Protective Value Life Study - Theory

There are several ways in which actuaries, underwriters, and medical directors can attempt to quantify the real value of a screening device, be it a laboratory test, an attending physician's statement, a motor vehicle report, etc. Each method invariably includes some form of comparing the cost (of a test) to the savings to be realized from future saved mortality because an impaired risk was not issued a policy at standard rates. As the cost component happens at issue time, but the savings is spread out over future policy years, a present value of savings is calculated. "Protective value" exists whenever savings exceeds cost. When savings equals cost, the quotient of cost divided by savings per thousand is called the Protective Value Threshold (PVT), the underwritten amount of insurance above which the theoretical returns to the company over time exceed the discount rate used to generate the present value of savings.

Assumptions must, of course, be made to complete any such study. So while the theory may be straightforward and correct, the results are only as good as the assumptions contained in the various input parameters. When possible, companies should always use their own real data in the calculations of cost and savings.

The 'cost' side of the protective value equation should include at a minimum the direct costs charged to the underwriting department to get the information solicited. This should include such hard dollar costs as collection fees (paramedical), transportation costs (FedEx), and laboratory analysis (if any). However, an estimate of certain soft dollar costs should also be made, such as the time it takes an underwriter or medical director to understand and use the results of the test. Some appropriate hourly charge for their time should be included. Overhead cost allocations should probably not be assumed because they are likely included in other areas of the underwriting budget.

'Savings' requires a number of assumptions, not the least of which is a basic mortality assumption to be used for baseline standard business. A lapse rate and an appropriate discount rate are also needed for the present value calculation. In addition, there are (at least) 3 other input parameters required: impairment prevalence, sensitivity of the test in question, and the exclusivity factor (sometimes called the 'attribution ratio').

An estimate of the degree of substandard mortality assumed is needed to be able to determine how much savings can be expected to be released over the study period, and how fast. The substandard assumption can be simplified if the degree of impairment sought can be expressed as a table rating, a percentage of the underlying basic mortality. Fortunately, this is a common and frequent way of assigning mortality debits.

In general, then, the basic protective value equation looks like this: if

Cost < Savings,

there is indeed value, where Savings here is denoted by
Savings= Excess Mortality x Underwritten amount x Prevalence x Sensitivity x Exclusivity Factor

or, in symbolic terms,

Savings= EM * U * R * S * T Where
EM= excess mortality savings per $1000 (i.e. present value of excess death benefits)
U= underwritten amount in $1000s
R= impairment prevalence of the population applying for insurance
S= test sensitivity, or how good the test is at finding the truly impaired risks
T= exclusivity, or what weight should be given the test as the only means to uncover or illuminate the impairment

Depending on the test in question, the above calculation can be done for single impairments or multiple impairments. Once the assumptions have been determined, the PVT is determined by dividing Cost by Savings per $1000.