A recent report from the Actuaries Institute Disability Insurance Taskforce has shone light on the long term sustainability of disability insurance, particularly individual disability income insurance (IDII) product offerings in both the retail and group space, which has for some time now, been of significant concern within the industry.

See link for full report: https://www.actuaries.asn.au/practice-area/individual-disability-income-insurance-in-australia

Of course, in December 2019, APRA had already raised the alarm by way of open letter to life insurers which sought to ‘address the poor performance of IDII and move the product to a sustainable state’¹.

As a result, the AI Taskforce considered it timely to undertake a comprehensive review of issues with IDII in Australia. With an ever increasing claims experience largely due to growing prevalence of mental illness in the community and comparatively rising premiums, the long term viability of IDII in the absence of critical reform or substantial intervention, is reportedly bleak and ‘at risk of failure’².

According to the AI Taskforce, IDII has been built on the:

‘optimistic assumption of continued economic growth as well as rising inflation and interest rates to mitigate any claims deterioration; but unfortunately over the past decade, this has not occurred and low wage growth and interest rates and pressure from changing societal expectations has continued’.

This has created ‘substantial stressors’, particularly for IDII which was described by Taskforce interviewees as a ‘broken product’.

In short, IDII is in desperate need of a reset. The AI Taskforce report provides a series of provisional recommendations and some tools to help the life insurance industry adopt better practices to ensure long term sustainability. Below, we’ve touched on a few of the key matters arising from the report which are particularly relevant to life insurers.

Product Design Issues

Traditionally, the sale of life insurance has been steeped in distribution targets, aimed at ‘optimising the advice/sales process.’ This means that for many life insurers, in order to compete in the market, providing various ‘add-ons’ or extra features into their product design has become par for the course. But this has had unintended consequences. The IDII products are now so complex and ‘too feature heavy’ that they have gradually strayed from attending to the customers ‘core’ disability insurance needs.’

Taskforce interviewees also observed that insurers are restricted in their ability to change or adjust the policy terms over the life of the Policy and ‘there is little provision made in pricing for future adverse experience’. These factors combined have resulted in unsustainable financial losses for insurers as the claims experience becomes more difficult to predict in light of ongoing economic uncertainty and a rapidly changing world.

Another glaring issue associated with IDII is the long term nature of the cover (whether that be group or retail) where substantial monthly benefits are paid on the back of increasingly generous policy terms (where claimants need only satisfy ‘any one income producing duty’ total disability definitions) for years on end. Claimants can easily find themselves on claim long into the future and in many cases, decades after the commencement of the claim.

Understandably, the flow on effect is that claimants will have very little, if any, incentive to return to work, which is of course one of the key aims of IDII cover. The evolution of ‘liberal policy terms’ has long been identified as a problem, with the NSWSC noting more than a decade ago, that IDII policies designed in this way, will result in a ‘disincentive to work’ unless the benefits of so doing ‘are that good that they outweigh the benefits which would be received whilst the insured remained idle’.

In an effort to reign in the long-term nature of IDII, the report noted that ‘APRA’s 2019 proposal to have 5-year contracts with guaranteed renewability on updated terms resonated with many Taskforce interviewees’. Indeed, APRA expects life insurers to ‘have a framework to periodically update policy contract terms, while ensuring policyholders’ insurability rights are maintained; and manage their exposure to long benefit periods and have effective controls to manage the associated risks’.³

The AI Taskforce otherwise considers that ‘loss minimisation principles’ should be expressly embedded in IDII policies (traditionally limited to policies of general insurance), there being an argument that claimants have a ‘clear obligation to take reasonable steps to minimise the period over which benefits are paid to them – and for example, avoid striving to return to work with appropriate treatment and rather continue to claim benefits’.⁴

Improving the Claims Process

Consistent with the recent ‘Hayne Royal Commission’ and the Life Insurance Code of Practice, the AI Taskforce has identified a number of shortcomings in relation to claims staff training and qualifications. Claims team members are ‘expected to have a wide range of skills and yet there are no formal training requirements, no industry wide professional standards and no qualifications for claims management.’ This inevitably results in a lack of understanding as to how IDII contracts operate resulting in a complicated claims processes which can lead to poor customer outcomes (for example, through misapplication of terms or the inappropriate use of GPs and experts).

The AI Taskforce highlighted the need for an increased focus on rehabilitation noting that:

‘rehabilitation support can make a difference, particularly early rehabilitation of the right kind. There was strong belief in the health benefits of work. There was an argument that payments should be more frequent than monthly so that there is more frequent interaction, which would help in getting people back to work and setting expectations, mindset etc. about returning to work.’

An increased focus in this regard, would certainly go some way to offset the ‘disincentive to return to work’ borne out of liberal policy terms and significant monthly benefits to retirement age. Early intervention is the key.

Claims assessments would also be better served with a simplified IDII Eco-System where information flows more freely among stakeholders. The AI Taskforce has quite rightly, encouraged increased ‘sharing of common information (subject to privacy and consent considerations) particularly when a claimant transitions between different disability support systems,’ because as is often the case, life insurers can often be inhibited in their capacity to offset claim payments due to a lack of understanding as to the nature of other benefits claimants may be receiving. This has been compounded by recent court decisions which have also highlighted the extent to which the matters discussed above (and within the report) overlap, particularly the relationship between product design and the claims assessment processes.

Implications

Whilst the above snapshot does not seek to capture all the issues raised within the report, the issues discussed will not be new to life insurers. Nevertheless, the report certainly gives the industry pause to once again take stock, and consider the direction of IDII going forward into the post COVID-19 world. Put simply, the report suggests things must change if life insurers are going to be in a position to offer a manageable and profitable IDII cover long into the future.

As noted within the report, some insurers have sadly withdrawn from the race, so to speak, and no longer offer Income Protection or Salary Continuance after incurring unsustainable losses year on year. A recent KPMG research paper found that ‘life companies lost $3.4 billion over five years’ which has ‘threatened the viability of the sector.’⁵ For the sake of consumers and the community more broadly, this unworkable model cannot be the way forward, particularly given the uncertainty presented by COVID-19, the effects of which ‘could be profound’.

The report observes that for too long now, the industry has been focused on competition and distribution of IDII, at the expense of long term sustainability; and if things are to change, and life insurers are to adopt the provisional recommendations and tools suggested by the AI Taskforce, and take action on these matters, it is going to require collective buy-in by all industry participants so as to avoid the inevitable arms race which has led us to this point.

Of course, having started the conversation in 2019, APRA has paved the way for the AI Taskforce report which, for the most part, appears to echo APRA’s previously held concerns in relation to IDII and its long term sustainability. Accordingly, for some time now, the life industry has been aware of APRA’s desire for insurers to have ‘appropriate mechanisms to keep products in step with changing external and consumer circumstances,’⁶ noting of course that ‘guaranteed renewability for extended periods causes significant difficulty in designing products that will remain sustainable and appropriate for consumers.’

Nevertheless, life insurers will have concerns about the practical effect of such change. For example, the renewal process (for IDII contracts with fixed terms and conditions not exceeding five years) and the disclosure/underwriting challenges that naturally follow as a consequence. Also, given AFCA’s focus on ‘fairness’, AFCA’s approach to disputes around non-disclosure and policy avoidance in this context is uncertain. Life insurers will be wary of the practical challenges presented by such sweeping product design changes and certainly, APRA has observed that up to this point, ‘the fear of first-mover disadvantage has proven to be an insurmountable barrier to (life insurers) making the necessary changes.’

¹ https://www.apra.gov.au/sustainability-measures-for-individual-disabili…
² Actuaries Institute Disability Insurance Taskforce Report – Provisional Findings and recommended Actions for Individual Disability Income Insurance (September 2020)
³ https://www.apra.gov.au/sustainability-measures-for-individual-disabili…
⁴ Actuaries Institute Disability Insurance Taskforce Report – Provisional Findings and recommended Actions for Individual Disability Income Insurance (September 2020)
⁵ https://riskinfo.com.au/news/2020/09/29/broad-changes-needed-to-sustain…
⁶ https://www.apra.gov.au/sustainability-measures-for-individual-disabili…