Challenges and Opportunities arising from the European Commission Guidelines on Gender Directive

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1 Challenges and Opportunities arising from the European Commission Guidelines on Gender Directive Andrew Kay, Scott Mitchell, Jim Murphy, and Manuel Tschupp May 2012 The European Commission published Guidelines last December on the application of the Gender Directive in light of the European Court of Justice (ECJ) ruling on the Test-Achats case. This paper summarises important facts for the insurance industry as well as possible opportunities and mitigating actions during the unisex era. INTRODUCTION National regulators and legislators have been concerned about how to progress following the decision of the European Court of Justice on the Gender Directive. To support a common approach across Europe, the European Commission has published Guidelines on the application of the Gender Directive to insurance (Guidelines i ). This briefing note summarises the key points from the Guidelines and considers the main issues for companies to address, as well as possible actions to deal with those issues. BACKGROUND In 2004, the Gender Directive was introduced with the aim of ensuring equal treatment of men and women in relation to the access to and supply of goods and services. For insurance and related financial services, the Directive required that where contracts are concluded (entered into) on or after 21st December 2007, gender cannot be used as a factor that results in differences in individuals premiums and benefits ( the unisex rule ). However, Article 5 of the Directive gave an option to countries to apply a derogation from the unisex rule. This would allow insurers to continue to use gender as a rating factor to set premiums or benefits, provided this was based on relevant and accurate actuarial and statistical data. Many EU countries applied this derogation for most lines of insurance business. TEST-ACHATS RULING In 2008, the Belgian consumer group, Test-Achats, took legal action in Belgium against the validity of the derogation for insurance. In September 2010 the EU Advocate General gave an opinion in favour of Test-Achats. This opinion was ratified by the ECJ in a judgment delivered on 1st March 2011 where they declared the derogation invalid with effect from 21st December This ruling has raised a number of questions for insurers trying to understand the implications for their business, including: Is existing business affected for example renewals, top-ups or reviewable contracts? What are the implications for new product pricing and marketing? Can information on gender still be collected and used for other purposes such as reserving and underwriting? Does the ruling have different implications for group and individual business? Given further pending European legislation, will the ruling have implications for the use of age and disability status in insurance? How should an insurer react to the new legislation, to avoid adverse selection effects and/or gain a competitive edge? EUROPEAN GUIDELINES To help address some of these issues, the European Commission issued Guidelines in December 2011 on the application of the Gender Directive in light of the Test-Achats case. The Guidelines are aimed at ensuring consistency of application of the ruling in the EU; however it is important to note that they are not a legal interpretation. We have included below a summary of the key points from the Guidelines. WHICH CONTRACTS ARE AFFECTED? The unisex rule will apply for new contracts from 21st December A new contract is one that May 2012

2 requires the consent of all parties, and this includes amendments to existing contracts where the agreement or amendment takes place on or after 21st December The Guidelines give a number of examples to illustrate this point. The following would be considered as new contracts to which the unisex rule would apply: Contracts concluded for the first time on or after 21st December 2012 (including offers made before this date, but accepted on or after it). Contract extensions concluded on or after 21st December 2012 to extend existing contracts which would otherwise have expired. The following examples would not be considered new contracts: The automatic extension of an existing contract if no notice is required to be given, where the terms of the existing contract allow for this. Adjustments made to elements of an existing contract (such as premium changes on the basis of predefined parameters ii ), where the consent of the policyholder is not required. Top-up or follow-on policies whose terms were pre-agreed in contracts concluded before 21st December 2012, where these policies are activated by a unilateral decision of the policyholder. iii A transfer of an insurance portfolio from one insurer to another, which should not change the status of the contracts included in that portfolio. Whilst the implications are clearer for new business unrelated to existing business, insurers will need to consider whether some features of existing business will be caught. Some examples include: Do the provisions of reviewable unit-linked protection policies meet the Guidelines definition of an adjustment based on predefined parameters? Do term assurance conversion options without future underwriting satisfy the requirement for terms being pre-agreed? Other features to consider are the treatment of top-ups, rider benefits, automatic indexation and non-linked surrender values. Whether product features can be treated as part of existing contracts is not a blanket decision it will depend on the specific wording in policy terms and conditions. CAN GENDER STILL BE USED? The Guidelines note that, whilst gender cannot be used as a factor that results in differences in individuals premiums and benefits, it can still be used as a risk-rating factor in general. For example, gender can be used in the calculation of premiums and benefits at the aggregate level, as long as it does not lead to differentiation at individual level. It therefore remains possible to collect, store and use gender status or genderrelated information for the following purposes: Reserving and internal pricing: Insurers can continue to collect information on gender for internal risk assessment and reserving. Marketing and advertising: The Gender Directive does not apply to the content of media and advertising. Therefore, insurers can continue to use marketing and advertising to influence their portfolio by pro-actively targeting certain customer groups. However, insurers may not refuse access to a specific product because of a person s sex, unless certain conditions are met. This leaves a risk for insurers that smarter customers can choose policies that are targeted towards the opposite sex. The impact of the Directive on business mix will likely differ by distribution channel customers from certain channels will, in general, be more or less sensitive than other customers in terms of price and inclination to take action upon differential treatment. For more sensitive channels, it remains a question whether it is permissible under the Directive to target certain groups via, for example, a carefully designed commission structure, whilst charging the same premium for males and females. In respect of life and health underwriting, the unisex rule means that premiums and benefits cannot be different between two individuals for the same insurance policy simply because their gender is different. However, in the Commission s view, the Test-Achats ruling only addresses the use of gender as a factor where the respective situations of men and women are comparable. The Commission notes that there are other risk factors, e.g. health status or family history, where differentiation is possible, and for the assessment of which insurers need to take gender status into account, in light of certain physiological differences between men and women. iv Also, in the view of the Commission, it still remains possible for insurers to offer gender-specific insurance products (or options within contracts) to cover conditions which exclusively or primarily concern males or females, e.g. prostate, breast or May

3 uterus cancer. This possibility is however excluded for pregnancy and maternity benefits. USE OF OTHER RATING FACTORS Rating factors other than gender can still be used, however companies will need to be careful with respect to indirect discrimination. The Guidelines note that, unlike direct discrimination, indirect discrimination can be justified if the aim is legitimate and the means of achieving it are appropriate and necessary. In practice this means that companies can use risk factors which might be correlated with gender, as long as they are true risk factors in their own right and not a proxy for the actual risk driver. For example, companies could continue to use car engine size as a rating factor for motor insurance, even if men typically drive cars with more powerful engines. In contrast, the use of height or weight of a person in relation to motor insurance would not be allowed as they do not directly affect the underlying risk. It might however be necessary to evaluate further true risk drivers to replace gender as an actual or proxy risk driver. MONITORING THE GUIDELINES Member States have to amend their relevant legislation according to the Gender Directive by 21st December The European Commission will monitor the situation to ensure that national legislation is in compliance with the Test-Achats ruling and will report on the position in At least in the short term, the Gender Directive will likely lead to an increase in average pricing for insurance, as insurers take additional risk relating to adverse selection and uncertainty over business mix. However, the European Commission has stated that it will monitor the insurance market in order to detect any unjustified price rises attributed to the ruling. POSSIBLE MARKET IMPACTS The impact for the insurance industry is potentially wide-ranging and includes: impact on profitability, impact on surrender rates for existing business, changes required to pricing and marketing strategies and product design, changes to underwriting, uncertain levels of new business sales during 2012 (will customers wait or buy now?), changes to policy illustrations systems for new and in-force business. However, times of change also create opportunities for insurers to gain an advantage, and monitoring the developments of competitors remains a high priority. It remains therefore important to discuss further possible mitigating actions for insurers. Some companies are likely to adopt a reactive approach. A typical approach by these reactive companies is to derive unisex premium rates, based on an expected business mix, and then incorporate a margin to reflect the risk of adverse selection. Other companies will be more innovative and proactive in trying to achieve some level of indirect selection of customers. For example, a competitive advantage is potentially achievable through new product design or innovative marketing strategy. More active strategies are likely to be more successful in gaining such a competitive advantage. In the following sections, we provide examples of possible innovation. ACTUARIAL CONTROL CYCLE Adopting a more dynamic pricing and monitoring process will be important for insurers to minimise the risks of on-going mis-pricing and adverse selection. This is especially true for a more reactive company. Compared to current pricing processes (e.g. annual re-pricing cycle), insurers will have to streamline their processes to allow more frequent and reactive re-pricing, as well as closer and more frequent monitoring of financial results. Otherwise, there is an increased risk of prolonged periods of mispricing, anti-selection and/or non-competitiveness. IMPACT ON UNDERWRITING Stricter underwriting might be required to gather additional information about the underlying risk of an insurance contract. The decision around the appropriate level of underwriting is usually a tradeoff between increased effort and costs versus corresponding reduced claim costs, or vice versa. However, under the Directive, increasing underwriting might help to avoid adverse selection, yet maintain lower premium levels than competitors who simply apply a conservative risk margin to unisex premium rates. MANAGING THE LAPSE (AND RE-ENTRY) RISKS ON EXISTING BUSINESS The risks associated with the Gender Directive do not only relate to the profitability of future sales. There is a significant risk relating to 'lapse and re- May

4 entry' on the in-force portfolio. For example, male customers with death cover might realise that it is cheaper to lapse their current policy and take a new policy with a lower premium, either with the same insurer (re-enter) or a different insurer. The level of customer rationality is difficult to forecast and will vary by portfolio or segment and potentially by distribution channel. Hence, closer monitoring (as part of the control cycle) and the identification of mitigation actions are needed. Such mitigation actions might include: Introduce customer incentives to stay. Monitor the rates of lapses and re-entry by customers. If the effect is significant, then salespeople can be (dis)incentivised to ensure that they do not encourage customers to lapse and re-enter. PRODUCT DESIGNS Product design is potentially an effective way to avoid the selection risks for new life and disability policies, and it may even possible to create commercially advantageous products. Amongst more sophisticated solutions, there are possible strategies to influence the gender mix balance of the portfolio or level of selection risk. OCCUPATIONAL PENSION AND GROUP LIFE BUSINESS The Guidance notes that the Gender Directive only covers private, voluntary insurance and pensions, and does not cover insurance associated with an employment relationship. Therefore, provided the employer is a party to an insurance or pension contract, the ECJ ruling does not affect this business. This might enable insurers to mitigate some of the selection risk via increased promotion of Group Life business, relative to Individual Life, where appropriate and marketable. However, if the employee has to conclude an insurance contract directly with the insurer without involvement of the employer, the Gender Directive rules will apply. AMENDED PRICING FRAMEWORK A pro-active insurer might want to use a more sophisticated pricing approach than just 'mixed gender premium rates'. The ratio of males to females is not homogeneous throughout an insurer's portfolio there are differences depending on product type, industry sectors, educational background, etc. An insurer could take these aspects, as well as some measurable trends, into account to reduce adverse selection for certain sub-portfolios. REINSURANCE Reinsurance contracts, including risk transfers and internal reinsurance, are not subject to the Gender Directive. Insurers that purchase risk reinsurance may still be exposed to risk arising from gender mix, unless reinsurers also offer unisex rates voluntarily. Additionally, the Directive might lead to less competitive reinsurance in the short to medium term. GENETIC TESTING As a more extreme mitigating action, there might be renewed interest from the insurance industry to lobby for the use of genetic tests in the underwriting process. Insurers could potentially argue more strongly that other aspects of customers' genomes become an even more important risk factor to know about and should be a fundamental part of the underwriting process. AGE AND DISABILITY The EU is working on an age and disability discrimination Directive (modelled on the Gender Directive) and had planned to use a similar derogation structure as had applied for insurance business. The Test-Achats ruling raises concerns as to whether this approach can now be used. As a result, insurers ability to price products allowing for age and disability status could be threatened. If this were to materialise then it could potentially lead to a community rated market, similar to, for instance, the Irish or Dutch health insurance market, where the premiums charged for a level of cover are the same irrespective of age, gender or health status. Whilst community rating can work for some types of insurance, more generally, a requirement for community rating could have very serious consequences for both insurers and consumers in a private voluntary insurance market. Increased uncertainty and the risk of adverse selection may result in higher prices for some insurance products, with other products withdrawn from sale altogether. Ultimately, this could result in a step change in the level of private insurance used in society. The Guidelines state that the Test-Achats ruling does not directly affect the use of other risk-rating factors, such as age and disability, however this is certainly a hot topic to watch. May

5 ABOUT MILLIMAN Milliman is among the world s largest providers of actuarial and related products and services. The firm has consulting practices in life insurance and financial services, property & casualty insurance, healthcare and employee benefits. Founded in 1947, Milliman is an independent firm with offices in major cities around the globe. MILLIMAN IN EUROPE Milliman maintains a strong and growing presence in Europe with 250 professional consultants serving clients from offices in Amsterdam, Brussels, Bucharest, Dublin, Dusseldorf, London, Madrid, Milan, Munich, Paris, Warsaw, and Zurich. europe.milliman.com i ii For example, a premium increase by a percentage based on the claims experience. iii For example, when the insured person wishes to increase the amount invested through a life insurance product. iv For example, a family history of breast cancer does not have the same impact on a man s and on a woman s health risk (and the assessment of this impact requires knowledge of whether the person is a woman or a man). Obesity is a risk factor, a measurement of which is the waist to hip ratio, which is not the same for women and for men. The Guidelines provide a list of further examples that remain possible. CONTACT For more information, please contact your local Milliman representative, or one of the authors: Andrew Kay andrew.kay@milliman.com Scott Mitchell scott.mitchell@milliman.com Jim Murphy jim.murphy@milliman.com Manuel Tschupp manuel.tschupp@milliman.com This paper only presents information of a general nature. It is not intended to guide or determine any specific individual situation and persons should consult qualified professionals before taking specific actions. Neither the authors, nor the authors employer shall have any responsibility or liability to any person or entity with respect to damages alleged to have been caused directly or indirectly by the content of this paper. This paper and any information contained therein are protected by Milliman s copyrights and must not be modified or reproduced without the express consent of Milliman. Copyright 2012 Milliman. May