Blurring the line: group and individual disability insurers are learning from each other's business. The result? They're writing more profitable products.

A decade ago, individual and group disability insurance were as different as a raw egg and a dozen hard-boiled ones.

Both kinds of disability insurance are intended to provide income to replace a portion of a policyholder's salary when that person cannot work due to an illness or disability. But the mechanisms to provide that nest egg protection were quite different.

Because individual disability, as its name implies, was sold to individuals, it required extensive underwriting on a case-by-case basis. Group, which is sold to employers, required less underwriting because the risk was pooled. Like all insurance, both types can be profitable when an insurer -accurately prices the product and sets aside adequate reserves, which earn an adequate return--a return that outpaces claims.

While, for the most part, the companies that have underwritten group disability have stayed away from individual disability and vice versa, both have learned lessons from each product, and both types of products are changing to reflect some aspects of the other.

Fewer, but Stronger

Faced with unprofitable business, many companies have fled both the individual and group disability market in recent years, while others have merged and consolidated to be stronger.

"It's definitely a shrinking market," Frank Darras, an attorney who specializes in disability claims, said. "In the 1980s, they underpriced policies. The policies were poorly underwritten, and insurers couldn't do anything to change the premium. They tried to outdo each other and win market share. Well, they won the battle, but lost the claim war."

Bigger companies, that can better afford to put experts on staff, often operate more efficiently than their smaller competitors. They tend to catch trends and respond to them more quickly, said Dan Skwire, consulting actuary with Milliman USA in Portland, Maine.

"Disability is a very complex business, particularly in regards to claims management and underwriting," Skwire said. "In order for companies to perform those functions effectively, they need to have a large pool of specialized resources--such as doctors, nurses, accountants, rehabilitation experts ... there's a big economy of scale to this business. A larger company can afford to have a lot of these experts on board, but it becomes a very expensive proposition for a smaller company."

Steven Farish, partner, national sales leader, for Palmer & Cay, an employee benefits brokerage in Columbia, S.C., said that in the past, many disability writers were predominately life insurers. "They sold it as a sideline and did a lot of shadow pricing. They sold the business at a loss, but put the money in the stock market and tried to make it up there. They didn't do a great job setting aside reserves, and only the big boys survived."

Both types of disability insurance have had profitability issues, but the individual market has been in more turmoil. About 47 companies have left the individual market in the past 20 years, and with good reason: carriers posted a statutory loss on the product from 1988 to 1999, sinking as low as -15.1% in 1994, according to Milliman Disability, Newsletter.

Group disability also proved to be a difficult line for many insurers, albeit not as difficult as individual disability. While there has been some consolidation in the group market, there have also been new entrants, such as UnitedHealthcare and the PMA Insurance Group, said Drew King, president of JHA Inc., a Portland, Maine-based disability reinsurance, market research and consulting firm and a subsidiary of General Re Life Corp.

"If you go back 15 years, there were probably 50 or 60 companies that offered individual DI. Now there are fewer than 20," King said. "The companies that chose to exit did so because the product was not profitable--it required a lot of capital, the plan design was too rich, they couldn't raise prices on in-force business and the target market, white collar professionals such as doctors and lawyers, became frequent users of the benefit. In the group disability market, despite some of the same issues, there are probably around the same number of carriers selling the product today as there were then."

The lines between group and individual disability coverage, however, aren't as defined as they once were.

Knocking on the Same Door

The growth of the voluntary market, where employees are offered the opportunity to buy disability coverage at the workplace, is one factor that's changing the face of both the individual and group disability marketplaces.

Ten years ago, most individual disability coverage was sold across policyholders' kitchen tables, unlike group, which was sold at the work site, said Joseph Foley, senior vice president of marketing development and communications for UnumProvident.

"Today, 80% of our individual disability insurance is distributed in the workplace," Foley said.

UnumProvident is one of a few companies to sell both individual and group disability coverage, and is by far the biggest carrier of both. In 1999, Unum, then the largest writer of group disability, merged with Provident, who was the largest writer of individual disability. Today, UnumProvident covers about one of every four policyholders with disability coverage (See "Giant in the Shrinking Market," page 62).

"The whole idea behind the merger was to take Unum's 100,000 employers and offer additional coverage to those employees," Foley said. "Often an employer buys group coverage, then employees can buy individual coverage in addition to that. If a company wants to offer individual coverage on top of group, frankly, they'd like to do it all with the same company. There's a common claims process, the definitions are the same. It makes sense for them to buy it from the same company."

MassMutual, which sells only individual policies, also is seeing tremendous growth in sales at the work site, said John Brady, general sales manager for MassMutual's Boston office.

"About half of our business is sold through the work site," Brady said. When sold at the work site, individual disability can take on some characteristics of group insurance. For instance, the insurer often does less individual underwriting.

Brady said MassMutual will write on a "guaranteed standard issue basis" at the work site, which means if at least 100 eligible employees qualify, they'll receive premium discounts and not have to go through the invasive medical tests required for traditional individual policies.

"The group [long-term disability] marketplace has really struggled in profitability for a number of years. They've had to restrict benefits and the amount of coverage they'll allow employees to have. Employees are more underinsured now, and they're looking for options to improve their income replacement if they are sick or hurt and can't work," Brady said.

Many employers are also purchasing voluntary group coverage. Like traditional group coverage, employees are pooled together and insurers underwrite the group risk, although employees, not the employer, pay the premiums through payroll deductions. Sometimes the employer will purchase up to a certain amount of coverage, and then employees can volunteer to buy additional coverage.

"Instead of a traditional LTD where the employer pays the premium and covers all employees, for a voluntary plan, employees pay the premium and they have the option to participate. It's more like individual coverage, but it's still group business," said Skwire of Milliman. "Group is in some ways moving to individual and individual is in some way moving to group. I agree the lines are blurring."

Also, group coverage has traditionally been much more affordable than individual coverage. The average group policy's annual premium generally runs between 0.5% and 1% of income, usually $200 to $225 a year, compared with the average annual cost of an individual policy, $825, according to UnumProvident.

Companies are beginning to offer less expensive individual coverage, however, through the work-site marketing programs and by lowering benefits. For instance, policyholders could buy just five to 10 years of coverage, instead of coverage that extends to age 65.

"Individual coverage is very customizable. It's not one size fits all. When we do work-site marketing, employees have options of adding or deleting benefits and getting to the price that fits their budget," Brady said.

Also, some short-term coverage is beginning to look like long-term coverage.

For instance, Farish of Palmer & Cay said some individual plans being sold through payroll deductions are short-term, but can extend out five years.

Lessons Learned

Another way the lines have blurred between group and individual disability coverage is the policy definitions. In the 1980s, some individual disability writers ran into problems writing what's called "own occupation" coverage, which provided protection lot insureds if they could no longer work in their specified occupation--even if they could work in another unrelated job (See "'Own Occ' Has Its Own Problems" on page 66.) The coverage also extended until the insured was age 65 or older.

Today, many companies have modified that definition. For instance, MassMutual will cover insureds if the disability prevents them from working in their regular occupation, as long as they're not working somewhere else.

"It provides consumers with a choice. The insurer can't force them back to work at an unrelated occupation, but if they voluntarily return to work--and are not making the same level of income as before--we will pay a percentage of their benefits. For instance, if they're making half of what they did before, we'll pay half of their benefit," Brady said.

Another common modification is "two-year own occupation," which means the coverage will be triggered for the first two years that the insured isn't able to work at his or her specific job.

Both definitions have been used in the group disability world "forever," Brady said.

Individual disability writers also took a page from the group disability world when they decided to cap benefit payouts. Group typically offers up to 60% of a person's income, less taxes. While individual writers would once offer coverage up to 100% of a person's income, that amount has been reduced.

In some cases, the benefits offered today aren't as rich as in the past. For instance, Brady said one competitor used to offer a 10% annual cost of living increase as a rider to its policy.

Also, over the past decade, the sale of disability insurance has shifted dramatically. In 1990, more than 80% of policies sold were noncancelable. Today, sales are evenly split between noncancelable and guaranteed renewable products, according to LIMRA International.

Insurers "have learned from the mistakes of the 1990s," said Darras. "They don't offer life-time coverage any more; it's frequently limited to age 65. We may see 24-month mental/nervous exclusions. We may see some exclusions or limitations for other conditions. From my perspective. the marketplace is coming back. The best news is the individual disability carriers that were killed in the 1990s have turned the corner and are making money in the individual market place."

Group writers are also learning from individual disability writers in implementing tighter underwriting.

"Underwriting is very important. You can't do everything with price," said Dick Mucci, executive vice president and director of the Hartford Life's group benefits division. Hartford Life purchased CNA's group benefit business in December 2002, and said it's the No. 2 writer of group disability insurance in the United States. It doesn't write any individual coverage.

"You can't make up for bad risk decisions by just charging a high price. You have to select companies and design benefit programs, and develop new underwriting techniques at the employee level. If you don't underwrite well at the individual employee level, people with problems will become those who predominately select the benefits," Mucci said.

Successful]l disability insurers will also have a role in getting disabled people back to work as quickly as possible, he said. "We look at what a person can do, vs. what they can't do," Mucci said.

It's important tot insurers to have expertise, he said.

"The disability insurance marketplace is a mature marketplace," Mucci said. "It's really survival of the fittest. The biggest challenge the industry has faced is the ability to grow profitably. This business is not for companies that don't make it intense. You can't do this on a part-time basis."

The Future

The disability writers remaining in the market are confident that the market will continue to grow and be profitable.

"But I think we need to find new buyers, new markets," said Foley of UnumProvident. "The industry has had a tendency to chase each others' business, which creates a lot of churn. I'm not sure that's good for the industry."

One area where he sees potential for growth is extending disability coverage to retirement contributions. "I think there's an opportunity for products that may fall between the group and individual worlds," Foley said.

MassMutual is one of several companies with such a product, and also offers coverage for bonuses and incentives that a disabled worker might miss.

Small employers are also a market ripe for growth, Brady said.

"For employers with less than 50 employees, maybe 40% have some group coverage. They have a very limited budget. Voluntary programs could be much more important to them, as a way to offer a benefit that doesn't cost the company anything," Brady said.

Also, small businesses could be interested in buying specialized disability coverage, such as business-overhead expense, which covers the fixed costs of a small business while the owner is disabled, or buy-sell insurance, which covers partners in the event one partner is disabled. The policy could provide money for the healthy partner to buy out the disabled partner.

"If you are a producer selling to the small business market, you have a lot of opportunity, not just with traditional individual policies," Brady said.

Insurers have a ways to go in educating the public about the need to buy disability insurance, said Edward E. Graves, professor of insurance at the American College in Bryn Mawr, Pa.

As many as 82% of Americans said they have no long-term disability insurance, or thought their coverage was inadequate, according to a 2000 survey by the American Council of Life Insurers and the Consumer Federation of America.

"It's a difficult line to sell. Most people are not geared toward looking at insuring their own income as a high priority, and those that do often times know more than they are revealing in the underwriting process,' Graves said. "But most people do not take any steps to insure that their most valuable asset--their ability to earn an income--is protected. They insure their homes and their cars, but those are a mere pittance compared to the ability to earn an income."

Mucci said Hartford has developed simpler, cleaner ways to educate consumers about their disability benefits. "It doesn't sound exotic, but it's very important," he said. "We're bullish about the market."

Voluntary Disability Results

The voluntary market for group
disability insurance--where
employees are offered the chance
to purchase their own coverage,
which they pay for through payroll
deductions--is growing rapidly.

                       2003      Premium
                   Premiums       Growth
                 $ millions    2002-2003

VLTD Sales             $151          29%
VSTD Sales              $65          -1%
VLTD In force          $579          23%
VSTD In force          $272          15%

Source: 2003 JHA Group Disability Market Survey

Key Points

* Group and individual disability insurance policies are becoming more alike.

* Individual policies are being sold at the work site, with less extensive underwriting.

* Group policies are being sold with tighter underwriting, and employees are paying at least part of the premiums.

Learn More

Unum Life Insurance Company of America (UnumProvident)

A.M. Best Company # 06256

Distribution: Individual disability products are distributed through independent insurance brokers and agents, corporate marketing agreements with other insurance companies, associations and financial institutions. Employee benefits products are distributed primarily through brokers, benefits consultants, and a direct sales force.

Massachusetts Mutual Life Insurance Co. (MassMutual)

A.M. Best Company # 06695

Distribution: About 60% of disability business is generated through independent brokers, 40% through career agents.

Hartford Life and Accident Insurance Co.

A.M. Best Company # 07285

Distribution: Products and services are marketed through company employees managed through regional offices, licensed agents, brokers, benefit consultants, and third-party administrators.

ABC's of Disability Insurance

All disability insurance is designed to replace income lost when a policyholder becomes disabled and unable to work. But not all disability insurance is the same.

Group disability is a more traditional line of insurance, in which similar risks are pooled together and underwritten as a group. It's typically sold to employers, who purchase the coverage for employees. The contracts usually run from one year up to two or three years, with the insurer able to change the premium rate at end of the contract--which is helpful if the price turns out to be too low.

Generally, the contracts provide replacement income of up to 60% of an employee's salary, up to a set dollar amount per month. Because the employer pays the premium, the disabled employees' benefits are taxed. Although there are some variations, group disability usually comes in two flavors: short-term and long-term. Short-term disability, as its name implies, is shorter coverage, usually kicking in after seven days and lasting up to 13 to 26 weeks. Long-term disability usually starts after a waiting period--usually 90 to 180 days, which is often covered by short-term disability--and can run until the employee is back to work, no longer disabled, or reaches a specific age or duration limit set by the plan.

Individual disability typically requires more underwriting. Each policy is medically underwritten, so the insured has to submit to various medical tests, and any pre-existing conditions can be excluded from the policy.

Usually, individual disability insurance also comes in two flavors: noncancelable and guaranteed renewable. Noncancelable means once an insured purchases the policy, the insurer cannot terminate coverage or raise rates for the life of the policy. The policies can be in existence for years, until the insured is 65 or longer, although the policies can also be purchased for a shorter period of time, usually for a lower cost.

Guaranteed renewable polices cannot be terminated by the insurer either, although unlike noncancelable policies, the insurer has the right to raise the rate if profitability becomes an issue. Insurers can't raise individual rates, however; they have to increase the premium on an entire class of guaranteed renewable policies at once. Policies are usually placed into classes based on the insureds' occupations.

Unlike group disability coverage, both kinds of individual disability coverage are portable, meaning insureds can keep the coverage throughout their lives, no matter where they're employed. And unlike most group coverage, individual disability benefits are not taxed, because the employee is paying the premium.

Giant in the Shrinking Market

Any discussion about disability insurance has to include UnumProvident. With $4.3 billion of in-force premium for group disability and $1.5 billion in in-force individual disability, UnumProvident is the top writer of both individual and group disability insurance in force--and it's led the pack in group disability for 28 years.

UnumProvident is also one of the few companies to write both kinds of insurance, said Joseph Foley, senior vice president of marketing development and communications for the company.

"The ability to put those two together drove the merger between Unum and Provident," Foley said. "Unum was the largest group writer; Provident was the largest individual writer. It was a deliberate strategy."

In fact, the UnumProvident organization also acquired Paul Revere. Unum, Provident and Paul Revere had ranked as the top three writers of individual disability before the mergers, said Dan Skwire, consulting actuary with Milliman USA.

With $2.03 billion in 2003 in-force premium for group long-term disability insurance, UnumProvident controls a hefty 27.5% of the market. Its nearest contender, MetLife, controls just 9.9% of the market and had $728 million in in-force long-term disability premium, according to JHA, a Portland, Maine-based disability reinsurance, consulting, and market research firm and a subsidiary of General Re Life Corp.

And with $640 million in 2003 in-force premium for group short-term disability, UnumProvident controls 24% of that market, also dwarfing its nearest competitor, Hartford Life, which controls 10.1% of that market.

UnumProvident continues its reign as the top writer of individual disability insurance, although its individual disability premium actually fell in 2003, according to JHA's 2003 U.S. Individual Disability Market Survey. The company touted its leading role in the industry, having generated $63 million in new sales from 69,000 individual income protection policies in 2003, according to the survey.

While UnumProvident retained its top seat in the sale of noncancelable policies, writing $52.3 million in premiums, that was a 15% drop from the $61.8 million in premiums it wrote in 2002. And in guaranteed renewable new sales, UnumProvident's premium of new sales fell 38% from the previous year to $10.6 million, and it ranked second to State Farm, which sold $18.1 million in new premiums for guaranteed renewable policies in 2003, according to the survey results provided by UnumProvident.

UnumProvident continued as the top writer of in-force policies for both kinds of individual disability policies, with $1.35 billion in annual premium and a 41.7% market share in noncancelable policies and another $116.6 million in annual premium, or 28.6% market share, of the guaranteed renewable policies in force.

Foley said UnumProvident's size gives it an edge over the competition.

"Handling the largest amount of disability claims in the industry, UnumProvident has an advantage identifying trends earlier than its competition. Additionally, the combined entity has been capitalizing on cross-selling opportunities for its individual and group products through a common distribution system," A.M. Best Co. said in its company report on UnumProvident.

Trouble in Paradise

Like many disability insurers, however, UnumProvident has run into some trouble by underpricing or under-reserving past business. In May 2004, UnumProvident announced a $967 million pretax charge, its third charge in 14 months. It also posted a $440 million pretax reserve strengthening charge in February 2004, and a $450 million charge was taken in March 2003.

The $967 million pretax charge included a write-off of intangible assets and a strengthening of reserves associated with its closed block of individual disability income. "The impairment charge reflects the organization's desire to segregate this business for reporting and management purposes. Additionally, the company purchased reinsurance coverage for this closed block and raised additional capital to partially offset this charge and expenses related to the reinsurance transaction," A.M. Best Co. said. "While all disability writers have been challenged in the current low interest rate environment, UnumProvident seems to be having greater problems with claim incidence and recoveries than many of its competitors. This lends some additional concern to A.M. Best, given UnumProvident's concentrated locus in income protection products and the increasing weakness in its core group long-term disability segment."

A.M. Best noted that in the mid-1990s, Unum Corp. experienced a significant increase in the number and severity of new group long-term disability claims in the United States due to several factors, including the elimination of white collar jobs, job stress and increases in mental and nervous claims. The problem has been attributed primarily to the fact that, Unum America, like other disability insurers, had sold large amounts of individual noncancelable "own occupation" disability insurance products in the 1980s to white collar professionals, including doctors and lawyers, with high amounts of coverage and long-term benefits. (See "'Own Occ' Has Its Own Problems" on page 66.) UnumProvident has since redesigned its individual disability income product portfolio.

That trend, which started in 1994, stabilized at a somewhat higher rate in 1995 as Unum America implemented a series of measures designed to address the increase, such as new case and in-force pricing actions, the establishment of a special unit to deal with complex claims involving multiple diagnoses and multiple physicians, a fraud investigative unit and new product introductions.

Foley said the market hasn't been particularly profitable in the past three or four years due to three factors:

* Disability claims have increased in a bad economic environment, which means going back to work is harder because there are fewer jobs to go back to.

* Interest rates have been at an all-time low, which puts pressure on disability writers' earnings.

* The aging of the population is resulting in increased claims.

The average age of claimants has moved from 40 in 1990 to 43 today, and policyholders are more likely to file a disability claim as they get older, Foley said.

Also, UnumProvident has been one of several companies to be named in a number of lawsuits, charging the company with refusing to pay valid disability claims.

"I don't think the disability business is any different from other industry sectors that plaintiffs attorneys zero in on," Foley said. As the biggest writer of disability insurance, UnumProvident also gets hit with more lawsuits than its smaller competitors.

"We're certainly not perfect, and we certainly have situations where we have litigation. But if you put the whole thing in context, our litigation rates are low. We regret having any lawsuits, but we paid out $5.6 billion in claims on 500,000 claims last year, and have maybe a couple hundred lawsuits," Foley said. "Our complaint trends are going down."

'Own Occ' Has Its Own Problems

To heal" disability insurers and industry watchers talk, one might think that "own occ" is a dreaded villain that's terrorized the industry, brutally sucking the lifeblood from its business and leaving a trail of red ink in its wake.

But "own occ" is not the bad guy in the latest "SpiderMan" movie--he's called Doc Ock," short for "Doctor Octopus." Own occ is industry jargon for a type of policy called "own occupation," which has proven quite troubling for some insurers.

Own occ coverage was quite common in the 1980s and early 1990s and protected policyholders in the event a disability kept them from performing their "own occupation"--the career they were in when they bought the policy. Insurers sold the coverage, which is somewhat pricey, to many high-income professionals, such as physicians, attorneys and stock brokers.

The coverage, which was rich in benefits, underpriced and poorly underwritten, became the Achilles' heel of the business, said Edward E. Groves, professor at the American College in Bryn Mawr, Pa.

"If a surgeon was disabled and unable to do surgery, he could collect on the policy--even if he was still able to make a living as a doctor," Graves said. "I don't know who was asleep at the switch here, but physicians are also the gatekeepers to say who has a disability. The marketing materials became somewhat self-fulfilling: it created somewhat of a moral hazard."

Adding to the stress of physicians was the birth of the managed care industry, which led to additional pressure for doctors to see more patients for less money. Plus, doctors began to see their medical malpractice insurance rates rise, while their bottom lines were falling.

Suddenly, for many doctors, tapping their disability insurance meant making more money than working, Graves said.

"It used to be many companies offered this 'true own occ.' It allowed the insured to double dip, in essence. They could work someplace else, even making more money than their original occupation, but the disability insurance would still be triggered," said John Brady, general sales manager for MassMutual's Boston office.

Better Off on the Couch

These policies often had what the industry refers to now as overly generous benefits, such as providing for the benefit to grow over time, as insurers expected physicians annual income to grow. With the rise of managed care, however, physicians' annual income was falling, not rising. Also, the policies often offered life-time coverage and unlimited benefits for mental and nervous claims.

"All of these things resulted in really hurting the motivation to return to work," Brady said. "Whenever you have people better off on the couch than at work, you've got a problem with that block of business."

The physician own-occ business represented a high portion of the marketplace, said Dan Skwire, a consulting actuary with Milliman USA. "Typically, physicians had fairly large-sized policies," Skwire said. "For some companies, they might have represented a third or more of their business. It was a significant issue in overall profitability."

Many companies responded by leaving the market, and routinely denying large disability claims, said Rhonda Orin, all attorney with Anderson Kill & Olick. Speaking of movies, Orin said she's the "Clint Eastwood of disability insurance" and often challenges companies to: "Go ahead and deny it!"

"I feel like an entertainer telling stories,' Orin said, "but I had an anesthesiologist with Parkinson's. They denied his claim. This is politically incorrect--but the only one who should be shaking during surgery is the patient. Or how about the microsurgeon who lost vision in one eye--they said he could use his other eye. They will truly deny anything. The principle is to deny first, and see if it will go away."

Frank Darras, an attorney with Shernoff Bidart Darras, said from his perspective, insurers seem to have a kinder, gentler approach to claims today than five years ago or 10 years ago.

"The trash-and-bash mentality of the early and late 1990s is gone. There was a mentality that carriers had to send a message that frivolous claims and lawsuits wouldn't be tolerated, and that everyone was a phony or a fraud. I think as they turned the corner in terms of making money on products they oversold and underpriced, they've become more reasonable and realize that not everyone is phony, fraud or fake," Darras said.

Many companies have stopped selling noncancelable disability policies that are occupation specific with lifetime benefits, but there are still some modified own-occupation policies being offered, Darras said. "From my perspective, the market is coming back. You see some carriers offering limited occupation coverage, for two years or five years or 10 years. Cost of living protections are still available," he said. "My advice to consumers is to shop around."

Joseph Foley, senior vice president of marketing development and communications for UnumProvident, said the company took the lead in changing the own occupation policies.

"Back in the mid-1990s, we made shifts in types of coverage," Foley said. "You can still buy own occ coverage, but not with the degree of benefits that you could have before."