Great Mistakes in Underwriting

1. Great Mistakes in Underwriting Presentation to ALUCA Melbourne October 2008 by Shauna Ferris Actuarial Studies Department Macquarie University

2. My background • Sex Discrimination Act & annuities • Genetic Underwriting Task Force • Today - an opportunity to learn and a donation from AMP…. Q. What is a great mistake?

3. “Speculative Investments” • A newspaper advertisement in 18th century England said: Alderman's Bond's life, for one year, now doing at 7%. • As with any type of gambling, the most successful life insurance gamblers were the ones who could get inside information ("hot tips").

4. Inside Information "A practice prevailed of insuring the lives of well known personages, as soon a paragraph appeared in the newspapers announcing them to be dangerously ill. The insurance arose in proportion as intelligence could be procured from the servants, or from any of the faculty attending, that the patient was in great danger.“ • Even at this early date, the collection of data for underwriting was presenting some ethical problems !

5. Ethical Issues "This inhuman sport affected the minds of men depressed by long sickness; for when such a person, casting an eye over a newspaper for amusement, saw that their lives had been insured in the Alley...they despaired of hope and thus their dissolution was hastened."

6. Charles Povey’s Trader’s Exchange (1706) Life Insurance Gambling gets organised… • Join by paying a small sum into a pool • Nominate any person as the insured life. • At the end of each quarter, divide the pool among the people whose nominees had died. Essentially just like a football pool...???

7. Povey’s Complaint Povey was apparently surprised to find that: “...many Impositions were put upon the Office in its Infancy, by Peoples Subscribing upon the lives of unhealthy Persons, and upon such too that it was morally impossible that they should live to twelve Months end.” (The Sun Insurance Office, Dickson, p 24) The Trader’s Exchange only lasted four years Conclusion: If you charge the same premium to everyone, you may create an adverse selection spiral. -> Need to assess the risks for each life.

8. Underwriting in London 1725 • Question: It’s 1725 in London. In the overall population, about 4% of the people die each year. When a customer comes in wanting to buy insurance for a 1-year period, what questions will you ask?

9. 1725 : Instructions to the agents of London Assurance (JIA XXVIII p218) • All Persons whose lives are to be assured must first appear before you, and then you are to take a convenient time to Enquire after their State of Health and manner of Life; either by Persons in their Neighbourhood, or by such other means, as you can best Inform yourself. • You are to be particularly carefull, that the Person who appears, is really the person, whose Life is to be assured. • It is always to be Enquired, whether the person whose life is to be assured hath had the small pox. • If a Woman’s life is offered, whether she be married or not, because Child bearing Women & Persons not having the smallpox must pay a higher premium. • If the Person, for whose Benefitt, the Assurance is made, is unknown to you, you are to learn if possible, the reason why the Assurance is made, for unless there are good reasons, the person assured may be in a worse state of health than you apprehend.

10. Causes of Death • Conclusion: • Design of an U/w form requires an understanding of the common causes of death (esp. early death) • The history of U/w reflects changes in causes of death over the centuries. • No questions about Smallpox or maternal mortality now

11. 1995-1999 Causes of Death(Causes of Death Among Australian Insured Lives, Leonie Tickle, AAJ, 2004) • Q. So will genetic factors be of interest to underwriters?

12. Substandard Lives Underwriting • Initially • “Just Say No!” to “delicate or doubtful lives” • Early annual reports often proudly recorded the number of rejections (a sign of sound financial management). In 1850: • Colonial Life, 179 applications, 31 declined • Aegis Life, 113 applications, 42 rejected

13. How to Select Healthy Lives • The Equitable (1762) • Applicants signed a statement of good health • No medical exam • An interview with the officials of the insurance company (Some officials had medical expertise) • Unhealthy-looking people ... rejected • Somewhat subjective ? • “Looks were everything” • Effect of repainting the interview room?

14. Medical Advice • In the late 1770s, someone suggested hiring doctors to give a medical exam to each applicant. • The idea was firmly rejected. • Q. Would a medical exam have given better risk assessments for the Equitable in 1770?

15. Medical Advice in 1762 • Stethoscope had not yet been invented (1818) • Thermometers were not reliable until after about 1840 • Spirometer not invented until 1846 • Could not use urine tests for diabetes (not developed until 1840s) • X-Rays (for diagnosing tuberculosis) were not invented until 1895 • Could not test for blood pressure yet (not invented until 1896) • Would not have known what to look for in a blood test. • (Ref : Roy Porter, the Greatest Benefit to Mankind) Life offices in the UK did not start requiring medical exams by their own doctor until about 1823.

16. The Philosophy of Medicine • 1827: British doctor commenting on the invention of the stethoscope by Laennac (a Frenchman): • “I am sure that Monsieur Laennac’s ingenious instrument will never come into general use in this country... not only because its beneficial application requires a good deal of trouble and skill, but also because its whole character is utterly foreign... To Englishmen there will always be something ludicrous in the image of a physician listening to the chest through a long wooden tube as if the disease were a living thing in communication with him... Besides, there is in this method a sort of bold faith in the physical examination of patients wholly alien to English medicine, more accustomed to calm cautious philosophical musings.” (Ref Dormandy, the White Death)

17. Medical Exams • Some people think that the life offices actually pushed the doctors into improving their use of new technology to assess health risks. “There is little evidence, especially in Britain, that the clinical examination was actually part of medical education or hospital practice. In a review of the surviving case notes from Guy’s Hospital London, [one researcher] found no evidence of physical examination prior to 1819, and little for the rest of the nineteenth century. We suggest that....the use of the clinical examination was the outcome of the interests of insurance companies.”

18. Insuring Substandard Lives • Competition: In 1824 two life offices decided to specialise in policies for substandard lives. • The Asylum“Confines its business to assuring the lives of persons going beyond the limits of Europe – predisposed to hereditary of other constitutional maladies – of delicate health – of peculiarity of form, whether natural or accidental – labouring under mania, melancholia or any kind of chronic disease, unaccompanied with immediate danger – females in a state of pregnancy – persons engaged in unhealthy occupations – and those who from inadequate testimonial, uncertainty of date of birth, or other causes, would besubject to rejection or an exorbitant rate of premium at other Offices.” (The Institute of Actuaries 1848-1948 p72)

19. The End of the Asylum • Relied on medical opinions. • Went broke in 1854 (actuarial scandal) • Profits were “plausible and utterly fallacious” • Q. How did they last 30 years ? • NB No solvency legislation at that time

20. Clerical Medical & General Life • Also insured substandard lives from 1824 • Relied on advice of doctors for underwriting • Produced first (?) life office substandard lives mortality study over 11 years(Assurance magazine, Pinckard, 1851)

21. A Great Mistake • Successfully identified substandard lives • Mortality of substandard lives was double that of the substandard lives • Unfortunately…. • They had only charged them 30% extra premiums. But.. A Great Mistake because thereafter “the directors have not been guided by medical science alone but have availed themselves further of the light thrown on such risks by facts and experience acquired in the previous 19 years.”

22. The Alcohol Controversy • In the 1840’s Mr Warner applied for insurance and was told that he would have to pay an extra premium because of his drinking habits.... • …. the problem was, he did not drink any alcohol • In 1840, higher premiums for teetotallers "on the grounds that abstinence from stimulants must necessarily impair his constitution and shorten his expectation of life".

23. A stubborn man… • Result : The disgruntled (teetotal) customer founded The Total Abstinence Life Assurance Company. • Result : Ridicule “It was absurd to suppose that the lives of teetotaller were any better, if as good, as others. The medical profession almost to a man was against them, and who were they to set themselves up against such learned authorities ?” • This company gave discounts for teetotallers for almost 100 years – but eventually discontinued as unjustified by the data.

24. Medical Questions Debated • 1848 Institute of Actuaries formed to discuss important issues • Q1. Extra Risks – of the British Empire • Q2. The problems caused by doctors • They want to be paid!!! Outrageous ! • Q. What is a doctor’s opinion worth, anyway?……eventually -> non-medical

25. Cost benefit analysis • For any test – Prevalence of disorder in target pop Accuracy of test Usefulness of test as predictor of Extra Risk for disorder Term of Policy, Size of SI Cost of test Cheaper sources of information Inconvenience to customers Q. At present, IFSA promises not to request genetic tests to be made. If no such promise, would you be requesting genetic tests ? Which ones ?

26. Genetics and insurance • Q. When did underwriters start using genetic data to assess risks? • A. c. 1820 ??? 1844 Underwriting form: • Have any of his family died of consumption? • Are you aware to what age his parents lived; or if they be still living, and what their ages are?

27. Family History • In 1886 an actuary wrote (rather gloomily) "I look upon hereditary influences as the first and most important factor in assessing the value of the life of an individual. They indicate the store of vitality with which he has been endowed at his birth. The member of a family which can only show among its records the havoc of early disease and death must be considered up to middle age to be a most precarious risk. The hand of death has been fastened upon him from his cradle."

28. Tuberculosis & Family History • Tuberculosis (phthisis or consumption) In 1890s, about 10% of all English deaths ( Lane, A Social History of Medicine) • Clearly, if actuaries could identify people who were susceptible to TB, this would be very useful in underwriting ! • But what caused TB ??? No one knew !

29. Underwriting Tuberculosis • Was there an inherited susceptibility ? • Most eminent doctors said yes! (is there?) • Some (less eminent doctors) suspected some sort of germ. • But …. eminent doctors considered this to be quite a ridiculous idea. • For decades, life insurers followed the opinions of the most eminent doctors • -> decline anyone with a family history of TB

30. Statistical Studies of TB • Actuaries began to publish studies such as An attempt to measure the Extra Risk arising from a Consumptive family history when the life proposed for assurance is physically Sound and Healthy" (HW Manly, 1892, JIA xxx) • Development of many concepts such as bias in samples, statistical significance, sample size, reliability of cause of death (AIDS?), etc.

31. An Actuarial Exam in 1895 (JIA XXXII, p36) • "A writer in a Medical paper states that his enquiries among 737 phthisical patients showed that • 351 cases arose from among 1,041 children of phthistical parents and • 386 cases from among 1,552 children of non-phthisical parents; From this he concluded that the influence of heredity cannot be put higher than 8.8 per cent... Is it possible that he mis-states the influence of heredity, and if so in which direction is it probable that his error lies ? What data would you consider necessary for a satisfactory investigation of the question ?“ • [I wonder if my students could answer this question? Perhaps I should put it on next year's exam ?]

32. Moral of the Tuberculosis Story • The Underwriters depended on medical experts • The medical experts were wrong ! • It is difficult to overturn "the conventional wisdom" in medicine (especially when vested interests are involved) Q for discussion : • "This is just history. These days our medical experts are scientific and hence it is unlikely that they would ever be wrong." Discuss !

33. Evidence Based Underwriting • Conclusion: • Many of the great mistakes in underwriting can be blamed on great mistakes in medicine… • -> Evidence based medicine? • -> Evidence based underwriting???

34. Statistics • Q: Does your life office conduct retrospective studies to see if your underwriting assessments have been accurate / profitable ? • i.e. if you have 1000 people rated +50%, is their mortality about 150% of standard? • Q: Do you know how well Australian life offices score in this regard?

35. Australian Underwriting Accuracy • A recent study of substandard lives underwriting in Australia Are substandard lives charged appropriate policy loadings? By Leonie Tickle, paper presented to the Institute of Actuaries of Australia convention 2005 • 100% A/E means exactly as predicted, Below 100% means too pessimistic.

36. Is it possible to do any better? • 1850s UK actuaries realised that their loadings were guesswork • Because everyone charged different rates • Insufficiency of data for small offices • Over the 100 years or so, from the 1850s to the 1950s, UK actuaries frequently suggested that should be a combined offices study of substandard mortality.

37. Practical difficulties • Generally considered too hard, too much trouble, too expensive, would be out of date by the time you finished, etc. etc. etc. “Underwriting is an Art, not a Science” • But of course they did not have a Disability Discrimination Act !

38. Productivity Commission • Review of the Disability Discrimination Act (2004) – criticism of the insurance industry from disability support groups, eg. • “inconsistent & inadequate risk assessment methods” • use of out-of-data statistics • “poor quality actuarial evidence used to justify decisions” • use of stereotypes(i.e. fails to take account of individual factors) • Q. Are these criticisms at all valid?

39. Reasonable to Rely ? • Under the DDA, insurers are allowed to discriminate based on data upon which it is “reasonable to rely”. • What does this mean in practice, in an area like genetics (where science is still at an early stage)? Is it reasonable to rely on the existing models?

40. 1990 model Eminent Actuaries Very Intelligent Sophisticated Multi-State Markov Model Most Up-to-date data available Expert advice from medical researchers The AIDS Controversy (UK)

41. The AIDS controversy

42. Actual V Projected AIDS Deaths in UK

43. Long Term Projections • Uncertainties included: • Reduction in risky behaviour when people at risk are educated • Length of time until successful treatment is discovered • Effectiveness of treatments in increasing survival time • Conclusion: Making long term predictions of mortality is highly speculative - especially in an area where medical knowledge is scant and developing. Even if you have a very sophisticated model

44. A Model for Breast Cancer Risk from BRCA1/2 Gene Mutation • Model from Use of a Markov Model to Estimate Long-Term Insured Lives’ Mortality Risk Associated with BRCA1 and BRCA2 Gene Mutations, by Robert J Pokorski and Ulrike Ohlmer, North American Actuarial Journal Vol 4 No 4 • Q. If we check back in 15-20 years, what is the probability that actual BRCA1/2 mortality will be close to our current estimates?

45. Another AIDS Controversy • In the UK, in the early 1990s, life insurers asked applicants if they had ever taken an HIV Test. • Q. What did the insurers do if the applicant reported that they had taken a test and it was negative? • Q. Was this a reasonable question?

46. PR Issues • A disincentive to take a test? • A Public Health Issue • A great deal of negative publicity for insurers • Ultimately, threats by the government to intervene • So how to balance Public Interest / PR against the need for risk classification?

47. The Public Interest • In some cases, there may be public interest or “fairness” arguments AGAINST using statistically reliable risk classification factors • E.g. battered wives, genetics, etc • Insurers argue that this may cause an adverse selection spiral. • But will it ?

48. Conditions for Adverse Selection Rating Restrictions DO affect * pricing / affordability * availability of insurance But obviously insurance systems can still be viable with SOME rating restrictions. Modelling can be used to estimate the effects of any such restrictions.

49. Finding an Equilibrium • When faced with rating restrictions, an insurance system’s equilibrium depends on • Number of extra risks in population • Size of extra mortality risk • Price sensitivity • Sum insured restriction • For models, see “Adverse Selection Spirals”, by deJong and Ferris, ASTIN

50. Genetics & Adverse Selection • Australia (IFSA study) reports roughly • 650 applications with genetic data in 4 years and over 2 million applications • Only 163 positive tests • Of these, some were carriers only, or confirming a previous diagnosis based on symptoms, or related to a treatable disorder (HH).