Where the Individual Disability Market Stands Today

Where the Individual Disability Market Stands Today
by Stephen Miller

Due to recent growth and a strong foundation, this market is heating up ... from flicker to flame!

The viability and future outlook for the individual disability industry has dramatically improved from where it was 10 years ago. Evidence of this turn–around can be found in the industry's current profitability and its development of new markets. In addition to the solid financial foundation the industry has built, favorable consumer demographics and limited market penetration hint at its growth potential. A close examination of the industry's earning and sales patterns, product trends, development of new markets and distribution characteristics help build a clear picture of the current state of the industry, its key drivers for success and its opportunity for future top and bottom line growth.

Profit margins for individual disability insurers still active in selling new business are at historically high levels. Milliman's August, 2005 Disability Newsletter reported that statutory non–cancellable product pre–tax margins before dividends were in excess of 17 percent for both 2003 and 2004. This level of profitability for active insurers is significant because they are likely the highest margins the industry has seen in 20 years or more. It is also demonstrated in the same Milliman newsletter that interest–adjusted loss ratios from 2000 through 2004 show both a stable pattern and a more favorable morbidity level than that of the 1990s.

The profitability of the DI market in recent years is remarkable when it is considered that pre–tax margins before dividends for the industry were negative from 1986 through 1998, bottoming out at negative 17 percent in 1995. This dramatic turn–around demonstrates the considerable success of the insurers who stayed in the business and remained committed to the product line. Since most business written was non–cancellable, the majority of product management activity was focused on new products and improved returns for sales going forward. By re–categorizing risk, raising premiums where appropriate, refining contract language and benefits, and investing in more timely and accurate underwriting and claims management practices, these insurers were able to substantially raise the bottom line over time.

The development of new markets has been and will continue to be an important success factor for the sustained profitability of the industry. New markets provide opportunity for growth, distribution expansion and risk diversification. The industry's success in developing and expanding the multi–life and worksite markets are two good examples. Both markets contribute top line growth, reduced acquisition expenses and improved spread of risk. The occupational diversification and lower acquisition costs associated with multi–life and worksite sales provide the industry with efficient channels for expansion and a more solid foundation than it has had in a long time. By comparison, sales in the 1980s and much of the 1990s were mostly face–to–face and comprised of an inordinate concentration of medical professional occupations.

Maintaining profitability in the increasingly competitive multi–life market, however, will require the industry to remain disciplined in its risk management and mindful of the lessons of its past. Competition for new cases has driven lower required participation rates and insurable lives, as well as higher guaranteed issue amounts. Multi–life premium is often deeply discounted relative to individually sold business. Continued aggressive and sales driven actions in this market could potentially pose a risk to the future sustainability of today's profit levels.

Today's high profit margins of active writers come at a time when the estimated investment income yield on mean reserves is the lowest it has been in the last 15 years that it has been tracked. Investment income is a significant component of profitability and returns are compressed by the low yields associated with new and re–invested assets. As yields eventually come back up, future profitability will also be enhanced.

Sales Growth
According to LIMRA International's annual sales surveys, the growth of new annualized DI premium has been modest to flat over the last four years, and the growth of new policies has been slightly negative. In part, this disappointing sales trend results from a limited number of insurers offering disability products, inadequate distribution development and diversification, and an overall lack of consumer education of the risk of long–term disability and its financial consequences.

Despite the flat sales growth trajectory, the consumer demographics for disability sales are arguably very positive. Indeed, if some hurdles can be overcome, the demographics point to the potential for significant future growth. The increasing financial dependence of today's workforce on their ongoing ability to earn an income, the statistical risk of long–term disability and the limited number of workers who have adequate, or even any, long–term disability protection all support the view that the industry has good growth potential. Let's consider each of these points individually.

The increasing dependence of workers on their ability to work and earn an income stems from their longer life expectancies, greater individual responsibility for funding their retirement and the resulting extended working years. Today, families are also vulnerable to the loss of their income because of high debt levels and low savings patterns as a percentage of disposable income. Concerns about the future of social security and pension benefits only add to the dependency of wage earners on their ability to work and fend for themselves.

The probability of becoming disabled on a long–term basis is significantly greater than that of death during the working years. For example, the probability of becoming disabled prior to retirement for someone age 42 is approximately 3.5 times higher than the probability of dying before retirement. Mortality and morbidity shifts sometimes move in opposite directions. This occurrence is referred to by some in the industry as the "air bag phenomenon." In other words, through the advancement of science and medicine, people now often survive certain illnesses and injuries that previously had been fatal. The survivors, however, often suffer long–term disabilities and are unable to work.

Far too few workers today have adequate or even any long–term disability protection. According to the U.S. Department of Labor, Bureau of Labor Statistics, only 28 percent of employees have private long–term disability coverage. While the percentage is higher for white collar professionals, technical and related employees, the reported 40 percent is well below the penetration rates for other types of insurance.

While the growth of total new annualized premium has been modest in recent years, guaranteed renewable product sales have been increasing more significantly. In 2002, guaranteed renewable products made up only 24 percent of new annualized premium, while in 2005, guaranteed renewable products have grown to represent almost 40 percent of new business premium. The increasing popularity of guaranteed renewable products is driven in part by the growth of the worksite benefits market. Worksite or voluntary benefits products typically have premiums paid through payroll deduction, are guaranteed renewable rather than non–cancellable, offer shorter benefit periods and have simpler, more affordable coverage protection.

The emergence of the executive multi–life market has also contributed to a new mix of industry sales. Combining multi–life with worksite sales, the shift from face–to–face to group–like sales is clearly evident. According to LIMRA, in 2002 face–to–face sales made up 57 percent of new sales weighted by new annualized premium. By 2005, face–to–face sales declined to only 47 percent of new annualized premium.

Product Trends
With multi–life and worksite sales becoming a significant part of individual disability sales, and with the group Long–Term Disability industry expanding its portfolios for voluntary applications, there is a clear convergence of product attributes taking place between individual and group designs. Hybrid product designs have emerged that utilize traditional elements of both types of products. For example, individual disability products may use group underwriting techniques such as participation requirements, consideration of who pays and how the case is enrolled, group industry classifications and guaranteed issue offers. These products also offer discounted premiums and reduced first–year compensation. Conversely, the group disability industry now offers greater product flexibility and choice of features, portability, modified short–form evidence of insurability and heaped first–year compensation.

Individual disability insurers today are unbundling product features and coverage benefits to drive maximum premium and coverage flexibility. Product designs today are also making use of riders to increase the amount of coverage that can be written without materially altering claim incidence and duration expectations. Examples of these types of riders include catastrophic disability riders and retirement income riders. A catastrophic disability rider can provide a benefit of up to 100 percent of earned income minus any coverage in force in the event of a serious injury or illness. This additional benefit is intended to cover expenses resulting from such serious disabilities as the irrevocable loss of sight, hearing, speech or the use of both hands or feet. Retirement income riders provide additional coverage designed to replace qualified plan contributions in the event of long–term disability. The benefits are paid into a trust and cannot be accessed until retirement.

Disability protection is becoming an increasingly popular element of living benefit designs within life insurance products or as optional riders. Disability income protection, along with death benefit protection, is fundamental to sound financial planning, and the industry is looking for ways to combine the coverages for greater convenience and value. Disability protection riders can provide important protection for specific financial components such as mortgages, or can provide more general income protection. These riders can, but generally do not, accelerate the death benefit. Disability riders typically offer simplified coverage with shorter benefit periods.

The trend toward combining elements of disability, long–term care and critical illness protection with life insurance is important for several reasons. First, it brings more insurers and distributors to the marketplace to offer income protection solutions. Second, it recognizes that increasing life expectancies increase consumers' needs to first protect their ability to earn an income and later to protect their assets. The combination of critical illness and long–term care with disability in life insurance living benefits adds significantly to the comprehensiveness of insurance protection, delivers marketing sizzle and broadens the distribution potential.

Increased Industry Activism
The dramatically improved profitability of the industry, the stability and commitment of the insurers in the business, and the emergence of new markets such as executive multi–life and worksite sales have given rise to renewed optimism and, as a result, increased industry activism. This activity is important because it promises greater and improved marketing and education of agents and consumers, resulting in better informed potential customers. A lack of pooled financial commitment and collaborative media content focused generally on disability insurance is one of the reasons the industry has not realized its growth potential and has achieved low consumer penetration.

On July 7, 2005 the International DI Society was incorporated. This group of nearly 200 producers, insurers, regulators and educators is dedicated to the promotion, education and awareness of disability insurance. This organization promises a strong mentoring program committed to developing the young talent the industry needs to remain successful.

The Council of Disability Insurers is another newly formed organization founded and governed by leading disability insurers. Founded in August, 2005, this organization's goals include raising awareness of the need for disability insurance among employees, employers and distributors, conducting related research, and establishing an educational and informational Web site.

American Health Insurance Plans (AHIP) has also stepped up their efforts in the disability field by being proactive in state regulatory issues that could impact disability benefits, launching a new Disability Income Associate (DIA) designation, creating an education and insurance information portal, www.healthdecisions.org, and publishing several consumer guides that focus on disability risk, financial risk and the limitations of public disability income programs.

Keys to a Successful Future
For the first time in a long while, the individual disability industry has a solid, profitable foundation to build on. However, to maintain or improve current levels of profitability while capitalizing on its growth potential, the industry will need to continue to execute in the areas that have helped restore profitability, as well as focus on ways to develop new markets, and expand its distribution and consumer base. Here are some keys to a successful future for the disability industry:

Adhere to a disciplined risk management approach. Occupational and geographic risk must be sufficiently diversified. Income replacement ratios and product design benefits must meet consumers' protection needs while always providing sufficient incentive to return to work. Underwriting offers need to balance top and bottom line benefits, and not be driven solely by competitive pressures.

The challenging litigation environment makes it essential that insurers strive to make policy provisions as clear as possible to both their customers and agents, and adjudicate claims in a fair, accurate, timely and professional manner.Technology needs to continue to drive automation, productivity gains, improved service levels and better management information. Expense management will continue to be a critical success factor for insurers.

Distribution expansion and diversification needs to occur. Disability insurers may be well served by taking a page from the life and annuity industries. These businesses have successfully developed simplified products and new business processes to appeal to a broader scope of distribution outlets. Additionally, the industry needs to continue to find ways to package disability products or riders with other life products for total financial planning solutions, convenience and value.

Insurers need to educate consumers and agents about the statistical risks of long–term disability and its financial impact, the fundamentals of product designs and the importance of good field underwriting. An increased number of insurers active in the disability industry would help boost consumer awareness, put greater advertising dollars into the industry and increase product selection. An expanded list of insurers in the market would also help broaden distribution development and training. However, the capital intensive and highly specialized nature of the disability business makes it unlikely that there will be a significant influx of new insurers. Still, the individual disability market may be a good strategic investment for a few select insurers given its attractive economics and limited competition and the potential synergies with other business lines coupled with the intense competition and margin compression that limits the growth potential of these other lines of insurance.

With the continued expansion of worksite and multi–life markets, the individual and group disability businesses of insurers that offer both product lines needs to become better integrated.

Breaking out of a silo mentality toward an integrated sales and management approach will drive improved growth and profit potential for insurers, and greater value and flexibility for their employer and employee clients.

Stephen Miller is vice president of business development for Disability Management Services, Inc. He can be contacted at Steve_Miller@di-mgmt.com.

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