Ben Stone examines the use of medical underwriting, previously just used for individual annuities, when purchasing bulk annuities

When pricing bulk annuities, insurers have traditionally estimated life expectancy using information already held by the pension scheme such as sex, age and postcode. A more sophisticated approach is to collect information on the medical history, smoking habits and other lifestyle indicators of individual members. This ‘medical underwriting’ has until recently only been used in the pricing of individual annuities. However, in the past year, providers of these medically underwritten individual annuities, such as Partnership and Just Retirement, have developed these propositions for the bulk annuity market. This potentially gives pension schemes the same choice which individuals have when purchasing an annuity with their DC pot – why let the insurer assume standard or even good health when, for a little extra work, the cost could be reduced significantly to reflect the true health status?

For a small scheme (perhaps up to 200 pensioners) or a sub-group of a larger scheme, these insurers would seek to assess medical information from those members who represent the highest liabilities. Initially these members would receive a questionnaire which, depending on the answers provided, may then be followed up with a phone call to discuss in more detail.

Trustees considering the purchase of a bulk annuity will need to think carefully about whether this form of underwriting is the best approach for them. For example, if underwriting reveals a healthier than expected population the trustees may face a higher price than would otherwise have been the case. If, as a result of these findings, the trustees then decide to go down the conventional, non-underwritten route, at a later date they may well be required to disclose that they have previously investigated a medically underwritten transaction and to share the results with the new insurers.

Similarly, trustees must be aware of the consequences of cherry-picking – if a scheme insures only impaired lives then it is likely to be harder and more expensive to insure the remaining members at a later date. Even underwriting a few key senior members could leave the rest of the scheme open to unattractive pricing in the future. This is because insurance companies currently price bulk annuities on the assumption that there are some impaired lives and some healthy lives in a scheme. If the impaired lives are insured separately then the price for remaining members is likely to go up.

Along with health status, another key factor to decide whether a cheaper price can be achieved across the whole scheme may simply be scheme size. For a small scheme with some impaired lives, an overall 15 per cent reduction in the overall cost is not unreasonable. This improvement arises because underwriting has identified that this scheme is less healthy than average assumptions made by insurers. However, a larger scheme with more members is more likely to lend towards the overall population average.

Inevitably, medical underwriting introduces a range of challenges for pension schemes and their trustees. Do they feel comfortable requesting this information? How will such a request be managed? How will the data be stored? Will members even respond to a request for sensitive private information? Such concerns will need to be judged against the potential to make a bulk purchase annuity more affordable for the scheme.

For schemes with the right characteristics, medically underwritten quotes provide trustees with a useful, additional option, but trustees should make sure they are fully aware of the challenges that going down this route may pose. Ideally, before obtaining quotes, trustees should combine their knowledge of the scheme membership with their advisers’ knowledge of the insurance market to consider whether this approach could be beneficial for their scheme.

At an industry level it is too early to say whether medical underwriting is likely to take root in the bulk annuity market in the way it has done for individual annuities. Non-underwritten annuities for individuals have already become more expensive, reflecting the expected ‘better than average’ health of the members who purchase them. Pension scheme trustees should keep a keen eye on whether the bulk annuity market develops in a similar way in the coming years and weigh the benefits and risks of being an early adopter in this market.

Written by Ben Stone, senior consultant at Towers Watson

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