05 September 2013

Pitfalls of Front Loading MediShield Life

MediShield premiums increase as the insured person grows older (or more precisely, as he or she moves from a younger age band to an older age band).

Some younger people seem attracted to the idea of front loading (also known as pre-funding) his MediShield, according to media reports.

There are two main front loading arrangements:

▪ The premium remains constant, possibly in real dollar i.e., inflation adjusted terms, throughout the person's lifetime, subject to adjustments from time to time to ensure that MediShield Life remains financially sound.

▪ The premium increases as an individual ages, but at a slower rate than if it had been based on age alone.

Both arrangements appear to be driven by two concepts[1]:

▪ A younger person can afford to pay more than the low premium he is paying presently, especially if he is working, but he may not be able to afford the high premiums when he is older. So, in a sense, pay more now in return for paying not so much in the future.

▪ Younger people should subsidise the MediShield Life premiums of the elderly, to show gratitude to them for their contributions.

Some older people are naturally very excited about the possibility of younger people subsidising their MediShield Life premiums. That is, until they realise that their children and their children's children may be the ones bearing the financial burden.

What are the pitfalls of front loading MediShield Life?

Front Loading for Whom?
If everyone pays the same premium when front loading is introduced under MediShield Life, then ceteris paribus (all else being held unchanged) young people will pay more than before front loading is introduced and older people will pay less.

This means that the young may be subsidising the old today. There is no reason why any person should subsidise another person's hospitalisation insurance.

If anyone, elderly or otherwise, cannot afford to pay his MediShield Life premium, it is up to the State to provide financial assistance. The Government should not shift this responsibility to other persons insured by MediShield Life.

Hospitalisation insurance is not, and must not be used as, a vehicle for inter-generation income re-distribution.

It is for this very reason that the Government has rejected social security schemes of the US and Europe, which generally rely on taxing the younger generation to support the older generation.

Any attempt, disguised in whatever creative form, to use hospitalisation insurance to re-distribute income by forcing any person to subsidise another person should be seen for what it is, and be strongly rejected.

Adequacy of Future Front Loading
If the young are forced to subsidise the old today, what assurance is there that there be enough young people in the future to sufficiently subsidise the future premiums of those who are young today?

Difficulties in Estimating Future Costs
Front loading requires reasonably accurate estimates of future hospitalisation claims requires assumptions of mortality rates, hospitalisation occurrences, hospitalisation costs, interest rates etc.

It is extremely difficult to estimate hospitalisation claims far into the future with any degree of confidence.

By way of an example, CPF LIFE will not pay its members if it is not solvent. Although CPF LIFE is unlikely to be insolvent, the possibility is real and exists and is provided for in Central Provident Fund Act. CPF LIFE takes into account mortality rates and interest rates only. In addition to these factors, MediShield Life has to take into account the more uncertain factors such as hospitalisation occurrences and costs.

These three above-mentioned difficulties may be avoided by having everyone (excluding new entrants with pre-existing illnesses) in the same age group pay the same front-loaded premium. In this way, no age group (e.g., the young) will subsidise another age group (e.g., the old). Any surplus in premiums collected less claims paid for any age group will be retained for the benefit of that age group for their use in the future. I will consider this arrangement only in the remainder of this article.

Significant Increase ≠ Significant Reduction
A person in his 20s currently pays $66 in annual MediShield premium.

A person in his late 60s currently pays $540 in annual MediShield premium.

If the premium for a 25-year-old person is increased 50 per cent, the $33 increase will reduce the MediShield premium of a 65-year-old person by 6.1 per cent, ceteris paribus[2]. This minuscule reduction is hardly meaningful.

No Assurance of Adequacy
Just because a person has front loaded his MediShield Life premium based on certain assumptions made by the Government, there is no assurance that the front loaded portion will be enough in the future.

A problem will arise if the members of an age group survive far beyond expectations, especially if this is coupled with higher than expected hospitalisation claims. Will the premiums spike up toward the end of their lives? Will the Government step in?

Front Loading Forfeited on Early Death
A person benefits from front loading if he lives to a ripe old age (provided the front loaded amount is not exhausted by low mortality rates and/or high hospitalisation occurrences and costs). The longer he lives beyond the median life expectancy, the more he stands to benefit from front loading MediShield Life.

If he dies prematurely, however, he loses the amount that he has front loaded.

The people who die young subsidise the premium of the people who live to an old age.

This should not be part of hospitalisation insurance.

Front Loading Forfeited on Withdrawal
If a person decides to give up his citizenship or permanent residency and withdraws from MediShield Life, he loses the amount that he has front loaded.

Front Loading Benefit on Late Joining
When a foreigner is granted citizenship or permanent residency at, for example, age 35, and joins MediShield Life, he will pay the same premium as those aged 35 but he will not have paid any front loading in the preceding years that other 35-year-olds have paid.

Not Everyone Can Afford Front Loading
Front loading assumes that everyone who is young can afford to pay more to front load, but that is not the case necessarily.

With compulsory MediShield Life, what happens when a person can't afford to pay his premium? Will the State assist?

No Ownership of Front Loaded Premiums
When a person contributes to his CPF account, the money is in his name. No one else can use it without his authorisation.

When a person pays MediShield Life premium, the premium is pooled and is used to pay the hospitalisation claims of all the insured persons (subject to deductibles and co-insurance).

MediShield Life is not a savings scheme.

If enough people want to save in advance for their future MediShield Life premiums because they can't trust themselves to save and/or not to spend what they have saved, the Government can set up a Medisave Plus account for them to save in their respective names — essentially front loading, but in their own names.

Future Changes
Front loading a future financial obligation is very risky when the front loaded sums are not in a person's control.

Just because MediShield Life will be managed by the Government doesn't remove the risks. It may even increase the risk because there is no one a person can turn to if he doesn't like what the Government of the day intends to do with it.

Laws and regulations may change. CPF savings and withdrawal rules have changed over the years, as has MediShield; the Dependants Protection Scheme was privatised. MediShield Life may be transformed into something quite different in 20 years' or 30 years' time.

It is always better to keep the money where you can control it.

More Front Loading
Front loading is a concept. Once MediShield Life members accept front loading (or have it forced down their throat), the next step is the degree of front loading. It is likely that the degree of front loading will be small in the beginning and will be raised in the future, just like GST.

Unfortunately, we will not know the degree of front loading because the base schedule (i.e., without front loading) will no longer be available.

The Government may be emboldened to introduce front loading in other schemes.

Insurance Principles
Front loading goes against the basic principle in term insurance that your current premium pays for the coverage that you want in the current period.

Insurance is not a mechanism for income re-distribution.

Insurance, especially hospitalisation insurance, is not a savings mechanism.


1. MediShield: Young People Willing to Pay Higher Premium TODAY 12 Jul 2013.

2. Although the $33 will grow to $158 over 40 years if invested at 4 per cent per annum return, I have not taken this into account because premiums and hospitalisation costs will also increase, possibly at a faster rate, owing to inflation.

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