is a general case of insurers.
Underwriting is the basic tool for insurers to build insurance policy that has the purpose of maximizing their premium income by balancing the premium rates against risks involved in relation to the applicant (American Academy of Actuaries 2001). The adverse scenario here is when underwriting is ineffective because the insurer is not an expert when it comes to actuaries. Actuarial service is the means to verify that guidelines used in underwriting are based on previous studies that have been regarded as average incidents that have high predictive value.
When actuaries are misleading, the incident such as outweighing of unhealthy individuals to healthy ones could happen. This condition can disrupt the profits of the insurer. When incidences of adverse selection are increasing, it is an indication that the insurer is accumulating unknown risks that can lead to high insurance costs (American Academy of Actuaries 2001). Adverse selection is an opportunity of applicants to catch insurers uninformed and to gain more from the latter. Information asymmetry is basically the risks attached to adverse selection because one party intends to gain from using information superiority (e.
g. salesman to customer). This condition results to inappropriate insurance policies that deviate from the realistic factors which the applicant intentionally conceals. The motivation to use this adverse selection is higher when the applicant is knowledgeable about his or her vulnerability to certain illnesses. The motivation is doubled when the insurer is not aware of this. This situation calls for the attention of insurers to better understand factors affecting adverse selection of applicants. The effort can minimize information asymmetry and leverage their risks against misquoted policies.
Recommendations The risks mentioned above can be effectively hedged by different means. One is reinsurance. Reinsurance is the process of transferring risk form one insurance company to another. An advantage of this strategy is that an insurer can obtain higher quantities of applicants even that exceed its capacity while serving as protection against extreme losses in the future. Alternatively, reinsurance can stand as marketing arm of insurers because clients can have greater amount of security with asset support coming from re-insurers.
It can also free portions of “tied funds” to cover policyholders and endeavor to be used in more active income-generating projects. This benefit is also the source of another advantage called surplus relief wherein the insurer can purchase surpluses of re-insurers to prevent turning down potential clients or finding additional sources of funding. Lastly, reinsurance can be used by insurers to minimized dependence on client’s underlying risks in which cases of lower rate of re-insurer’s policy can lead to greater insurer margins.
For Security System, US government can adopt case study from Chilean framework. In the latter policy, Chilean workers enjoy as high as 70% of their salaries when they become disabled claimants (cited in National News 2007). This is a higher figure than the US counterpart. The framework requires workers to maintain policy savings up to 50% of their total disability policy. The share of the government is the other half in the event that the worker fails to reach the total price of the disability insurance.
Further, there is also a safety net through investment earnings accumulated by the worker’s in their annuity premium which is used to cover their wages when they become disabled. This process put burden to the retirement accounts of workers that reduce excessive incentives seen in replacing early retirement to disability benefits. Efficiency in disability applications is also assured by competitive market because not only public boards are allowed to appraised applicants but also private pension funds.
There are also no closed-ended rules like the openness of the system to accept workers that are earlier evaluated as permanently disabled to work again. As a result, the Chilean government is successful in cutting the costs of disability insurance due this cost- sharing scheme. The last strategy calls for a drastic change in the policy structure of insurers. This is entering the bancassurance. When insurers merge with a bank, their combined assets can exceed performance of reinsurance and in turn can lead to higher performance indicators.
Bancassurance can reduce the dependence of disability insurers to the subsidies of healthy workers. Thus, the depth of assets and market share of a combined bank entity and insurance entity can outweigh the traditional needs of risk classification. The insurer can take as many applicants as it can. However, the cost of integration must be evaluated in order to compute cost-and-benefit factors in the merger. The trust inherent to banks and consultancy inherent to insurers can also post threat to efficient integration. For shareholders, minimizing the risks of their insurance companies can increase their wealth.
When assets are free as a cause of reinsurance, their companies can allocate them to income-generating projects which cannot be done when assets are tied to secure policyholders. Alternatively, when assets are substantial due to bancassurance, the preceding need is not crucial while the company has greater assets to allocate. Through sharing schemes, shareholders (e. g. public) is assured that public funds are maximized. References Levantesi & Menzietti (Unknown). Longevity and disability risk in enhanced life annuities. Available from <http://www. actuaries. org/LIFE/Events/Stockholm/Lavantesi_Menzietti.
pdf> [Accessed on 9 October 2007] Risk Classification in Voluntary Individual Disability Income and Long-Term Care Insurance (2001). American Academy of Actuaries 2001. Available from <http://www. actuary. org/pdf/health/issue_genetic_021601. pdf> [Accessed on 9 October 2007] Study Claims ‘Perverse’ Incentives Causing U. S. Disability Costs to Soar (2007). National News. Available from <http://72. 14. 205. 104/search? q=cache:WliO2dwYArAJ:www. insurancejournal. com/news/national/2007/09/27/83791. htm+perverse+incentives+Security+System&hl=tl&ct=clnk&cd=1&gl=ph> [Accessed on 10 October 2007]