IN COMMON with other markets around the world, particularly Australia and the United States, claims ...
IN COMMON with other markets around the world, particularly Australia and the United States, claims experience for income protection (IP) insurers in the UK has been poor. IP is a difficult risk for insurers to manage profitably.
But why has experience been so poor and how successful have attempts to remedy the situation been?
IP has been available in the UK for over 100 years. The policies have changed a lot during this time. A typical IP policy currently being sold has the following features:
l Benefits payable if the insured is totally unable, by reason of sickness or accident, to perform the duties of his/her own occupation and is not currently employed.
l Benefits payable to a maximum age of 60 or 65.
l A maximum benefit of 50% of gross pre-disability earnings is payable.
l The policyholder does not pay taxes on the benefits.
l Benefits received from other sources are offset against IP benefits.
l A choice of deferred periods is available. Four weeks, 13 weeks, and 26 weeks are the most common.
l Applicants are fully underwritten, with substandard cases being either rated or issued with exclusion clauses. Occupation is a key rating factor.
l Insurers generally use four rating classes depending on the level of disability risk, for example, class 1 would include accountants and actuaries, and class 4 would include manual labourers. Premium rates are often guaranteed.
For many years, UK insurers concentrated on selling insurance products with significant savings components, the most important being pensions and other retirement vehicles, with-profit endowments, and unit trust products. Protection products, such as term assurance or IP policies, were often perceived as secondary lines. As long as IP policies were not overtly unprofitable, insurers were happy to put relatively little effort into developing the product .
Unfortunately, the implications of this approach became clear only after claims experience began to deteriorate in the late 1980s and early 1990s. There were major problems associated with the IP product in all areas. On the underwriting side, the market was characterised by poor training and expertise levels among staff, particularly failure to understand the differences between mortality and disability risks.
Another problem was inadequate application forms that failed to prompt the right disclosure or provide sufficient detail about the applicant's occupation. There was also an over-emphasis on the reliability of information supplied by the applicant's own doctor.
On the actuarial side weaknesses were also present, such as inefficient collection of claims data at an industry level and by individual insurers. For example, industry claim inception and termination experience for 1989 did not become available until 1995.
Then there was the failure to measure the financial performance of the IP block in its own right. In many offices, poor IP performance was masked by good performance from other product lines. As a result the need to take remedial action was not identified until it was too late. Likewise, the use of traditional 'Manchester Unity' sickness techniques for pricing and particularly for reserving acted to conceal, rather than reveal, emerging trends.
Lack of resource
On the claims management side, the key problem areas were under-resourced and under-skilled claim teams. This resulted in inadequate efforts being made to validate claims prior to paying them and once in payment, claims were not actively reviewed or managed. The root of this problem was a desire to keep expenses under control.
On top of this was an over-reliance on information supplied by the claimant's doctor who was acting as an advocate for the claimant in many cases.
The primary factors driving the deterioration in claims experience were increasing competition between insurers, a change in the structure of the employment market and attitudes towards work, all of which were exacerbated by an economic downturn.
The increased competition between insurers manifested itself in policy features and underwriting. On one hand insurers introduced more generous benefit definitions (particularly a move from 'any occupation' as the standard to 'own occupation') and benefit formulas as well as an increased use of rate guarantees.
At the same time, occupational underwriting became more generous, with high-risk occupations moved into lower risk categories for marketing reasons. The effect was to make it easier for policyholders to qualify for benefits and more difficult to persuade them to return to work.
In the early 1980s, the economy in the UK underwent significant changes, shifting from a manufacturing-based economy to a service-based one. Accompanying this was mass unemployment and the growing use by employers of early and ill-health retirement to reduce the workforce. One unanticipated consequence was an increase in the degree to which long-term illness and absence from work became socially acceptable, particularly for previously taboo illnesses such as stress. When the UK underwent another economic downturn in the early 1990s, the foundation was in place for IP insurance policies to be used by policyholders to preserve their financial position in a difficult economic climate. In effect, prolonged sickness was a financially and socially attractive option.
The impact of these factors on claims experience is shown in the charts opposite. The first shows the claim inception experience in the years 1975 to 1994 for males shown are the ratios of actual claim inceptions to expected claim inceptions. Data is given separately for deferred periods of four, 13 and 26 weeks.
While experience for business with shorter deferred periods has been relatively good, the 26-week deferred period has been poor, with claim inception rates rising more than 50% by the end of the period. This pattern is explained by the failure of insurers to begin claims management until the claimant had already been sick for some time, at which point it was difficult to get them back to work. The experience for female lives was also poor, running between 50% and 100% higher than that of males (female data not shown in the figures).
The second chart shows the recovery rates shown are the ratios of actual claim recoveries to expected claim recoveries. Low recovery rates are bad for insurers because this means that claims last longer than anticipated. The graph shows a clear and significant deterioration. Recovery rates in 1994 for all deferred periods were running at half the level of that in 1975. The experience of females was similar to that of males.
The early 1990s saw insurers wake up to their IP problems. A number of insurers had to realise very large losses, some in excess of £100m. Premium rates for new and (if possible) existing policyholders were also increased.
Some insurers withdrew from the market; others withdrew their guaranteed rate products. Underwriting and claims handling improved, and the actuarial profession recognised the need to improve data collection and analysis. Sales were hit badly and have only now recovered to the levels of 1990.
So, have these actions been effective? Claims experience data in the UK is now available to 1998, and the patterns are mixed. A number of unexpected results have appeared. Recovery experience is very similar between males and females, occupations, and despite the substantially improved economic position, recovery rates have not improved significantly since the early 1990s. The inception experience for policies with a longer deferred period has not improved either.
The reason for these patterns is not fully understood. If the economic downturn was responsible for the deterioration in experience, then one would expect claims experience to subsequently improve. This should act as a warning to insurers to maintain risk management discipline.
Experience in the UK has been far from unique. The US market suffered similar problems a few years earlier and the Australian market a few years later. Although each market had its own unique features, the common denominator was sales in a highly competitive environment of policies with an 'own occupation' definition of disability. The key lesson is that 'own occupation' IP insurance is a fundamentally high-risk line of business, and a factor insurers need to manage effectively.
Ross Ainslie is head of product research at General Cologne Re
