For the purpose of this section, examples are based on death benefits, but principles remain the same for other benefits such as disability, impairment and dread disease.
What is rating?
Insurance companies base premiums on the risks they accept. The higher the risk, the higher the premium charged. It is therefore important that the risks of insuring someone’s life are correctly rated.
While rating is an internationally accepted practice, the specific rating criteria and application of the criteria differ from country to country.
Rating Factors and Premiums:
There are essentially two different approaches to rating: a discrete approach and a continuous approach.
Most life companies currently use the traditional discrete approach to rating. Based on an individual’s rating factors (income, gender and education) he or she is placed in a discrete rate group. Everybody within that rate group then pays the same premium. Typically, there are eight rate groups for men and eight rate groups for women (four for smokers and four for non-smokers).
The continuous approach is a relatively new approach to rating. There are no discrete rate groups. Effectively each client is charged a unique premium based on his or her rating factors.
What are rating factors?
The risk of dying is affected by several risk factors. Generally, an older individual has a greater chance of dying than a younger individual (all other things being equal). Therefore, age is a risk factor. Other risk factors include gender, access to healthcare, nutrition, other lifestyle factors, and so on.
In some cases, these risk factors are easily determined, for example age and gender. However, other risk factors are not so easy to determine, like access to healthcare and nutrition. If the risk factors are not easy to determine, proxies are found for these risk factors. For example, income is generally a good proxy for access to healthcare and proper nutrition.
The combination of the risk factors that can be determined (such as age and gender) and proxies for the other risk factors (such as income) are known as rating factors.
Rating factors are therefore the factors that determine the risk group into which an individual is placed. By applying the rating factors insured lives are divided into groups where the risk of dying is similar. This enables the insurer to charge a fair premium for each life for the risk being accepted.
What rating factors are typically used?
In this section, the most common rating factors are discussed shortly. It is important to note that different rating factors may be used for different benefits. For example, occupation is typically used when rating occupational disability benefits but is less important for death benefits, unless the occupation is high risk, for example, an Explosives Handler.
Generally, the older an individual, the higher the risk of the individual dying in a given year. Older people therefore generally pay higher premiums.
Generally, women tend to live longer than men. This means that the risk of a woman dying is less than the risk of a man dying in any given year (and hence women generally pay lower premiums).
Income plays an important role in determining an individual’s standard of living. Generally, a higher income means better access to healthcare, a healthier lifestyle, resources to overcome difficulties, and so on.
This means that people with higher incomes tend to represent a lower risk and are thus charged lower premiums.
Better-educated people tend to live longer than less educated people. This is because individuals with a high level of education often exhibit greater awareness of health issues leading to healthier lifestyles, better nutrition, and so on.
Education and income are often correlated in that people with better educations may earn higher incomes. However, education is also an important factor since it may also be a predictor of future earning potential.
Generally, people who smoke tend to die sooner than people who do not smoke and therefore they pay higher premiums.
Once again occupation is quite closely correlated to both income and education.
However, occupation is also an important rating factor. For example, the nature of the work may increase the associated risk. For example, underground mining and police work are inherently dangerous.
An individual’s state of health is also an important rating factor. Again, the impact of this factor depends on the benefit applied for. For example, consider an individual with a history of back problems. He or she may be charged an extra premium for occupational disability cover since the back problem increases the chance of a disability claim later. However, the back problem may not increase the individual’s chance of dying and therefore not impact on the death benefit premium.
Insurers need to ensure that any rating factors that are applied can be justified statistically. For example, if income is used to determine premiums, the impact of income on the associated risks needs to be justifiable statistically. This is referred to as fair discrimination.
In addition, fair discrimination should not infringe on an individual’s human rights. For example, even if it were statistically justifiable, race would not be used as a rating factor.
Therefore, the effects of various rating factors on the risks being assessed are based on statistical evidence. Wherever possible, South African statistics are used to show the impact of rating factors on premiums charged. If South African data does not exist, overseas data may also be used.
Individual rating versus community rating
This document relates to individual life policies where individual ratings are applied. This means that an individual’s premium is dependent on the rating factors mentioned above such as age, gender and state of health and everyone is charged a premium corresponding to the risk that he or she represents.
In a community rating model, the premium is often independent of some or all the rating factors and an average rate is applied. This approach is typically used in group life insurance and funeral insurance and men, women, smokers and non-smokers all pay the same premiums.
The advantage of using an individual approach to rating is that clients are charged a fair premium for the risk they represent. For example, healthy lives are not subsidising less healthy lives.