PREMIUM PATTERNS AND COVER GROWTH
This section describes the different premium patterns available on new-generation risk products. These are also sometimes called funding patterns or increase options.
The options described apply to level cover. There are also several different ways to structure cover growth on a policy, which are discussed in the next section.
Level Premium Pattern
The policy owner can choose to pay a level premium for a level amount of cover over the term of the risk-benefit. A change in premium may occur at the end of the guaranteed term. There may be a guarantee that premiums will not increase during a certain period. At the end of the guarantee period, the premium may increase as a result of a review of general risk rates. These increases are not impacted on by your age or medical status and you do not need to undergo new medical examinations and blood tests.
With a level premium pattern, the insurance company effectively takes the mortality or morbidity curve over the future lifetime of the insured and flattens it out. The policy owner, therefore, pays a premium that is initially more than the true underlying risk, but less later, as indicated in the graph below.
The advantage of the level premium pattern is that it provides stability to the policy owner. Premiums will remain the same over the long term.
Compulsory Premium Increases and Implications
Compulsory premium increase options all offer initial premiums lower than the level premium pattern, but these premiums are contractually required to increase in a pre-determined way to maintain the chosen level amount of cover. The steeper the premium pattern, the cheaper the initial premium will be. This principle is illustrated in the table below, which indicates the possible initial premium payable under different compulsory premium increase options, compared to a level premium of 100. (Initial premiums shown are purely illustrative.)
Level premium pattern
5% compulsory growth
7% compulsory growth
10% compulsory growth
These options therefore do get more expensive over time. Clients should also realise that premium increases due to reviews after the guaranteed term, or due to additional cover, are required on top of scheduled compulsory increases.
Contractual premium increases may not be skipped, reduced, or cancelled. Should the client no longer be able to afford the compulsory increases, he or she should contact the insurance company to make alternative arrangements. This will mean a reduction in the cover amount and consideration could be given to moving to a level premium from there on.
Compulsory increase patterns
These options are once again described in terms of a level amount of cover.
These compulsory increase patterns use a flat increase percentage to mimic the risk curve. The premium is contractually required to increase annually at a fixed rate, for example 5%, whereas the underlying risk curve typically increases by a lower percentage at younger ages, and a higher percentage at older ages.
A minimum entry age is usually attached to these increase patterns. This ensures that the new business premium rate increases by at least the compulsory increase percentage from year to year, so that the client is not better off lapsing the policy each year and taking out a new one, instead of taking up the compulsory premium increase.
Fixed compulsory increase percentages now range between 3% and 10% per year. The higher the compulsory increase percentage, the lower the initial premium will be.
The age-rated premium pattern also offers a cheaper initial premium, which will become more expensive over time. In this case, the annual increases follow the shape of the risk curve more closely, which means increases that are lower at the younger ages, and higher at the older ages.
The renewal rate at each age typically corresponds to the new business rate at that age.
These patterns also approximate the underlying risk curve, in that they require lower compulsory increases at younger ages, and higher increases at older ages.
But it differs from the age-rated pattern in that the compulsory annual increases required at each age are fixed upfront, for the duration of the policy. These premium patterns typically mimic the underlying risk curve less accurately than the age-rated premium pattern, as required growth rates increase in a more structured manner from year to year, as indicated in the table below.