Future Increase Option

A future increase option is a provision, usually added to a policy as a rider for an extra premium, that guarantees the policyholder the right to buy stated additional amounts of coverage at defined future dates or on defined life events, without providing new evidence of insurability. The California Department of Insurance's glossary defines the same benefit under the name regulators generally use for it: guaranteed insurability is "an option that permits the policy holder to buy additional stated amounts of life insurance at stated times in the future without evidence of insurability." The point is worth stating precisely because the name obscures it. The option does not make a policy larger; it makes the insured permanently eligible to make it larger, which is a different and in some ways more valuable thing. Coverage bought under the option is priced at the insured's age at exercise, so the guarantee is about health rather than price. It should not be confused with a cost-of-living rider, which indexes a benefit already held, though some contracts use overlapping words for the two.

The risk being transferred is unusual, and understanding it explains everything else about the provision. Ordinary insurance transfers the risk of a loss. This transfers the risk that the insured will stop being an acceptable applicant, whether through a diagnosis, a change of occupation, or a hazardous new pursuit. That risk is one-directional and irreversible: a healthy person can always buy more coverage on the open market, and an unhealthy one usually cannot buy it at any price. So the option is worth nothing to those who never need it and a great deal to the few who do, which is the ordinary shape of insurance applied to eligibility rather than to loss.

NAIC's description of the life insurance version states the two halves that matter. Its consumer guidance says a guaranteed insurability rider "lets you increase your death benefit at certain times in the future without a medical exam", and that "how much it costs to increase the benefit will depend on your age and the amount of the increase, not your health or lifestyle". Read the second sentence carefully. The premium for the new coverage is not frozen at the original age; it is the price for someone of the insured's age at exercise. What is frozen is the insurer's obligation to sell, and the fact that a decade of medical history cannot be used to reprice or refuse it.

On disability income coverage the same idea addresses a different problem, which NAIC also names. Its disability guidance observes that "because your benefit payment will not increase automatically as your income rises, it may be possible to purchase additional coverage to keep up with raises or promotions". A monthly benefit chosen at 28 is sized to a 28-year-old's income, and disability insurers cap benefits as a proportion of earnings, so the coverage falls behind a rising career unless it is topped up. The option is the mechanism for topping it up. One qualification is worth checking in the contract rather than assuming: the guarantee concerns health, and whether the insurer still applies financial underwriting to income or occupation at exercise is a term of the particular policy.

The exercise structure is where contracts differ most. Four things vary, and each can be found in a paragraph of the rider. When the windows fall, which may be at set ages, on policy anniversaries at intervals, or on named life events such as marriage or the birth of a child. How much may be bought at each window, and whether an unused allowance carries forward. When the option expires altogether, which is usually an age. And whether skipping a window forfeits only that tranche or the whole remaining option.

Long-term care is the one product where a model regulation spells the mechanic out, and it is expressly use it or lose it. NAIC's Long-Term Care Insurance Model Regulation lists among the three permitted forms of inflation protection an option that "guarantees the insured individual the right to periodically increase benefit levels without providing evidence of insurability or health status so long as the option for the previous period has not been declined", with the increment measured against 5% annual compounding. That is not a rider a buyer adds. Section 13A makes it one of three forms of an offer the insurer must make, and section 13G requires a signed rejection if it is refused. The long-term care insurance page covers how the three forms compare. What transfers to other products is the structure: a chain of options where declining one link can end the chain.

The same benefit turns up in reserving requirements, which is a small sign that regulators treat it as material rather than cosmetic. Section 18A(19) of that regulation lists "guaranteed insurability option" among the policy factors an actuary must take into account in setting reserves, alongside waiting period, maximum benefit and inflation protection provisions.

The option is bought at issue, for an extra premium, and specifies a total amount of additional coverage and the dates or events at which portions of it may be taken up. At each window the insurer notifies the policyholder, who elects to buy some or all of the available tranche. The new coverage is issued without health questions or an examination, and is priced at the insured's attained age. If the window passes unexercised, the tranche is generally lost, and on some contracts the remaining option is lost with it.

A hypothetical example of what the provision is for. Suppose an insured buys a disability policy at 30 with a $3,000 monthly benefit and a future increase option carrying $6,000 of additional benefit, available in four tranches of $1,500 at ages 33, 36, 39 and 42. He exercises at 33, taking the benefit to $4,500. At 35 he is diagnosed with a chronic condition that would make any fresh application unsuccessful. He can still exercise at 36, 39 and 42, adding another $4,500, so his benefit reaches $3,000 plus $1,500 multiplied by four, or $9,000 a month. Without the option his coverage stops at $3,000 permanently, because no insurer will underwrite him after the diagnosis. The option is worth $6,000 a month of benefit in this scenario and nothing at all in the scenario where he stays healthy and can buy coverage on the open market anyway. Each tranche is priced at his age when he takes it, so the later ones cost more per dollar of benefit than the original policy did.

The decision at purchase therefore turns on two questions rather than one. How likely is the insured's need for coverage to grow, which is mostly a question about income and dependents. And how much would it cost to be unable to buy that additional coverage, which is a question about what a permanent loss of insurability would mean for the household's plan.

Pros

• It is the only way to keep the door open to more coverage after a health change, and after the change nothing else is available at any price.
• The additional coverage requires no medical exam or health questions, and the price turns on age and amount rather than on health or lifestyle.
• It matches coverage to a rising income without requiring the insured to buy more than they need in their twenties.
• Because each increase is priced on age and amount rather than health, the cost of exercising it can be worked out in advance.

Cons

• The premium is paid for years for a right most policyholders never exercise.
• Each increase is priced at the insured's attained age, so the option guarantees availability, not affordability.
• Windows are typically use it or lose it, and on some contracts skipping one forfeits the rest of the option.
• The option itself expires at an age set by the contract, often well before the coverage does.
• On disability income coverage the guarantee concerns health; whether income and occupation are re-examined at exercise is a contract term, and financial underwriting can still limit the increase.