PERMANENT SICKNESS INSURANCE by D. J. BOND JSS 17 (3

JSS 17 (3) (1963) 195-224
PERMANENT SICKNESS INSURANCE
by
D. J. BOND
(A paper discussed by the Society on 8 March 1963)
NATURE OF CONTRACT
sickness insurance was last discussed by this
Society in 1952 when K. Medin submitted a paper on some of the
theoretical aspects relating to this class of business (J.S.S. I, 76).
At that time only a handful of offices transacted this insurance in
this country and of these some did not seem to actively pursue the
business. Since then its value, both in conjunction with a life
assurance policy and as a separate contract, has become far more
widely recognized and I therefore hope that a brief look at the
practical considerations involved may be of general interest.
The name 'permanent sickness insurance' is possibly misleading. The insurance provides an income during total incapacity,
terminating at an age chosen by the insured when the insurance is
effected. It cannot be cancelled by the office solely on the grounds
of an adverse claims experience. Accidents, provided they are not
deliberately self-inflicted or excluded specifically by the policy
conditions, are covered. Perhaps a better description is 'noncancellable sickness and accident insurance', although both titles
are effective in distinguishing this type of insurance from the
annual contract where cover is granted only on a year-to-year
basis.
Since the benefit takes the form of an income during total
incapacity, the definition of incapacity must be tightly drawn. A
great deal depends on the reputation of the insurance office as to
whether its definition is accepted by the insured. The definition
must cover the following points:
(i) Incapacity must be 'total and complete'. Partial incapacity cannot be included.
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(ii) The insured must be unable to follow any part of the duties
of either his 'own occupation' or 'any occupation'. If the
definition refers to 'own occupation' the position if the
insured engages in another occupation, following total incapacity from following his own occupation, must be laid
down.
(iii) The position following retirement or partial retirement for
reasons other than total incapacity before the terminating
date of the policy must be laid down.
(iv) The period for which benefit is paid must be clearly
defined.
Partial incapacity, that is, where a policyholder is able to perform some part of his own occupation, is not covered. There are two
main reasons for this. First, it would be exceedingly difficult to
assess the degree of disablement. Secondly, many people in their
fifties reduce their general standard of health by trying to maintain
the speed at which they were able to work in the past and are
accordingly advised to 'take it easy' by their medical attendant.
An office which paid benefit for partial incapacity might well
receive a number of claims for benefit where the sole ailment was
advancing age. One may illustrate the importance of this point by
considering the earnings of dentists. As a whole, dentists reach
their maximum earning capacity early in life, after which their
income tends to fall with advancing age. This is illustrated in the
following table which shows median earnings of general dental
practitioners, in age groups. It has been taken from the report of
the Royal Commission on Doctors' and Dentists' Remuneration
1957-60.
Median earnings
1955/56
Age group
30-34
35-39
40-44
45-54
55-64
£
2270
2500
2540
2300
1600
Own occupation or any occupation. Where the definition refers
to own occupation, some benefit is payable on total incapacity from
following that occupation, even though the insured is fit enough to
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undertake some other employment. Obviously if the insured does
take up alternative employment, benefit must be reduced: for
example, by the proportion which his earnings from his new
occupation bear to his earnings prior to his incapacity. By taking
up alternative employment the insured would increase his total
income no matter how small the income from his new employment and he would thus be encouraged to try to rehabilitate himself, although he would not be penalized if he did not do so. As
an example of the working of this provision, a general medical
practitioner became totally incapacitated from following his own
occupation by ulcerative colitis. He obtained a position as a medical
journalist so that the proportionate benefit rule applied. Eventually
he was so successful in his new occupation that his earnings from
journalism exceeded those from his medical practice prior to his
incapacity, when benefit from his policy ceased. If the office had
paid benefit only on total incapacity from following any occupation, he would have been less likely to seek alternative employment for fear of losing benefit. Strictly speaking, of course, with
the more stringent definition no benefit at all would have been
paid although I doubt whether any medical officer would have disputed this claim on these grounds. In my view the definition
referring to own occupation may be preferable even from the
office's point of view as well as being more generous to the insured.
Retirement. It may be argued that when an insured has retired
for reasons other than total incapacity before the terminating date
of the policy, the policy should be cancelled since he would then
not lose any income on becoming totally incapacitated. Also,
some maintain that benefit should be reduced if the insured's
income falls below a certain level. The other point of view, with
which I am myself in agreement, is that the full amount of the insurance may be maintained up to the terminating date of the policy
even though the insured may have retired. An early retirement
or fall in income may well have been due to a gradual deterioration in health so that if the former rule is applied the insurance may
be reduced or cancelled just when it is most needed. Also, an
insured who had been totally incapacitated for a long period might
be unable to return to his former level of earnings. Where benefit
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D. J. BOND
may be continued in full to the terminating date of the policy the
definition of incapacity after retirement is usually strengthened by
inserting such words as, for example, 'being confined to bed or
house'.
It should be mentioned here that when considering proposals
for large amounts of benefit account is taken of the possibility of
reduced earning power in the future in deciding whether to grant a
policy for the total amount of benefit proposed. This is especially
important when considering dentists as is shown above.
Period of benefit. Policies are issued where benefit commences
on incapacity or where benefit is payable after the first 4, 13, 26,
or even 52 weeks of continuous total incapacity. To eliminate petty
claims, benefit is not usually payable under an immediate benefit
policy for any period of incapacity lasting less than 1 week.
Benefit for shorter periods would in any case be hardly worth
while to the insured whilst the cost to the insurance company,
both in amounts of benefit paid and costs of administration, would
be quite substantial. Benefit is paid for total incapacity whilst on
holiday. Sometimes holiday sports are excluded (e.g. ski-ing)
although the number of claims arising from holiday sports seems
to me to make the exclusion unnecessary.
The moral hazard is of far greater importance in permanent
sickness insurance than in life assurance. It is not so much that
the insured knowingly defrauds the insurance company as that he
may subconsciously defer a return to work beyond the period
which is strictly necessary. For example, how many people recovering from an illness lasting 2 or 3 weeks, or more, would consider resuming their duties on a Friday? Yet, if they do not return
to work until the following Monday, the insurance office has to pay
benefit for an additional three days. The benefit under any such
insurance must therefore be such as to encourage the insured to
return to work as soon as he is able to do so. It is convenient to
consider the three aspects of this independently: When should
benefit start? When should benefit end? How much?
When should benefit start? Not until the incapacity has affected
the insured's income. For example, a company secretary may,
under his service agreement with his company, be entitled to his
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full salary during the first 6 months of any period of absence from
duty on account of ill-health. Such a person should not be permitted to effect a policy where any benefit is payable before he has
been totally incapacitated continuously for 6 months. On the other
hand, a single-handed pharmacist who would be obliged to secure
the services of a locum immediately he became incapacitated
would be justified in effecting a policy giving benefit from the
commencement of any period of incapacity.
When should benefit end? The insurance should terminate at an age
when the insured anticipates that he will no longer be likely to
suffer financial loss on becoming incapacitated. For men, this is
the expected retirement age—normally 65 or 60—although policies
are sometimes issued to age 55 and occasionally to age 70.
How much? The normal maximum amount of benefit which the
insured may effect is three-fourths of his normal gross earnings at
the time of effecting the insurance. The policy should contain a
provision that in the event of the insured effecting a subsequent
policy so that the benefit provided by all his insurances taken
together exceeds three-fourths of his normal gross earnings at the
time of effecting that policy, the benefit under the existing policy
would be reduced to bring his total benefit to within the maximum
permitted.
Account is sometimes taken in calculating the maximum benefit
permitted, of the insured's National Insurance benefit. For
example, for a man earning £1500 per year, benefit of £14 per
week plus National Insurance of £7. Is. od. per week (the benefit
at the time of writing for a married man with two dependent
children) would give a total income on incapacity of £21. 1s. od.
per week, almost exactly three-fourths of his normal earnings.
The taxation of sickness benefit is dealt with later. Briefly, the
effect is that initially benefit is paid free of tax. Thus, when considering those with an income in excess of, say, £4000 per annum,
the net income may temporarily increase on claiming benefit even
though this benefit may be within the three-fourths maximum. It
may therefore be necessary to limit benefit still further, taking into
account the insured's tax position so that there remains an incentive
for a return to work.
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Waiver of premium benefit is sometimes incorporated in these
contracts. Normally premiums are waived for the period during
which benefit is being paid except that no waiver is granted for the
first, say, 3 months of any period of continuous total incapacity.
(This is designed to keep the number of cases where premiums are
adjusted to within reasonable limits.) Of course, where waiver is
not granted the same effect can be obtained by slightly increasing
the amount of benefit. For example, where the cost of each £1 per
week of benefit is £2 per annum, the annual premium for benefit
of £25 per week is £50. If the insured wished to cover the premium he could increase his proposal by £I per week at an additional annual premium of £2, giving a total premium of £52 which
is, of course, approximately equal to the additional benefit.
Some offices offer permanent sickness insurance only in conjunction with a life assurance contract. The amount of sickness
insurance which may be effected is usually lower than may be
effected with an office offering permanent sickness insurance
contracts as separate policies. In some cases benefit is limited to
waiver of the premium. A paper on these combined policies was
submitted to the Students' Society in 1948 by H. F. Purchase
(J.S.S. 8, 121). On re-reading this paper I was impressed with the
similarity of the considerations involved which, on second
thoughts, should have been obvious. The main distinction
is that the benefits being lower, considerations regarding the
maximum amount of benefit which may be effected are not usually
relevant.
OCCUPATION GROUPS AND UNDERWRITING
It is well known that the amount of sickness varies widely with
occupation. This is mainly due to four reasons:
(1)
(2)
(3)
(4)
Higher standards of fitness required for some occupations.
Type of work (risk element).
Type of person employed.
Availability of steady work. If positions are, or are likely to
be in the future difficult to obtain, any minor illness may be
used to secure in effect unemployment benefit.
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Provided there is a sufficiently large body of lives in each occupation, statistical data may be used to measure the effects of (I)
and (2) and to a certain extent (3), and premium rates could be
computed from the results. The effects of (4) are unpredictable
and statistical analysis is of little value here. Thus, very great care
must be exercised in assessing the risk when the insured follows
an occupation which is subject to periodically slack periods or
where the insured is employed in an area with one major industry.
Usually occupations are graded into a small number of categories
and where the occupation is not in the highest category an addition
to the normal premium is imposed. There could, for example, be
four major groups as follows:
Group A: Sedentary workers, professionally qualified men.
Group B: Light manual workers (e.g. shop assistants), salesmen
and representatives, foremen, farm workers.
Group C: Semi-skilled factory hands.
Group D: Labourers, heavy engineering factory hands, miners.
The additional premium required by Groups C and D can
usually only be estimated by working from National Insurance
statistics since relatively few people from these groups are interested in effecting this type of insurance with an insurance office.
National Insurance statistics also show that self-employed
people experience less sickness in the first 6-month period of sickness than employed people. (See Report by the Government
Actuary on the Second Quinquennial Review of the National
Insurance Acts 1946-46.) This is reasonable since the self-employed
have more incentive to return to work as soon as possible, often
before they are completely recovered. In any major illness, however,
they are unable to return no matter how much they wish to do so,
so that there is less difference at the longer durations. One office
makes an allowance for this difference between employed and selfemployed where the period of deferment is less than three months.
Changes of occupation. Any change in occupation must be
notified to the insurance office to permit re-assessment. Obviously
this is especially important when the definition of incapacity refers
to own occupation, although the office must in any case reserve the
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right to deal with a policy in any way on notification of any change
of occupation.
Acceptance
In comparing the medical evidence required for permanent
sickness insurance and for life assurance, the following two points
must be remembered:
(i) There is a wide range of disabilities which may affect the
proposer's future health without necessarily affecting his
longevity.
(ii) The amounts at risk in permanent sickness insurance are
higher than they appear to be at first sight. £20 per week is
not excessive and proposals for this amount are commonplace. But on a permanent breakdown in health this is
equivalent to £1000 per annum which could be paid for
many years. It is certainly my impression that the average
total amount at risk under a permanent sickness insurance
policy is greater than under a life assurance policy. Consequently, medical examination is often required. Even if
proposals are accepted on a' non-medical' form, the questions
are more comprehensive than on many life assurance nonmedical forms.
The following methods of dealing with sub-standard lives are
available:
(a) Imposition of an extra premium.
(ft) Exclusion of claims for benefit where incapacity arises from
certain specified causes.
(c) Limitation of type of policy to be issued.
(d) Declinature.
The first three may of course be used individually or more than
one in conjunction.
Imposition of an extra premium. This course is taken if the
insured is in a state of poor resistance to future disease either
following an illness or if his general state of health on examination
is unsatisfactory.
An example of a disability leaving a general poor resistance to
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disease is diabetes mellitus. There is, for instance, a higher incidence of both coronary thrombosis and pulmonary tuberculosis
amongst diabetics than amongst the general population. Also,
although insulin has kept the immediate effect of diabetes under
control, its long-term effects are yet to be discovered. In the
absence of adequate statistics of the morbidity of diabetics in a
suitable form, the medical officer is asked to estimate the future
additional morbidity as best he can. Suppose he estimates that
the additional morbidity will be 50% to age 50,100% from age 50
to 55, prognosis after age 55 unpredictable. The proposal would be
limited to terminate at age 55—method (c) and the appropriate
extra premium to that age calculated according to the medical
officer's estimate.
A loading is often imposed for overweight. It might also be
imposed:
(i) When a prognosis of a recent disability is uncertain (when
the additional premium could be reviewed after a period
free from similar conditions, possibly 5 years).
(ii) Where the proposer has a defect or absence of a paired
organ, without abnormal risk of recurrence of the cause of
the impairment. For example, a proposer who has lost the
sight of one eye will be permanently incapacitated if he
loses the sight of his remaining eye, whereas a person with
normal sight in both eyes on effecting the insurance would
not necessarily be incapacitated.
(iii) When the proposer has suffered from a series of minor infections, possibly unrelated, indicating a general poor state
of health.
Exclusions. When the proposal comes up for assessment although
the overall picture given by the proposer's medical history and
present state of health is naturally of prime importance, the possible
future effect of every past illness has to be considered. Generally,
previous disabilities may be put into one of the following categories:
(1) Having left no effect and thus ignored.
(2) Having left a localized weakness thereby increasing the risk
of recurrence of that particular disability.
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(3) Having left a general state of poor resistance to future
disease.
A high number of incapacities fall in the second category and are
usually dealt with by the imposition of an exclusion. It is possible
that if there were a sufficiently large body of insured lives with a
medical history of having suffered from a specific complaint to the
same degree, being healthy in all other respects, statistics could be
collected to enable the office to charge an appropriate additional
premium and give full cover. Apart from the difficulty of paucity
of data, however, there are often two factors which make an exclusion the only feasible method to adopt. These are:
(a) Where an operation or further treatment is contemplated,
or would have been contemplated had the exclusion not been
imposed.
(b) Where the periods of incapacity are likely to be of long
duration the experience would fluctuate greatly from year to
year, making the cost of full cover difficult to calculate and
so high as to be unattractive to the insured. One important
example of this is mental illness of any type. If there has
been any history of mental illness involving incapacity from
work, the office may exclude claims for incapacity due to
anxiety state, neurosis, psychoneurosis, and even psychosis.
Limitation of benefit in this way has been criticized in the past
in the Institute. However, while it may be agreed that exclusions
should be avoided wherever possible (since they lessen the value
of the contract which then gives only incomplete protection), they
do enable a policy to be issued where declinature would be the
only alternative course.
Special terms on permanent sickness insurance policies may, of
course, be reviewed at any time and if warranted by circumstance
may be removed. Often a review may be offered after a policy will
have been in force for a stated number of years. This implies that
if there is no medical evidence of the condition at that time and
there has been no recurrence of the condition subsequent to
effecting the policy, the exclusion will be removed. The offer to
review frequently assists in persuading a proposer to complete
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although usually only a small minority, in my experience, are dissatisfied with the terms of acceptance. Where possible, of course,
an inquirer is warned that special terms may be required before a
proposal and medical evidence are submitted. This is often possible
where the inquirer already holds permanent sickness insurance
since his medical history can be followed very closely. The
scanning of papers on receipt of an inquiry is in fact important in
that any adverse medical history can be acted upon at the earliest
stage. Otherwise the inquirer has the legitimate complaint that
'You knew about m y . . . , why leave it until acceptance to tell me
that it would affect my proposal?'
Limitation of type of policy. An example of limitation of the
terminating age has been given above. The more common limitation is in the period of deferment. A proposal for immediate
benefit may be declined, but a proposal for 1 or 3 months' deferred
benefit may be accepted at the normal rate of premium. For
example, a proposer who already holds an immediate benefit
policy may have frequently claimed for minor conditions and is
not acceptable as a candidate for further immediate benefit. One
rarely comes across a policyholder who may be thought to have
claimed under his policy fraudulently. One cannot help suspecting
an insured who claims 2 weeks' benefit every August!
Where exclusions are objected to, a deferred benefit policy may
sometimes be offered free of restrictions. A history of inguinal
hernia would not often preclude acceptance without qualification
under a 6 months deferred benefit policy. In the great majority
of cases an operation would have been performed and recovery
completed long before the expiration of the 6 months.
It is sometimes argued that those whose policy is subject to an
exclusion should not be required to pay the full premium. Suppose, for example, a proposer has had a prolapsed intervertebral disc
and that this condition is excluded. He could say that the office
would expect to pay some benefit for claims due to prolapsed disc
under policies which had been accepted without qualification and
that therefore the cost of his insurance should be less. This argument only holds good on the assumption that the insured whose
policy bears an exclusion is no more liable to other causes of total in-
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capacity than an insured whose policy is issued without any restriction.
A comparison has been made in my office between the sickness
experienced by those whose policies were issued excluding benefit
for certain conditions and those whose policies were issued without those restrictions. This showed that the rate of morbidity was,
on average, higher for the group whose policies bore the exclusion. It appears that an insured who has had one type of serious
illness may take longer to convalesce from an illness unrelated to
the condition excluded than an insured who has been granted full
cover. There may even be grounds for requiring an additional
premium when policies are issued with an exclusion.
Declinature. There are always, unfortunately, a few proposals
which cannot be accepted on any terms. There is little to comment
upon except that sometimes a proposer has no knowledge that he
has suffered from a specific ailment and therefore a special provision cannot be imposed excluding benefit for incapacity due to
that ailment. Declinature may be the only alternative.
Conversions
Permanent sickness insurance contracts are converted far more
frequently than life assurances. Taking into account the number of
types of policy available and the fact that a man's salary arrangements may change, either because he has changed his employer
or because he has moved to a higher grade in his existing employment, this is only to be expected and even encouraged. Suppose
an insured had effected a 3 months deferred benefit policy and
owing to a change in his circumstances will in future be paid for
the first 6 months of any period of incapacity by his employer. It
is obviously in the interest of the office to allow him to convert his
policy to 6 months deferred benefit.
CLAIMS PROCEDURE
The details referred to have been satisfactorily used in my own
office. In any procedure adopted, however, the following principles
should be taken into account:
(a) The procedure should be as routine as possible.
(b) Reference must be made to the insured's file.
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(c) All certificates should be as simple as possible yet comprehensive.
(d) The initial certificate must be received within a reasonable
time and must cover certain points as set out below.
(e) Progress certificates should be required at reasonable intervals.
(f) Cheques must be despatched promptly.
(g) Rehabilitation after a long illness may require special
consideration.
(a) The procedure should be standardized to lessen the risks of
error, especially when the department may be under pressure
during an epidemic.
(b) From the insured's file the following must be checked:
(i) The occupation and country of residence are as shown in the
policy and that age has been admitted.
(ii) All premiums have been paid to date (there will be no need
to check on title if the insurance has been made nonassignable by the office).
(iii) If there are linking-up periods, no previous claim has
terminated within the period.
(iv) There is no special provision in the policy or, if there is one,
that it does not refer to the present cause of incapacity.
Incidentally, because this information has to be obtained for all
the insured's policies, it is more convenient to file his correspondence
and policy details in one folder and not keep separate files for each
policy.
(c) The completion of the certificates is the responsibility of the
insured and any charge made for their completion by the medical
attendant has to be met by him. Any irrelevant information should
therefore be excluded as far as possible. On the other hand, the
certificates must contain such information as to enable a reasonable
assessment of each illness to be made so that the medical officer
can be sure that there is no undue deferment of return to work.
(d) Notification of total incapacity must be given within a prescribed period since otherwise:
(i) the date of commencement of total incapacity cannot be
established without uncertainty, and
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D. J. BOND
(ii) any doubts as to the validity of the medical evidence may not
be resolved.
Under immediate benefit policies notice should be given as soon
as possible. For deferred benefit policies notice should be given
not later than, say, 13 weeks after the commencement of incapacity if benefit is deferred 6 months or more. This ensures that
notification is within a reasonable time from the commencement of
incapacity and yet the claims department is not dealing with a
large number of cases where the duration of incapacity will not
extend to the period of deferment. Incidentally, it also provides
the office with information—although meagre—of a possibly
severe illness. This may be of use if further insurance is contemplated.
The initial certificate should be completed by the insured, where
possible, and by his medical attendant. It should cover the
following points:
(1) The date when total incapacity commenced must be stated
and confirmed by the medical attendant.
(2) The precise nature of the illness must be given.
(3) Where there has been a previous illness which is possibly
related to the present incapacity, the date and duration of
that illness must be given.
(4) The medical attendant should be asked to estimate the
duration of total incapacity.
(5) The medical attendant should be given the opportunity of
giving any information he may consider to be relevant.
If there is any suspicion that the condition has been caused or
aggravated by intemperance or deliberately self-inflicted, further
inquiries must be made. In the case of alcohol it should be
remembered that the primary condition could be of a neurotic
nature leading to alcoholism. This is more usual than alcoholism
causing neurosis.
Dealing with item (3) above, this information should be checked
to see if the previous illness had occurred before effecting the
policy and, if so, whether it was disclosed. Discretion must be used
if it had not been disclosed. An illness of a minor nature could
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have been forgotten at the time the proposal was submitted and had
it been disclosed it would have been ignored when deciding the
terms of acceptance. On the other hand, deliberate non-disclosure
should result in the cancellation of the policy.
Although taking into account the medical attendant's estimate
of the duration, the office must be prepared to use its own discretion and experience in assessing the probable period of incapacity. For example, appendicectomy could be described as
such by the medical attendant and a simple one should take no
longer than 3 to 4 weeks, sometimes only 2 to 3 weeks. Hence,
even though a medical attendant gave the prognosis as 8 to 10
weeks, a progress certificate should be asked for at the end of 4
weeks. If this threw no further light on the matter (i.e. by revealing
peritonitis or other complications), the office should inquire as to
the reason for the prolonged convalescence. Conversely it may be
advisable for the insured not to return to work too soon. Consider,
for example, pulmonary tuberculosis. Whilst it is true that new
drugs are now available to control this condition, inadequate rest
could bring on a relapse with the result that both the insured and
the office would suffer.
(e) The interval before progress certificates are required varies
with the conditions. For example:
Influenza
Coronary thrombosis
Pulmonary tuberculosis
fairly short
2 to 3 months
2 to 6 months
The progress certificate, which need only be completed by the
medical attendant, should show:
(i) The precise nature of the illness. This is required again in
case there has been any change in the diagnosis.
(ii) That the insured is still totally incapacitated.
(iii) The estimated time for return to duty.
(iv) Any special features necessitating a long period of incapacity, taking into account the nature of the illness.
(v) Any other information the medical attendant may think
relevant.
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On receipt of the progress certificate, the medical officer compares the information with that in the initial certificate and is in a
position to estimate when he will require a further certificate or if
he requires further medical evidence. This procedure is then
carried on until the claim is terminated.
(f) It is of course obvious that cheques must be dispatched
promptly. If an insured is totally incapacitated his benefit may be
his sole income and he may rely on this to the same extent as an
employee on his salary.
(g) After a long illness it is virtually impossible to say that the
insured is totally incapacitated one day and fit for work the next.
To start with, there must be a reasonable period of convalescence.
Then the insured may do a little part-time work to see how he
fares. If he has been incapacitated for 6 months or more it may be
necessary to allow him to work part-time for a month or so as
gradual rehabilitation. The insurance office must be prepared to
go outside the strict interpretation of its definition of incapacity to
deal with such cases. Also, if an insured holding deferred benefit
makes an unsuccessful trial return to full work he would strictly be
required to forfeit benefit for the period of deferment for a second
time, which is obviously inequitable. No hard and fast rules can
be laid down about how these cases should be dealt with but it
should be remembered that a generous decision will enhance the
good reputation of the office, both to the insured and to his business
and social acquaintances.
SPECIAL CLASSES
Women
A whole paper could be devoted to permanent sickness insurance
for women. All I can do here is to touch briefly on the main considerations and to draw attention to the necessary limitations
which have to be imposed.
Women are not permitted by any office, to my knowledge, to
continue their insurance on retirement from gainful employment
unless this retirement has been caused by total incapacity. In the
large majority of cases retirement is caused by an improved
financial status of the husband, and not through any deterioration
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in health. It is advisable to ask for a declaration at least once a
year that the insured is fully employed.
The insurance office must decide on its attitude towards
gynaecological conditions. My own office takes the view that no
maternity benefits should be paid but that there is no more reason
to exclude other gynaecological conditions than to exclude those
conditions which are peculiar to men from policies issued on male
lives. Benefit is held in suspense during pregnancy and for 3
months after its termination. At the end of this period cover is
reinstated irrespective of the insured's state of health at that time
provided that she is gainfully employed or if she is totally incapacitated but intends to resume gainful employment on recovery.
In the latter case, benefit would be payable as though the incapacity had commenced immediately following the suspense period.
It is surprising to many proposers that insured women experience
a substantially higher rate of morbidity than men. The reason for
this is difficult to pinpoint. It is certainly not due solely to gynaecological conditions since even if these are excluded, the morbidity
rate for women is still greatly in excess of that for men. In my
office the overall ratio of actual to expected number of days of
sickness (based on the Manchester Unity A.H.J. rates) has been
calculated for different groups for many years. This percentage for
women has been consistently approximately 175% of the percentage for men in the comparable group. I have investigated the
rates of sickness by age for the years 1956 and 1959 and have found
that there is not much difference between the rate of sickness for
women and the rate for men up to age 50, but that over that age
the rate for women is double that for men. A previous investigation covering the years 1950-54 inclusive, however, shows an
excess over all ages. Obviously the experience will have to be
watched closely to see whether there is a definite change in the
pattern of morbidity. Several theories could be advanced to
explain the difference but without further experience these could
not be substantiated. Whether the difference in experience is due
to random fluctuations or not, however, it remains a fact that
insured women have experienced almost double the male rate of
sickness, and premiums for women must be calculated accordingly.
14
ASS
17
212
D. J. BOND
Cover outside the United Kingdom
Cover is not automatically granted outside the United Kingdom
except for a period of, say, 13 weeks in any one period of 12 months
to cover holidays, lecture tours, etc., abroad. The reasons for this
are:
(a) The possibility of living in an unhealthy climate or in unhealthy conditions.
(b) The difficulty of obtaining reliable medical certificates in
remote areas.
(c) The possible lack of medical facilities.
(d) The difficulty of investigating any doubtful diagnosis in
remote areas.
The significance of (a), (b) and (c) has been lessened by the
advances of medicine and travel facilities, although those of nonEuropean stock who may be more liable to reside in the remoter
and poorer areas overseas are not granted cover overseas by any
office transacting business in the United Kingdom, to my knowledge. The effect of (d) is minimized if the benefits are such as to
encourage a return to work at the earliest opportunity. Provided
then that:
(i) an insured is of European stock and his previous medical
history does not suggest that he would be adversely affected
by living in an overseas climate;
(ii) his insurance is converted, if necessary, so that no benefit
is payable whilst he is in receipt of income from his new
employment;
(iii) the benefit does not exceed the maximum percentage of
his earnings permitted by the office;
(iv) the policy is endorsed granting cover whilst holding a
specific appointment and that on leaving that appointment
the policy would become invalid unless the prior consent of
the office had been obtained;
it is practical both to extend cover overseas under existing contracts and to issue a new policy to a proposer resident overseas.
My office has kept separate statistics of those resident overseas for
PERMANENT SICKNESS INSURANCE
213
a number of years and these suggest that there is no significant
difference in the rates of sickness experienced by those overseas
and by those in the United Kingdom.
Group policies
These policies normally cover employees of one undertaking.
They do not include proprietors. Benefit is usually deferred three
or six months and may be payable direct to the employee or to the
employer.
Generally, the same considerations apply to both group policies
and individual policies although waiver of premium benefit may
be usefully incorporated since otherwise an employer might be
paying a premium for an employee who had been incapacitated for
many years and whose position had been taken over.
TAXATION
This may be considered under three general headings, as affecting
(i) an individual policyholder, (ii) an employer and employee in a
group policy, and (iii) the insurance office.
An individual policyholder
Premiums. There is no tax relief on the premiums (except when
benefit becomes subject to tax) whether these are paid from a
business account or not.
Benefit. This is taxed in the hands of the recipient under Case
III of Schedule ' D ' as unearned income, but by concession the
benefit is not assessed to tax unless it has been received continuously for the whole of a fiscal year. In this event, the premium
is, again by concession, allowed to be set off against the benefit as
an expense.
Group policies
Employer
Premiums. Provided that the insurance is, in effect, a staff
welfare scheme and does not cover proprietors (such as directors
or partners), premiums are allowed as an admissible expense of the
business.
Benefit. Where this is paid to the employer it would, in practice,
probably be credited to salaries account and so be taxed in the
14-2
214
D. J. BOND
hands of the employer (who would continue to pay the whole or a
proportion of the normal salary at least equal to the amount of
benefit to the incapacitated employee).
Employee
Premiums. Where the employees make a contribution to the
cost, this contribution is dealt with as though they had effected
individual policies. Where benefit is paid direct to the employees,
for those earning over £2000 per annum the cost to the employer
of providing the insurance is included as part of the employee's
remuneration for tax purposes.
Benefit. Where benefit is paid direct to the employee, it is taxed
in his hands as though he held an individual policy, i.e. under Case
III of Schedule ' D ' , subject to the concession mentioned above.
Where benefit is paid to the employer, any payment made by him
to the employee is taxable in the same way as the employee's
normal salary.
The insurance office
Under this heading one has to consider the cases of mutual and
proprietary offices. Each requires different treatment as regards
taxation although it will have been noticed that whether mutual or
proprietary, sickness benefit is taxable not at source but in the
hands of the recipients. In the case of a mutual office there is no
machinery affording tax relief on management expenses of sickness
funds under I.T.A. 1952, Section 425. Also, the Ayrshire Case
(1946) decided that the sickness fund of a mutual office cannot produce a Sec. 341 Case 1 notional tax loss, and consequently it
cannot make a Case 1 profit. The corollary to this is that there
is no profits tax liability. The overall effect is that such a fund can
only earn interest net of standard rate. With a proprietary office it
seems that the same tax considerations apply to that part of the
sickness fund applicable to and reserved for the policyholders (i.e.
the valuation reserve) as in the case of a mutual office. It is the
proprietor's surplus or deficiency that is subject to Case I Schedule
' D ' and profits tax computations and a possible Sec. 341 loss
claim.
PERMANENT SICKNESS INSURANCE
215
PREMIUM BASIS
Rate of sickness
The latest comprehensive tables available are the Manchester
Unity tables relating to the years 1893-97. The rates shown are
now completely out of date and should only be used after being
adjusted to allow for the office's experience. The A.HJ. table is
the one normally used, each period of sickness being often adjusted
by a constant percentage for all ages.
Mortality
Since the cost of permanent sickness insurance increases with
age there is, under a net premium valuation, always a positive
reserve. Thus the higher the rate of mortality assumed, the higher
the expected release of reserve from mortality. (This is dealt with
more fully later.) Therefore, it is important that the rate of mortality should not be over-estimated.
If the sickness insurance is coupled with a life assurance contract,
it would appear inconsistent to employ different mortality rates
for the sickness insurance and life assurance sections. Under these
circumstances, the rate of mortality employed should be as close
as possible to that experienced and any valuation loss on mortality
on one section would be offset by a valuation profit on the other.
Interest
A net rate of interest should obviously be employed. If separate
investments are held for the fund, it is possible to immunize the
fund. For complete immunization the average outstanding term
of the investments should be only about one-half of those for a life
assurance fund, since payments out of the fund are made throughout the duration of the contracts. This is usually impractical since
in most offices there are not separate investments for each fund and
consequently the investments held are usually too long. If therefore a permanent sickness fund and life assurance fund are secured
on combined assets, an opinion must be made as to whether interest rates will rise or fall in the future. If interest rates are
expected to rise in the future, the valuation should be strengthened,
possibly by creating a special contingencies fund.
2l6
D. J. BOND
Expenses
The gross expenses have to be allowed for in the premium since
the expenses are not deductible from the gross interest income in
calculating the amount on which tax is assessed. Other than this,
the same considerations apply as in a life assurance fund except, of
course, the cost of claims administration. Ignoring increases in
cost due to inflation, the cost of claims administration will increase
approximately with the rate of sickness and may thus be expressed
as a constant percentage increase in the net premium. Strictly,
allowance should be made for future claims administration costs
in the valuation although in practice this reserve is allowed for in
the margin allowed in the valuation basis.
There are no 'large case reductions' (except for any large group
policy). One reason for this is that the insurance office cannot
offer an unlimited amount of insurance to everybody and it might
appear unreasonable to limit the amount of a proposal (for example,
because the proposer wished to effect more than the maximum
percentage of his normal earnings) and by so doing, make the proposer lose the benefit of a large case reduction.
Contingency
Little is known about the long-term changes in the rate of
morbidity. Even if we had more information, we would have to
allow for considerable year-to-year fluctuations. Also, since the
office expenses per policy are higher than, say, under life assurance
contracts, the effect of inflation is more pronounced. It is therefore necessary to include quite a high loading for contingencies.
One method of dealing with this loading is by offering withprofits contracts. Reversionary bonuses which are paid alike to the
insured who has made no claims and to his colleague who has
claimed frequently (and who is probably more in need of the bonus)
can be an attractive feature of these insurances. I often wonder
why such a scheme is not more widely adopted. One reason may be
the relatively unfavourable tax position of the sickness insurance
fund although in my experience this does not appear to have any
significant effect.
PERMANENT SICKNESS INSURANCE
217
VALUATION AND ANALYSIS OF SURPLUS
The following notes refer to a net premium valuation. Naturally,
a gross premium method may be employed, the usual precautions
being taken to eliminate negative reserves.
Sickness
It is reasonable to adopt the same rates of sickness as those used
in calculation of premiums, provided that this rate exceeds the
actual rate of sickness adjusted to include the loading for the cost
of claims administration. Unless the actual sickness rate is significantly above the expected rate for any group, there is no allowance
to be made for claims in course of payment on the valuation date
since this allowance is automatically included in the valuation
reserve. If the actual rate significantly exceeds the expected rate,
this should be dealt with by amendment of the valuation basis. It
does not meet the problem to make a specific reserve for outstanding
claims.
For analysis purposes, the overall sickness surplus (or deficiency)
for the valuation period (assumed to be 1 year) must be calculated
excluding the effects of mortality. A possible method is as follows:
Let x be the exact age on the valuation assumptions, and Byx the
total benefit for exact age x on date y. Then
In other words, the average benefit in force in respect of a group
aged(x-½) exact on (y — ½) for the year to (y + ½) is approximately the benefit in force for a group aged x exact on y. Hence,
the expected claims in respect of the above group amount to
approximately
Assuming that the sickness claims are spread evenly over the year,
the total claims for all age groups expected from y to(3y+ ½) are
2l8
D. J. BOND
Similarly, the expected claims from (y + ½) to (y+1) are
Interest for one half-year is added at the valuation rate.
Mortality
The same considerations apply when choosing the rates of
mortality for both the premium basis and the valuation basis. For
the analysis, the valuation surplus (or deficiency) is the difference
between the expected release of reserve on death and the actual
release of reserve (on the valuation basis) on death, accumulated to
the end of the year at the valuation rate of interest.
Let Ryx be the reserve under a group aged x exact on valuation
date y. Then, following the same method as used for calculating
the surplus or deficiency on sickness, the expected release on death
is
Interest
The rate used must be not more than that used in the calculation of the premiums. To eliminate so far as possible changes in the
valuation basis a lower rate of interest may be used.
The interest profit for the analysis is calculated in exactly the
same way as in a life assurance fund.
Loading
The valuation assumptions as to sickness, mortality and interest
rates determine the size of the net premium, and thus the amount
available to cover management expenses (possibly excluding those
for claims administration if these are included in the margin
allowed in the rate of sickness). If there is a loading loss it may be
due to the valuation basis being too stringent, the rate of premium
being inadequate or—and most probably—a large amount of new
business in relation to the size of the fund.
In a life assurance fund valuation of whole-life and endowment
assurances the reserve may easily be adjusted by (1 + k) V—k where
PERMANENT SICKNESS INSURANCE
2I9,
k is the excess per unit sum assured of the initial expenses over the
renewal expenses. Unfortunately, there is no easy adjustment to
the valuation reserve in a sickness fund and unless a valuation constant of, sayk/äx:n/\,where x is the exact age at entry on the valuation
assumptions and n is the term of the policy, is recorded, approximate methods will have to be employed. While such an estimate
may be considered necessary, it should be remembered that the
cost of securing new insurances will tend to decrease as the insurance office's name becomes established, so that any such adjustment should be carefully watched.
Lapses
No surrender value is payable under permanent sickness insurances although there is always a positive reserve on a net premium
valuation. The justification for this is that there is selection against
the office by the insured who lapses his policy so that, although
there will be a valuation profit, the office will have lost an insured
who had no prospect of claiming benefit. Where the valuation
profit from lapses is at a significant level, it may be appropriate to
set aside this profit in a contingencies fund to help meet the higher
expected rate of claim of the remaining policyholders.
Effects of a change in the valuation basis
Sickness rate
An increase in the sickness rate will bring about an increase in
the valuation reserve. If, for example, the sickness rate was increased by 10% (the mortality and interest rates remaining unchanged), the present value of expected future sickness benefit, the
net premium (provided that the office premium has a sufficient
margin over the increased net premium) and hence the value of
future net premiums would be increased by 10%. Consequently
the valuation reserve would also be increased by 10%.
Mortality rate
The value of expected future sickness benefit, the net premium
and the valuation reserve will all decrease on an increase in the
22O
D. J. BOND
mortality rate, the sickness and interest rates remaining unchanged.
This may be demonstrated as follows:
Value of benefits. The present value of sickness benefit expected
at age x + n of a group now aged x is: D x + n + ½ z x+n /D x . Obviously,
the higher the mortality rate, the lower this value and hence the
lower the value of all future expected sickness benefit.
Net premium. Sickness increases with age. If therefore P is the
level net premium, this premium will be more than sufficient to
meet the expected cost of claims in the early years. The higher cost
of claims in later years is then met by:
(a) The net premium P.
(b) The amount accumulated from the excess of P over the
expected cost of claims in the early years.
(c) The accumulated reserves released on the expected number
of deaths.
The higher the expected number of deaths, the higher the sum
released by (c) so that the expected sum released by (a) and (b),
and consequently the net premium P, is lower since the expected
cost of the claims of the survivors is not increased. This may also be
demonstrated as follows:
Now Zx+n increases as n is increased. Also, the higher the
mortality rate, the lower the value of Dx+n+½/Dx or in other words,
the greater the decrease in the values of D x + n + ½ as n increases.
If, therefore, D' is from a table with a high mortality rate and D
is from a table with a low mortality rate
since on the left-hand side, the lower values of D' are more heavily
weighted. From this we have
that is, the higher the mortality rate, the lower the net premium.
PERMANENT SICKNESS INSURANCE
221
Valuation reserve. The reserve is the amount accumulated from
the excess of P over the expected cost of claims in the early years
plus the accumulated reserves released on the expected number of
deaths ((b) + (c) above). The higher the mortality rate, the lower
the value of P and hence the lower the sum available from (b).
Thus, a larger sum must be available from (c) since the cost of
expected claims of the survivors will be identical whatever the
mortality rate. Since mortality increases with age, the bulk of the
sum will be released during the latter years of the insurance and
thus with a high mortality rate the valuation reserve will increase
more rapidly during the currency of the insurance and will therefore never reach the level of the reserve based on a lower mortality
rate. Hence, the higher the mortality rate, the lower the valuation
reserve.
Interest rate
If the sickness and mortality rates remain unchanged an increase
in the interest rate will reduce the present value of expected future
sickness benefit, the net premium and the valuation reserve. This
must be so since there is always a positive reserve.
Conversions
In view of the high number of conversions it is useful to have a
simple method for calculating the revised premium. One method
may be demonstrated by considering an insured who effected
a three months' deferred benefit policy terminating at age 65 when
he was age 25, at an office premium of P325:40 . Ten years later he
wishes to convert to six months' deferred benefit for which the
normal office premium at his attained age would be P635:30 . Now,
had he effected a 3 months' deferred benefit policy at age 35 he
would have been required to pay a premium of P335:30 and he would
secure exactly the same benefit in the future as under his existing
policy (assuming he was not claiming at the date of conversion).
But under the latter policy he pays a premium of P325:40 so that he
has secured an annual reduction of (P335:30 - P325:40 ) by his premiums
paid in the first 10 years. This reduction may then be transferred
to the new type of benefit so that his premium after conversion
222
D. J. BOND
6
3
will be P 35:80 - (P 35:30 )+K where k is a small loading for
expenses. Where the age at maturity is altered the annual reduction
is spread over the revised outstanding term by ä/ä .
SICKNESS EXPERIENCE INVESTIGATIONS
The comparison between the actual and expected morbidity
rates should be made in as detailed a form as is considered possible,
taking into account the size of the experience. Otherwise, it is
like valuing a life assurance fund without making any investigation
into the suitability of the rate of mortality used. Indeed, for a
permanent sickness insurance fund it is of even greater importance
to make this comparison owing to the lack of consistent or continuous investigations. This will have been apparent already from
some of the problems on assessing the additional risk for different
occupation groups, for medically impaired lives and for females,
and from the fact that the sickness rates most frequently used were
compiled 60 years ago.
As a consequence of the lack of suitable statistics, many important questions are left unanswered. These include:
(a) What has been the overall change in the morbidity rate since
the Manchester Unity tables were compiled?
(b) To what extent is this change due to
(i) advances in medicine?
(ii) changes in social attitudes towards sickness ?
(iii) the general economic situation?
(c) What are the effects of selection?
(a) There has been no pooling of the morbidity experience of the
relatively small number of offices that undertake permanent sickness and accident insurance although no doubt every office, like
my own, has made more or less detailed investigations into its own
experience. It is tempting to envisage the setting up of an investigation such as the continuous mortality investigation to which life
offices contribute data, but differing policy conditions, the different distribution of occupations as between one office and another
and no doubt other factors make it almost certain that the com-
PERMANENT SICKNESS INSURANCE
223
bined data would be too heterogeneous to be of much value. It is
also likely that the total amount of business in force over all offices
is not yet sufficient to allow very much in the way of sub-division
to overcome these problems.
(b) The office records provide much accurate data relating to the
insured's medical history. There is therefore much scope for investigation of the long-term effects of various illnesses. The
resultant information is of value both to the underwriter and to
medical statisticians. In paragraph 38 of his paper in J.I.A. 83 on
the measurement of morbidity, Benjamin gives an example of the
scope of the statistics which may be derived from this source. Office
investigations might also be made to calculate the relative effects of
(i) and (ii) above. At the present time the effect of (iii) is a completely unknown factor. In a general economic depression if an
insured is unemployed on becoming incapacitated, it is obvious
that he will defer any recovery so long as he is able to do so. On
the other hand, an insured in work might lose his employment if he
is absent for too long and this might result in his returning to work
more quickly than he would otherwise have done.
(c) One of the major problems of the actuary in dealing with a
permanent sickness insurance fund is that there are no published
select rates. In an office transacting considerable new business in
relation to the size of its existing insurances, the eventual rate of
sickness will exceed the present aggregate rate unless the office can
maintain the ratio of new business to existing business.
An investigation was made a few years ago in my own office comparing the aggregate sickness rate for the year 1953 with the rate
calculated by excluding all those policyholders who had effected
their first insurance within the previous 4 years. Since it was
impracticable to trace back all the conversions from one type of
insurance to another (e.g. 1 month's deferment to 3 months'
deferment) the results are not 100% accurate but they are, nevertheless, valuable and I show below a comparison of the aggregate
rates with the ultimate rates by (i) period of incapacity for all ages,
(ii) age group for all periods of incapacity.
Of course, these figures do not show whether a period of selection
of 4 years is sufficient—for the 'after 2 years' period I doubt
D. J. BOND
224
whether it is. Also the variation in the percentages means that too
many conclusions should not be drawn from these figures. They
do suggest, however, that the aggregate rates should be increased
by 5 % for short periods of incapacity, increasing to about 10 %
for long periods of incapacity to obtain the 'ultimate' rates. One
would expect the percentage to increase with duration of incapacity. First, a policyholder who has held his policy for less than
2 years cannot be claiming in the ' after 2 years' period. Secondly,
an insured recently medically selected may well be incapacitated
by a minor infection soon after effecting the insurance. He is less
likely to be incapacitated by a serious complaint.
Percentage of ultimate to aggregate rates of sickness
First
3 months
105
(i) By period of incapacity for all ages
Second
Second
Second
3 months 6 months 12 months
106
97
After
2 years
106
108
(ii) By age group for all periods of incapacity
Percentage
Age group
104
44½~49½
108
49½-54½
99
101
84
54½~59½
104
103
59½-64½
64½-70
134*
For all periods of incapacity and all age groups combined, the percentage
Age group
24½-29½
29½-34½
34½~39½
39½-44½
Percentage
6o*
was 104.
* These groups are small.
The percentages of ultimate to aggregate rates by age group do
not show any consistent trend. One hypothesis consistent with
these results is that the percentage addition is constant for all age
groups.
The limited information concerning the effects of selection,
coupled with the lack of suitable up-to-date statistics, may well be
the main stumbling block for those insurance offices with no
experience in permanent sickness insurance which are contemplating entering this field. This insurance is, however, becoming
increasingly popular and deserves the serious consideration of all
actuaries.