The recent news that the rate of price inflation has dropped dramatically is welcome news. The reduction in CPI to 3 per cent after a long period where annual rates have been substantially in excess of the Bank of England’s target of 2 per cent should provide some optimism.
That said, there appears to be much confusion amongst the general population regarding the measures of inflation. RPI or CPI? This will undoubtedly be made worse given the latest announcement from the ONS that they intend to modify the basis of calculating RPI. But the BOE attitude survey in May revealed that the public expect inflation to push up to 3.7 per cent in the next 12 months. This has sparked concerns that we are, again, building general inflationary pressures into our mind set.
Against the backdrop of medical inflation – the term regularly used to describe the rate of increase in PMI subscription rates – such developments are interesting. The term is loosely used in the industry, but has become widely accepted. There is a grim acceptance that medical inflation will always be much higher than general price inflation. This has a number of consequences for PMI products in the UK.
Before looking at the consequences, however, let us take a look at medical inflation and its drivers. Laing & Buisson’s annual review provides a useful starting point, with aggregated historical data for the UK PMI market. From this we can calculate the average rate of increase of subscription costs per subscriber. This shows that during the period 2000-2010 the compound average increase was 5.25 per cent a year. During the same period CPI increased by 2.0 per cent a year. Hence medical inflation, on this crude basis, outstripped price inflation by 3.25 per cent.
We have seen evidence from the US that medical inflation has typically increased by as much as 4 per cent over CPI. The drivers of these increases are many and complex, but can be simplified to increases in utilisation of the benefits together with higher average claim costs. The former reflects both higher expectations for healthcare provision from those people with PMI cover and also frustration with the NHS. The latter continues to increase, despite shorter hospital lengths of stay and less invasive surgical techniques, because of salary costs for the specialist medical staff and the costs of the new technologies.
It would be easy to fall into a number of traps based on our understanding of the drivers of medical inflation. First is the oft-quoted criticism we hear from clients that the industry and insurers in particular take these increases too glibly. I have seen insurers’ quote renewal terms incorporating double-digit future inflation rates and clients unsurprisingly recoiling from this and reminding them that salary rates and input costs for their raw materials are not being allowed to increase in this way.
The factor that clients particularly dislike is the implicit link of the insurers’ administration margins to these high inflation rates. By calculating the administration margins as a percentage of the overall cost it means these also increase at the same high rate – much higher than you expect if these were calculated separately. A further consequence of these increases is that employers are looking more closely at the plan design to consider how to mitigate the increases.
There is a grim acceptance that medical inflation will always be much higher than general price inflation. This has a number of consequences for PMI products in the UK
Simple short term solutions include introducing or increasing a claim excess, reducing the scope of benefits covered or reducing the contribution base, for example by only covering the employees’ costs and not the family. These typically produce one-off reductions in cost and are not long term solutions.
Some companies are now considering approaches that we have seen in the US, broadly described as a DC style of medical benefits. Under these arrangements, the company does not commit to picking up all costs for the medical scheme but establishes a base level of contribution and will increase this contribution in line with an index of salaries or prices. The balance of costs will therefore fall on the employee. This approach has the merit of clarity but is likely to lead to selective withdrawal of better risks from group schemes over time with the result that costs per subscriber increase even faster than they would have done had the scheme remained unchanged.
This problem is not likely to go away in the near future. We need to explore better solutions than those currently in existence or risk the real threat of a declining PMI market as customers withdraw their support.
