Mining a rich vein: low market penetration offers insurers with conservative products and strict underwriting a chance for profit in individual disability-income insurance. (Life/Health: Disability).

Only a few years ago, the potential profitability of individual disability insurance was anything but golden. In fact, the state of the business during the 1990s was like a movie about the Gold Rush played in reverse, as more than half of the individual disability carriers exited the business for the comforts of the lines of insurance they knew best.

Today, the landscape for individual disability insurance is ripe for mining. The market has turned around in recent years, and the hard lessons learned from past mistakes have paved the groundwork for a profitable future. For individual life carriers, long wary of the risks associated with individual disability, this market beckons a closer examination.

Market Potential

The first article in this series (Best's Review, February 2003) explained that the need for individual disability insurance is greater than ever, due to trends in income, consumer debt, demographics and employee benefits. Only a small portion of the population actually owns individual disability policies, however. The U.S. Bureau of Labor Statistics has determined that only 25% of U.S. workers are covered by group long-term disability insurance. The number of people covered by individual disability is approximately 10% of the number covered by group long-term disability. So, except for a few professions that have been traditionally targeted by individual disability carriers, this market is very underpenetrated.

During the 1990s, the disability insurance industry experienced market contraction and consolidation. About half the companies in the individual disability market 20 years ago are now active. The marketplace has become very concentrated to a handful of disability writers.

Because of relatively fewer providers, new business writings have significantly dropped from previous levels. Recent indications, however, are that sales are starting to increase as disability writers focus on growth for their book of disability business.

Indications are that new business has been much more profitable This is likely a result of more restricted contractual features, along with higher pricing, tighter underwriting practices and a more proactive claims management.

The demonstrable need for disability coverage, coupled with low market penetration in certain market segments and an environment of reasonable competition with profitably priced products, means there is gold to be found.

Lessons From the Past

It is no secret that individual disability insurance has had a rocky past since the mid-1980s, as a result of extensive competitiveness that led to liberal products and underwriting practices. Only since 1999 has the combined industry profitability turned positive. (See "Noncancelable Disability Experience" chart above.)

Many lessons--learned the hard way--have been incorporated into individual disability products and underwriting practices since the mid-1990s.

* Products are more conservative today For example, only a few companies offer lifetime benefits, and many companies limit the benefit period on mental/nervous claims to only 24 months. There is also limited availability of "pure own OCC" coverages. "Pure own OCC" is a more liberal definition of disability wherein insurance benefits are paid when the insured cannot work or cannot perform the duties of his or her own usual occupaton because of a disability, but may be working and receiving income from another occupation.

* Virtually all companies now require some form of financial documentation at underwriting to validate that the amount of disability coverage is appropriate for the income level. More attention is paid to appropriate income replacement ratios. Sound risk management practices such as these had been long ignored in the individual disability market.

* Companies recognize the need to diversify their markets. Traditionally, individual disability carriers targeted medical occupations such as physicians, surgeons and dentists. As the economics within these professions soured during the early 1990s, so too did the overall profitability of individual disability insurance.

Many companies exited this market as losses accumulated during the late 1980s and throughout the 1990s. As a result, the volume of new individual disability premium is only two-thirds of what it was at its peak in 1989. For many of the companies that decided to stay in the market, implementing the lessons of the past within their products- and risk-management practices has finally produced positive margins.

Few realize that, during this 15-year period of historical losses for the individual disability market, some carriers were able to maintain consistent profitability in their individual disability lines. The secrets of their success were simple enough:

* They knew their markets, focused on them and maintained an adequate spread of risk.

* They resisted competitive pressures to overliberalize their products and thereby charge inadequate rates.

* They maintained disciplined underwriting practices and proactive claims management.

While it has taken some companies longer than others to come around, individual disability carriers have learned that sound long-term profitability in this market can be achieved when companies have the discipline to implement and maintain sound risk management principles within their products, underwriting and overall management of the business.

Entering the Market

Individual disability has not been an easy sale despite the undeniable need for it. The American Council of Life Insurers' Life Insurers' Fact Book 2001 reported that individual disability represented less than 1.5% of all premium receipts in 2000 from individual annuities, life, health, disability and long-term-care insurance. Life agents in general have been reluctant to sell disability because of the complexities of the contracts, the relatively high premiums and the difficulties of disability underwriting. Recent trends demonstrate, however, that individual disability insurance can be sold successfully using more simplified underwriting, if offered in the right setting, along with soundly designed products that have shrugged off the expensive bells and whistles of yesteryear.

Getting beyond these traditional obstacles, the individual disability market offers several advantages:

* An ever-increasing need for disability insurance;

* An underpenetrated market;

* The appeal of the disability product to a wide variety of demographic segments, and, therefore, a way to penetrate existing markets or develop new markets;

* An opportunity to leverage an insurer's existing distribution network, technology and underwriting infrastructure;

* An opportunity to grow insurance assets not prone to the risk of dis-intermediation;

* Diversification to an insurer's life, annuity, long-term-care and other insurance risks;

* Fewer competitors than ever before; and

* A more sensible competitive environment among disability carriers that have no desire to repeat the past.

Entering the individual disability market is not easy and certainly not without risks. With the appropriate attention to sound risk management principles and the hard lessons from the past, however, the chances for success are far greater than they have been for a long time.

[GRAPH OMITTED]

Individual Noncancelable Health Insurance Results, Top Writers--2001

A large portion of noncancelable health premiums are represented by
individual disability-income coverages written before the mid-1990s. The
majority of individual disability-income products sold today aren't
classified as noncancelable. Ranked on net premiums written in 2001.


                                                      % Market
Rank            Group (1)                    AMB#        Share

1               UnumProvident Corp          69743         31.3
2               Amer International Group    70342         24.6
3               Northwestern Mutual Group   69515         11.2
4               Aon Corp                    70178          7.5
5               MassMutual Financial Group  69702          7.1

Total Industry                                           100.0

                                              Net Premiums
                                                Written

Rank            Group (1)                             2001

1               UnumProvident Corp          $1,480,222,958
2               Amer International Group     1,161,338,531
3               Northwestern Mutual Group      529,864,767
4               Aon Corp                       352,911,773
5               MassMutual Financial Group     335,020,196

Total Industry                              $4,723,011,041

                                              Net Premiums
                                                Written
                                                            %
Rank            Group (1)                             2000  Change

1               UnumProvident Corp          $1,493,349,576    -0.9
2               Amer International Group     1,163,360,359    -0.2
3               Northwestern Mutual Group      504,988,176     4.9
4               Aon Corp                       344,959,104     2.3
5               MassMutual Financial Group     315,611,117     6.1

Total Industry                              $5,245,821,957   -10.0


                                             Loss     Expense   Combined
Rank            Group (1)                   Ratio       Ratio      Ratio

1               UnumProvident Corp          116.6        35.4      152.1
2               Amer International Group     51.7        35.0       86.6
3               Northwestern Mutual Group    95.7        29.4      125.1
4               Aon Corp                     34.5        54.2       88.7
5               MassMutual Financial Group   66.0        43.4      109.4

Total Industry

Note: Group totals, as prepared by A.M. Best Co., are presented on an
aggregated basis.

Source: A.M. Best Co. data.

Robert W. Beal is principal and consulting actuary in the Portland, Maine, office of Milliman USA. Andronico L. Castillo is vice president and actuary at Munich American Reassurance Co.