Income Protection – A Time for Review

Are the current range of disability income products and associated underwriting and claims processes to blame for the insurance industry’s sustainability woes? Munich Re’s Alexandra Threlfall, in conjunction with Andrew Francis, has produced a series of articles which explore the income protection market in Australia, and what needs to change to promote a more sustainable insurance sector. The following article features excerpts from this series…

Issue 1 – An overview of the retail disability income market

The income protection marketplace

Income protection (IP) has been a huge marketing success in Australia over the last decade… the product has typically sold very well and in 2014, $480 million in new annual premium sold in Australia, equivalent to approximately 63% of life cover only sales and over 1.75 times trauma sales 1. New business sales have almost doubled in the 5 years from 2010 to 2014 compared to the prior five year period from 2005 to 2009.

Whilst sales have shown a consistent and upward trend, the same cannot be said of the sustainable development and profitability of such products. A brief look at the past 30 years shows a tendency toward a period of relatively good experience and profitability which prompts an investment of profit margin into improved policy terms with a view to increasing new business sales. The ‘improved’ policy terms lead to an increase in claims, triggering a contraction of terms in an attempt to halt the deteriorating experience. After a period of relatively stable profits, the cycle repeats itself…

The way forward – a new approach

The way forward requires a number of product dimensions to be addressed simultaneously with a transformational approach setting out the road map for a new way of doing business. The ideal way to achieve this is through measures that are win-win for all parties involved – that is, they improve the position for clients, advisers, insurers, reinsurers and shareholders.

Figure 1 – The principles of sustainable disability income

…Such has been the enrichment of product features and relaxation of benefit definitions over recent times that premiums have not kept pace and worse still, significant unintended moral hazard risks have been introduced or heightened. This is compounded by the effects of annually reviewable premium structures and elevated policy lapses. This points to more pain ahead for customers, advisers and writers of IP business unless these design weaknesses are addressed…

Such has been the enrichment of product features and relaxation of benefit definitions over recent times that premiums have not kept pace

Issue 2 – The core need

The product features ‘arms race’

IP insurance is straight forward in principle – it provides monthly financial payments upon the occurrence of illness or injury that prevents a person’s ability to work. IP is intended to provide a replacement of a proportion of pre-disablement earnings until the period of incapacity ceases or to the end of the policy term, typically retirement age, whichever happens first. Cover was originally intended to meet such basic needs as household bills and everyday living expenses, with strict underwriting criteria and clear benefit definitions.

However, over the years, market competition has led to expanding benefit coverage that could be called a ‘product arms race’.  Most insurers, supported by their reinsurers, have embraced this ‘game’ because a primary point of competition is product feature comparability on the various comparison portals, supported to an extent by an over-reliance on a research score to justify the basis for a product recommendation in the context of a strong compliance regime.

The development approach of simply adding more and more features in the belief that this equates to a better product is misdirected. The result of competing purely on product features is that we have cover with generous terms that no longer aligns to the core need. It often provides benefits that exceed the financial loss, leading to a better financial position on claim than off for some claimants, as well as placing increasing pressure on the premiums that customers have to pay for such cover.

This short term focus leads to a vicious circle of the ‘product arms race’, whereby weak fundamentals contribute to and compound poor experience, with any response, whether it be premium increases or increasingly more competitive new business offers to attract greater sales, likely to further fuel deteriorating experience.

Figure 2 – The vicious circle of income protection

Generous terms

…The core product typically offers a 75% replacement of pre-disablement income and this is then supplemented by:

  • A definition of pre-disablement income that can result in especially generous replacement ratios for those whose income has been reducing prior to claim; where for agreed value it preserves income from application, with no limit to time or extent of reduction in income, and for indemnity it often allows the highest average income for any 12 month period in the three years prior to start of the waiting period
  • Agreed value contracts with limited controls to adjust benefits should the income stated at application not be an accurate representation of their income at the time
  • A generous allowance for indexation of policy benefits, typically the greater of CPI and 3 to 5%, which in a low inflation environment and low income growth can increase the potential replacement ratio as policy duration increases, and
  • A generous definition of total disability, allowing claimants to generate up to 20% of their monthly income or work up to 10 hours per week with no reduction in the benefit payable regardless of what income was earned in those 10 hours.

The core product with the extra implied benefits as described earlier can be supplemented by the following optional benefits:

  • A disability ‘booster’ benefit paying an extra 1/3 of the monthly benefit for a pre-defined period at start of claim, and
  • An additional 5% of a claimant’s insurable income to cover superannuation contributions or, for some companies, mortgage payments during claim.

These optional policy features extend the potential replacement ratio to well over pre-disabled income in the early stages of a claim and indicate that cover is no longer in line with actual loss of income, providing a much broader lifestyle coverage…

…we are paying out more for claims than we mean to under such policies. The incremental enrichment of product features not only affects the level of benefits paid, it also has unintended consequences on claimant behaviour and the overall claim rates and claim durations…

Equity in benefits

…Currently, the typical product offer includes a standard and a plus option, with the standard option generally containing the same definitions as found in the plus product and the main differences being the inclusion or exclusion of ancillary benefits. The great irony is that the generous terms that make it easier to start a claim are provided as inbuilt benefits across all levels of cover while it is the ancillary benefits typically associated with increased support for recovery and shorter claim durations that are extra cost options. This imbalance in cover needs to be reversed and a simpler, foundation product that is aligned with core needs and promotes recovery should be made available, with the following characteristics:

Cover that meets core need Terms that are less susceptible to indirect drivers of claims and selection behaviours. Limit benefits to a percentage of actual financial loss
Simpler definitions Terms that can be applied with greater clarity and certainty and thus produce a more predictable experience
Limited ancillary benefits Inclusion of features that only support recovery, return to work and replacement of actual loss
Lower premium with more stability over time Stronger price differential between a foundation level of cover and one providing more generous terms. Greater stability over time due to the more predictable experience.

Providing a much clearer distinction between the levels of cover, means that customers will have true choice in the cover they take up.  A ‘top end’ level of cover will still be available to customers who want broader cover with the more generous terms, such as higher replacement ratios and a greater range of ancillary features that may pay benefits not always directly aligned to financial loss. However, customers must also be willing to pay a substantially higher premium that reflects the greater claims cost of such a product and which may also be more susceptible to volatility and indirect drivers of experience than simpler and more objective definitions.

The policyholder/insurer relationship

…Policy renewal is the main touchpoint customers have with their insurers. With most IP policies bought on the stepped premium model, policy renewal is marked by year on year increases, providing a very poor representation as to the level of service being provided by the insurer. If a client does not believe that their health has deteriorated and increased their likely need for the insurance at the same rate that the premium increased, the perceived relative utility of each dollar spent on insurance will have reduced.

There is a huge opportunity to elevate core insurance functions into high value service offers

The complex web of issues that policy renewal invokes through the perceived inequity of premium increases, the reduced relative affordability and how the policy renewal may be perceived as a representation of future service may provide sufficient reasons for a customer to choose not to continue their policy. Products with generous terms have a negative impact on claims experience and ultimately the profitability of the book and make base rate increases on top of age and CPI increases even more likely, compounding the issues already discussed…

…There is a huge opportunity to elevate core insurance functions into high value service offers that differentiate the customer experience. 2

Equity in service

One of the core needs for customers in the provision of service is that there is equity and they are treated fairly. Insurers can provide much greater transparency and guidance as to what the policy renewal and claims process will entail, so that customers’ expectations are set up-front, helping to reduce the anxiety about a very unfamiliar service experience for the client.

Providing clear communication about policy renewal and what a client can expect is important in demystifying the process, as well as providing some basic education as to why premiums increase each year and the options customers have to manage the increasing cost. Also, it is an opportunity to introduce and promote existing components of the cover, such as features to increase cover without underwriting, or reduce it if their needs have changed, giving the customer a sense of choice and control at policy renewal…

Issue 3 – Communication

Customers want change

…We should consider asking whether customers properly understand their cover, are satisfied that it meets their core requirements and gauge their level of comfort about paying for the cost of ‘luxury’ features.

Research conducted by the Association of Financial Advisers (AFA) in 2013 3 suggests that there is consistent feedback regarding lack of trust that consumers have of the life insurance industry and its commitment to consistently pay valid claims. Complex and legalistic language and 100 plus page policy documents clearly do not help, with the adviser often required to act as the interpreter of benefit coverage and the middleman in the handling of claims.  One must ask: “Does the customer really need or even want such a level of complexity?”

We think customers do want change, including plainer language, clear and objective benefit features and claims definitions that provide reduced subjectivity at claims stage to make claims more certain, as well as achieve greater stability in long term premium expectations.

Subjective definitions

The majority of Australian IP contracts offer a three tier total disability definition which entitles claimants to a full benefit on the most beneficial of the three:

Duties Not working in usual or any occupation and unable to perform one or more important income producing duties
Hours Working in their usual or any other occupation for up to 10 hours per week and unable to work for more than 10 hours per week in their usual occupation
Income Working in their usual or any other job and unable to generate more than 20% of their pre disablement income in their usual occupation

Putting the generosity of this tiered approach aside for a moment, there are clearly high levels of judgement required to assess whether a definition has been met or not.

Take the first one, which hinges on the meaning of ‘one important duty’. Which duty will be determined to be sufficiently important to entitle an individual to a full payout, especially when insurers are not always clear about an individual’s key duties for ‘generic’ occupations (e.g. ‘manager’) across different industries and trades? This points to the insurance industry needing to improve its underwriting of ‘important’ job duties and potentially deciding the degree to which it wants to monitor material changes to job duties since the policy was taken out (in order to maintain this definition with more certainty).

Then, there is the problematic and arguably flawed ‘10 hours’ definition. Whilst encouraging claimants to maintain some level of employment after injury or sickness is well intended, the industry has created problems for itself by needing to find ways to objectively ascertain that no more than 10 hours have been worked by an individual. 10 hours becomes a financially important tipping point as to what benefit amount will be paid. More importantly though, with changing modern working lives, many individuals, especially business owners, can earn a substantial portion of their pre-disablement income by changing their working patterns and organising their week accordingly and income earning capability is no longer necessarily proportional to hours worked.

For partial disability, the claims definition has a similarly tiered structure and thus a similar problem as described above.

These are examples that cause issues for customers and insurers alike. For customers, at the time of submitting a claim, it is not clear what evidence is required to meet the definition of disability and whether or not their adviser (or a lawyer) will be required to assist the claims admission process. For insurers, there is a need to actively and consistently manage much more evidence: usual job duties, working hours and income…

More objective terms

…Reintroducing objective and clear definitions for income protection will improve overall application of definitions at time of claim in a number of ways:

  • Improve the capability with which claims assessors can interpret policy definitions
  • Provide greater confidence for claimants in the process and reduce adversarial outcomes
  • Reduce the need to involve lawyers in determining how to assess a particular claim
  • Ensure that definitions are applied in a way that is consistent with how actuaries have interpreted the definitions for setting of assumptions
  • Reduce future uncertainty regarding the potential for interpretation creep by the courts and, over time, by the market

Information sharing

Customers want information and insights from experts. Life insurers, by nature of the business we are in, receive a breadth of detailed information about how people recover from different illnesses and injuries. It makes sense that customers would look to us as experts and expect us to share any valuable information that may help them in their own recovery.

While for an individual a health condition is typically new and daunting, claims departments have seen most common conditions many times before and have a unique perspective to observe the impact of customer behaviour, the level of engagement with GPs, specialists and other health care professionals, plus the effectiveness of a range of treatment regimes on the duration and overall degree of recovery. This value of experience can be shared explicitly to improve customer views about the service and support provided. It may also help to remove perceptions about any imbalance of information power, particularly if we use that information to say to customers: ‘With x condition we would have expected you to have returned to work by now’, but have never previously shared that expectation or knowledge with them.

Information sharing can also be used in more subtle ways to help focus behaviours in a certain direction. Setting expectations with customers upfront about typical claim duration for conditions can help remove uncertainty as to how the claim will progress, while easing the sense of need for the claimant to prove their condition each month. People also unknowingly tend to conform their behaviours to what others are doing 4 and, by sharing how long others with a similar condition would typically be off work, insurers can subtly shift durations toward a certain outcome while at the same time improving claims experience and customer satisfaction.


…At last count there were at least 50 benefits and features across the market, with many using vastly different terminology and one benefit having six distinctly different names between providers to cover the same benefit…

…Perhaps the industry should self-regulate in this regard and develop a standard for summarising the structure and benefits under each product which will not only help customers, but advisers as well. A simple document that is consistent between all insurers to be used in the sales process would go a long way in improving the ease with which people can begin to understand our products…

Issue 4 – Claims processes

Lack of historical investment in claims processes

The design of IP products to date has made claims management increasingly difficult…

The lack of growth in claims managers within the industry and the poaching of claims staff from one insurer to another has further exacerbated the problem

…Further, claims departments have borne the brunt of the relaxation of policy terms, with claim volumes far outpacing growth in the number of experienced and qualified claims managers…

…The result has been stretched claims resources, distracted by increasing claim volumes with limited capacity to focus on long term strategic planning regarding claims management. The lack of growth in claims managers within the industry and the poaching of claims staff from one insurer to another has further exacerbated the problem, directing attention away from the underlying problem to deal with superficial recruitment issues.

The product factors that have heavily impacted claims departments are not the only issues that claims managers have had to handle. Inherent aspects of the medical landscape and its approach to occupational disability have also played a part in the complexity of managing disability claims.

The role of GPs

A claimant’s regular doctor plays an important role in Australian IP. The GP provides the initial diagnosis to confirm claimant disability and it is this diagnosis that sets the date of disability and triggers the start of the waiting period. This claimant/GP relationship is built-in to policy contracts and whilst the insurer has the opportunity to challenge the opinion of a GP and ultimately decide the outcome of claims, the burden of proof is generally with the insurer.

The time-constrained primary care model can give rise to a number of limitations in medical care 5 , particularly for patients with chronic illness, including:

  1. Care not necessarily aligned with evidence-based guidelines
  2. Limited engagement in proactively educating patients in self-care practices
  3. Limited multidisciplinary approach within general practice

…Insurers currently struggle to co-ordinate the resources needed to consistently assess claims holistically across bio-psycho-social criteria. This creates a more GP-dependent model which is typically overly medicalised, increasing the focus on medical impairment at the expense of more holistic psycho-social factors. Such an approach may further entrench disability and in doing so, overlook the more useful approach of ‘work-ability’.

Greater focus on holistic support

…Through our IP products, we already offer a range of support and services to customers through the claims process by way of rehabilitation, carer payments, household support, business coaching etc. However we thoroughly undersell the benefits of these services, describing them in a dry and technical manner and relegating them to the position of ‘ancillary’ benefits or packaged as part of an extra cost option (if they make it into the policy terms at all). Perhaps it is time that claims services become the ‘sizzle’ in the product and the value that these services provide are brought to the forefront.

In a recent paper surveying customer and claimant perceptions about service 6 , ‘holistic support with recovery’ was nominated as one of the key ways in which customers would like the claims process to be managed.  We believe that the focus of IP policies should be changed so that the ‘wants’, by way of holistic support services, become the primary benefits under the policy and these are ‘supplemented’ by the ‘need’ in the form of income replacement benefits, which will continue to form part of the base cover.

…In addition, the range of support services could be expanded:

  • Psychosocial support such as greater home services, where the customer is responsible for the care of dependents (whether children, adult children with disabilities or elderly parents)
  • Psychological services
  • Financial or business management services for self-employed customers whose poorly performing business are contributing to their condition
  • Vocational assessments and retraining

Focus on ability not disability

Traditionally we have talked in terms of disability and what the person cannot do, requiring a customer to demonstrate to us that they are ‘disabled’. Whilst the term disabled is an insurance definition which most of us will readily associate with a contractual construct to help apply policy provisions at claim time, the same word to the person on the street has a very different meaning. This focus on disability and what a customer cannot do can entrench a mindset of long-term work incapacity for individuals, particularly if the customer has felt the need to defend the legitimacy of his or her injury or illness to the insurer in order to prove ‘totally disability’.

Once disability has been established, too often attempts to engage a customer in return to work activity may be perceived as the insurer trying to ‘get out of paying a claim’ 7. However, the health benefits of work and its role in recovery have been well documented. In 2012, the Australasian Faculty of Occupational and Environmental Medicine (AFOEM), part of the Royal Australasian College of Physicians, published a paper on this topic called the Australian and New Zealand Consensus Statement on the Health Benefits of Work (HBOW) 8. The primary purpose of HBOW was to raise awareness regarding the health benefits of work and negative consequences that can arise from long term absenteeism.

Shifting the focus away from disability to what the person can do provides a platform from which to integrate work or aspects of work into the recovery process…

Issue 5 – Risk management

Short term focus

…As part of the price competition, stepped premiums dominate the market (over level premiums). As premiums follow the natural ageing process, there is no incentive for a policyholder to keep their existing policy if another insurer offers a better product with more features at a similar or lower price. Taken in combination with easy replacement transfer terms (where customers can provide limited health information at underwriting stage for the new (target) policy) and general increases in disability premiums due to poor claims experience, the industry is seeing sharply increasing lapse rates.

These lapses are highly likely to be concentrated towards the more healthy lives and thus insurers’ in-force books are deteriorating in quality year-on-year as the less healthy are naturally more inclined to claim. This is well and good if the deterioration was priced into retail rates in the first place, but this is generally not the case…

Risk management at new businesses

…Ensuring that, at commencement, the risk accepted is consistent with the assumptions developed when pricing the product is the critical first step. With the mandatory non-medical limits having increased substantially over the last five to ten years, we need to revisit how health underwriting is applied and improve our accuracy of predicting the health prospects of an applicant. One such way is multi-factorial risk ratings where, rather than assessing an individuals’ risk based on his or her BMI and blood pressure as separate risks that are added together, the combined risk of these two factors is calculated. For example, someone who has a BMI of 37 with a systolic blood pressure reading of 90 might be considered a standard risk, whereas the same BMI coupled with a systolic blood pressure reading of 100 pushes them into a medium risk category 9.

The multi-factorial risk assessment can add significantly more precision to the underwriting process but it can be extended even further, with a similar approach to the emerging use of profiling within claims also applied at underwriting. Traditional factors such as industry/occupation, age and medical history can be coupled with holistic factors such as health habits, resilience, workplace satisfaction, as well as home demands which are correlated with claims duration to build a broader profile as to the potential risk an individual might represent in respect of both incidence and duration. Understanding the interplay of multiple factors, not just medical but also psycho-social factors, disclosed in an application will allow us to build a profile to improve predictive capabilities for claims at a more granular level.

A broader set of questions, as well as the manner in which questions are asked can directly input into a more comprehensive risk profile of an applicant. Further, ceasing obviously poor practices such as waiving medical loadings, when the underwriting process has clearly identified a need for that individual to be loaded, should occur. These practices dilute the quality of the overall pool and ultimately mean that the healthy individuals are subsidising the non-healthy individuals based on some arbitrary factor…


IP experience has significantly deteriorated in the last five years and the analysis provided in the five issues of this series has illustrated some of the contributing factors. The most worrying feature for insurers and customers is that, for current style policies, the future is likely to see elevated claims and potentially a continued upward trend due primarily to generous terms, antiselective lapses and further resource stress upon claims management teams.

…Whilst the issues that have led to the deteriorating experience in the Australian disability market are numerous, it means that the opportunity to respond and develop a new disability proposition that taps into customer motivators is significant. The insurer that moves first will be able to develop a unique competitive position that both attracts and retains the best type of customers and the type of business which will deliver superior characteristics of profitability…

…The ideal outcome is to create the opposite of the vicious circle, that is a virtuous circle that is self-sustaining through strong principles and risk management activity that contribute to positive customer experience, motivating beneficial behaviours. The ultimate position is where customers become advocates of their experience and through word of mouth, the industry grows. This is a long term vision but it must start somewhere.

Figure 3 – Virtuous circle of income protection

By working through the issues and improving the whole process, the Australian success story about income protection can be restored so that it is not only a success story about sales but also about a profitable business model with customers at the centre.

Alexandra Threlfall
Alex Threlfall is the Senior Research Propositions Specialist in the Research and Development team at Munich Re with a particular focus on product strategy and disability. Alex has more than 15 years experience in the life insurance industry with roles in product development, strategy and service delivery at a number of direct offices.

Alex is currently studying psychology and is passionate about the subtle motivators of wellbeing that can impact on individuals’ health and ability to recover and the interplay that can have with insurance.

Andrew Francis
Andrew originally trained in Australia as an actuary before joining Munich Re UK Life Branch in predominantly business development and client facing roles. His key focus has been on insurer competitive advantage whether through product development, pricing improvement, risk selection, risk management, value chain optimisation, efficiency gains and the enablement of technology. Andrew led the newly created Research & Development team at Munich Re for over 18 months, leveraging his international experience in the Australian market and further developing concepts and propositions in order to provide a value adding service to our clients.

To access all five articles in the Income Protection – A Time for Review series, click here.

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  1. Plan For Life, 2014 

  2. AFA (2013) White Paper: The Value of Protection 

  3. AFA (2013) White Paper: The Value of Protection 

  4. Thaler, Richard H., Sunstein, Cass R. (2008) Nudge: Improving Decisions About Health, Wealth and Happiness 

  5. Harris, M.F. and Zwar, N.A. (2007) Care of Patients with Chronic Disease: The challenge for general practice, Medical Journal of Australia 

  6. AFA (2013) White Paper: The Value of Protection 

  7. AFA (2013) White Paper: The Value of Protection 

  8. Australasian Faculty of Occupation and Environmental Medicine (2011) Australian and New Zealand Consensus Statement of the Health Benefits of Work 

  9. Armuss, A. (2014) The Multivariate Risk Calculator, Munich Re