Channel Profitability and the Single-Rate Filing Constraint
Northbridge Life sells a fixed-benefit hospital indemnity policy through two distribution channels. Channel A - a call-center agency working purchased lead lists - produced 7,400 of last year's 12,000 new policies. Channel B - career agents servicing employer payroll-deduction accounts - produced the remaining 4,600. The chief actuary's annual report shows Channel A with 61% second-year persistency and an 88% paid-claim ratio, against 89% persistency and a 61% paid-claim ratio for Channel B. Average acquisition cost is $310 per policy in Channel A and $180 in Channel B. The product is filed statewide on a single rate manual; the state uses prior approval for rate changes with a 60-day review period. Management has set a 15% growth target and is asking whether to double down on Channel A.
1. What do the two channels' numbers actually tell you, and how large is the profitability gap? Show the reasoning, not just a verdict.
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Start by putting the two channels on the same scale, because the paid-claim ratio alone is misleading.
- Claims: A runs 88% of premium versus 61% for B - a 27-point gap on every premium dollar.
- Acquisition: $310 versus $180 per policy, a $130 gap. On, say, $700 of annual premium, that is roughly 19 points of first-year premium; amortized over an average life of about 3 years in A and 6 years in B, the annual drag is very roughly $100 versus $30 per policy per year.
- Persistency: 61% second-year persistency means A loses almost four in ten policyholders before the acquisition cost is recovered, and it also signals that many buyers did not understand what they bought.
The combination - high claims, short duration, high acquisition cost - is the classic signature of adverse selection plus poor sales quality, not of a bad rate. Buyers responding to a lead-list pitch are disproportionately people with a reason to want hospital indemnity. Note also what the data cannot tell you: the paid-claim ratio does not decompose into morbidity versus anti-selection, and persistency differences may reflect billing method rather than risk. Before pricing action, ask for a claim-duration and diagnosis study.
2. Management wants to expand Channel A. Given the single statewide rate manual and prior-approval process, what are the realistic options and which do you recommend?
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Options, roughly in order of speed and defensibility:
- File a separate policy form or rate manual for the lead-list channel. Pricing by distribution channel is legally fragile: channel is not a risk characteristic, and a regulator may view it as an unsubstantiated rating class or as avoiding the real issue. It also will not clear 60-day prior approval before the growth target matters.
- Tighten underwriting inside Channel A - scripted health interview, prescription-history database check, a short pre-existing-condition exclusion period, and a longer waiting period on the indemnity benefit. This attacks the anti-selection directly and needs no filing if it stays within the existing underwriting rules.
- Fix the economics at the source - cut lead-cost-driven compensation, require a quality-audited sales script, and set a persistency-based compensation holdback.
- Cap rather than expand - hold Channel A at current volume while 2 and 3 are tested.
Recommendation: cap Channel A at current volume, implement option 2 and 3 for two quarters, and re-measure claim ratio and 13-month persistency before committing to growth. Doubling a channel with an 88% paid-claim ratio and 61% persistency converts a manageable problem into an irreversible one, and a hastily filed channel-specific rate invites both disapproval and a market-conduct inquiry.
3. A marketing executive argues that higher claims in Channel A simply reflect "sicker buyers" and that raising the statewide rate 20% will fix it. Evaluate that argument.
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A 20% statewide increase is the wrong instrument for three reasons.
It taxes the good channel to subsidize the bad one. Channel B at 61% claims would absorb a 20% increase it does not need; its healthy policyholders will lapse or shop, leaving a smaller, worse book - the death spiral that makes a single-rate structure dangerous once distribution quality diverges.
It cures the symptom, not the cause. If the problem is anti-selection at the point of sale, a price increase reduces volume in A but leaves the selection mechanism intact; the buyers who remain are those who still find the product worth 20% more, which is not the population you want.
It may not survive review. A filing that raises rates on a statewide basis while the actuarial memorandum points to one distribution channel is internally inconsistent, and 60-day prior approval gives the regulator time to ask exactly that question.
The testable hypothesis is that Channel A's morbidity is concentrated in early durations and in a small number of diagnosis categories. Run the claim study first; if the excess is duration-specific, an exclusion or waiting period is the surgical fix and a rate increase is the blunt one.