End the Income Protection product arms race

Income protection (IP) has been a huge marketing success in Australia over the last decade. It looks good and sales are high. In 2014, Aus$480 million in new business (157,000 policies) was sold in Australia, equivalent to approximately 63% of life cover only sales and over 1.75 times trauma sales, with a small increase evident in 2015 numbers to September 2015 [Plan For Life 2015]. Other countries even look to Australia as a case study on how to sell IP covers.

But while sales have shown a consistent, upward trend, the same can’t be said of the sustainable development and profitability of these products. Insurers and reinsurers declared losses of Aus$569 million on retail Income Protection coverage in 2014 alone. Whilst the full year 2015 results have not yet been released, the year to September 2015 shows that losses  continued in 2015 for IP. These losses continue the industry’s long and difficult relationship with retail Income Protection.

Combining the results of Munich Re’s claims cost analysis with market premium rates suggests that premium rates are in the order of 25% or more below levels that would reasonably cover the cost of claims and deliver a reasonable profit margin.

So why are these products not profitable? The short answer is that the current price does not match the product design. So, is the product underpriced or is the product overly generous? The fault has to lie in development of product features well out of the bound of IP’s original intention.

So how did we get here? The product features ‘arms race’

One major contributing factor to the current situation is the pressure to have product ratings that support insurance recommendations and strong competition between fellow insurers. This pressure has created a sort of product features ‘arms race’ where insurers are adding overly generous features, followed by the necessity of raising premiums to cover the cost of luxury features, then more features being added to attract more customers.

Features 2_Income Protection - Figure 2 - The vicious circle of the product arms race.jpg

These features can lead to the payment of claims being well above the actual income lost, in some cases 130% of pre-disability income can be claimed.

The problem is complicated however, and there are other factors involved. The current lack of broad industry experience studies and the use of a very old standard industry table (IAD89-93), which lacks granularity, have definitely contributed to the imbalance between the product and its cost.

So how can we fix it?

The most obvious solution is updating the current product. This means matching IP Cover to its original intended purpose, with a particular focus on designing benefits and features that do not deliver replacement ratios in excess of the loss incurred. Further, policies must be simpler, fairer and more equitable for policyholders.

The fact of the matter is, most customers understand very little about their cover, few would be comfortable with paying for the cost of ‘luxury’ features that far exceed their core requirements, but that’s what most are unwittingly doing. We think it is our duty as an industry and in the best interests of the majority of policyholders to keep cover in line with real needs and keep premiums affordable and sustainable.

By developing a new product, using more relevant pricing tables and measuring the product features against insurance principles, the industry’s continual slow bleed from over generous IP can be stemmed.

Issues and benefits

Of course there are arguments against a product like this. These are mainly centred around its potential poor ratings, and subsequently not being picked up by advisors, leading to poor sales. This is unlikely though, Munich Re’s broad portfolio shows advisers already sell significant volumes of lower specified (and cheaper) products when there is an alternative. Surely, best interest means ‘affordable and sustainable’, not just ‘add as many features as possible’.

The benefits of this overhaul could be more far-reaching than you might think. Of course there is the obvious reduction to claims cost and increase in profit, but the implications are broader. It’s not a secret that customers lack trust in insurance companies. Simpler, clearer products that are fairer for all policyholders will help improve transparency, and go a long way towards enhancing customer perception. It will essentially address many of the fundamental risk aspects that are currently problematic for Australian insurers such as claims trends and costs, as well as lapse rates and customer satisfaction.

For further reading on the current state of Income Protection in Australia, and a more in depth view of the studies undertaken by Munich Re on the subject, click here.


About the author

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 ten 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.