Income protection – the ADL dilemma

Described by one adviser as “flawed, intrinsically unsound and distinctly un-TCF”, activities of daily living (ADLs) attract a fair amount of opprobrium from intermediaries.

The inability to perform a specified number of listed activities as a criteria for a consumer to secure an income protection (IP) pay-out is, depending on who you speak to, grossly unfair or a simple means of ensuring affordability.

The continued existence of the activities approach is complicated by the fact that some friendly societies offer own occupation policies to all categories of applicant. Given that most providers admit that theADL model is less than ideal, some intermediaries are questioning why they persist in offering it to clients already cynical about their commitment to paying claims.

“Activity-based definitions are a particularly ineffective means of determining inability to work,” says Alan Lakey of Hemel Hempstead-based IFA firm Highclere, who has conducted his own research to prove his point (see table).

“The problem arises when you analyse the activities and realise the scope for non-payment to somebody who cannot work. The proof of this is blindness. “Most people struck down by blindness find it incredibly difficult to continue to follow their own occupation in the way they had done previously. If you look at the activity definitions you will find plenty of companies where blindness only fails one or two of the activities when two or three are required for a successful claim.”

A FRIENDLY APPROACH

Lakey says he places the vast majority of IP business with Cirencester Friendly and Pioneer, both of which offer own occupation policies to all applicants for the duration of their claim.

“It’s the only definition worth having,” says Pioneer’s brand marketing manager Nick Jones. Friendly societies have traditionally concentrated on blue collar workers and Jones speculates that insurers’ focus on occupation classes one and two means they lack the data to inform the creation of own occupation policies for higher risk applicants.

The niche argument is echoed by Cirencester friendly, a company which claims to have almost tripled its business in the last ten years.

“Because we only sell IP we’ve got to make an effort to be good at what we do,” says chief executive Paul Hudson, who suggests the contrast in offerings lies in the fact that some big providers do not see IP as core to their business. He argues that weaknesses in product design characterised by ADLs are likely to perpetuate poor sales, creating something of a vicious circle.

Roy McLoughlin of IFA firm Master Adviser agrees.

“When I’ve been offered ADLs a lot of people are really cynical about it,” he explains. “There are some real grey areas. The last person I tried said ‘I don’t want to do it’– they just didn’t believe it would ever pay out. Own occupation across the board has got to come in.”

SYMPATHETIC INSURERS

The industry is not unsympathetic to advisers’complaints. Several providers, including Bupa and Fortis now reserve activity-based policies for clients unemployed at the time of occupation – a so-called “housepersons benefit”. LV=’s Mortgage and Lifestyle Protection, targeted at those in non-manual occupations, is another example of own occupation cover.

“Our view is that we would rather not offer cover if the client is misled about the type of cover they have got,” says Martin Werth, managing director of Fortis Life. He argues that while IP is affordable for classes one and two “and to some extent three” it is much harder for class four. “This is where I think there is a role for some sort of accident and sickness cover,” he says.

The friendly societies have been quick to identify this gap in the market and in recent weeks the industry has seen the arrival of two new short-term income protection/replacement products. Both Foresters Friendly Society’s Sickness Plan and Pioneer’s Bills and Things require no more than a doctor’s note in order to certify a claim.

Like Fortis, Zurich offers “suited” occupation cover, which in Zurich’s case may replace own occupation after the first 12 months of a claim.

“Agood illustrative example might be a carpenter where after 12 months we might want to look at a definition based on that person’s training, experience and education,” says Zurich’s head of underwriting Phil Brown. “They can’t any longer do manual carpentry but could they, for example, teach carpentry skills at a college? We like to think we have the best of both worlds.”

Werth stresses that Fortis has spent some time refining the definition of a “suited occupation” in order to achieve a high degree of fairness. For example, training, skills and expertise will be taken into account but not education, removing the artificial distinction between an electrician with A levels and one without.

Brown is aware of the arguments of those competitors who continue to offer an ADL approach.

“It might be clearer for the assessment process,” he concedes. “But it raises the bar tremendously in terms of how bad somebody’s got to be.”

Head of protection at Friends Provident MarkJones describes own occupation IP as the “Rolls Royce” end of the spectrum.

“To a large extent you do get what you pay for,” he argues. “WithADLyou’re saying if the worst happens you’ve got an 80% chance of paying out. It doesn’t look like protection but mitigation to me.”

Friends Provident, nevertheless, continues to offer its “Amended Definition of Incapacity” to applicants in an occupation “where the risk of a claim from an otherwise minor conditions is much greater than normal.”

SOME BETTER THAN NONE

Several insurers are prepared to defend the activity-based approach.

Will Kentish, head of disability claims at Norwich Union, believes it is a “sound” product.

“It allows customers who may not be able to have cover to be protected,” he argues. “The tests are designed not to measure ability to perform the customer’s usual occupation, but the functions commonly required to work generally. It is important that the customer understands the fundamental difference to avoid disappointment at the time of claim.”

Kentish’s claim that insurers are “constantly” reviewing these tests is backed up by the fact that Norwich Union updated its own list in April. It now includes nine “personal capabilities” and five “serious conditions” which the insurer believes “more accurately reflect the core duties of a normal working pattern.” The latter comprises blindness, deafness, terminal illness, complete dependency and mental illness.

“The NU definitions are possibly the most practical of the ADLs being used,” concedes Lakey. “If every company adopted such a wide-ranging definition the IP world would be a better place.”

Chris McFarlane, head of protection at LV= says that while consumer research indicates that people want to be covered for the ability to do their own jobs, this proves “difficult” for manual workers. The key, he argues, is clarity.

“If someone takes out work tasks cover we’re insuring them for the inability to do work tasks,” he says. “Nowhere in the definition does it say whether they can do the job or not”.

MikeTaylor, chief underwriter and head of claims at AXA, describes activities of daily work as an objective measure of capability aligned with state welfare reform.

“There are by no means perfect,” he acknowledges “but what they do do is give you a starting point to say ‘is this right?’”

He suggests that AXA will take a “holistic” view of claims, including those which fail to meet the activities criteria.

While admitting that the inequity of cover offered to different occupations means the product “needs more work”, he argues that offering own occupation to those in high risk professions would make IP unaffordable.

Ian Smart, head of product proposition at Bright Grey, agrees.

“Working tasks definitions are normally offered to those deemed too risky for an own occupation definition,” he confirms. “Those for whom an accident could take them out of action for quite some time, a bricklayer for example. Because of the environment that is a reasonably common occurrence so the risk of a claim is quite high. If we offered an own occupation policy the chances are they could not afford it.”

“If you allow everyone own occupation, claims would rise based on allowing that definition,” explainsJulie Scott, underwriting manager at Munich Re. “Is it reasonable to effectively allow the better risks to subsidise the poorer risks if such a strategy was adopted? I guess technically there is a price for everything, however people may be unwilling to pay for it.”

Scott suggests that smaller societies may have a more “specific and targeted pricing and claims strategy” but also that the larger providers may pursue occupation classes one and two as “more attractive risks” and so refrain from seeking out the remainder of the market.

LAYING DOWN THE GAUNTLET

For advisers looking at activity-based IP, the challenge lies not only in confronting customer cynicism but in the sheer variety of activity lists, ratios and definitions in the marketplace. Lakey believes that the extent to which these lists are “friendly” (likely to pay out) varies enormously.

“Friends Provident often wins the ‘best’ IP provider award yet their two out of five requirement is far less friendly than LV= which requires failure of three of eight tasks,” he suggests.

While Aidan Levy of progress from Royal Liver suggests that standardised activity definitions across the industry would go some way to addressing the problem, some, including Kevin Carr of PruProtect, argue that this would remove an important field of competition from the market.

Norwich Union’s Will Kentish is alone in suggesting that for own occupation and ADL-based policies, “each method has its merits.” “I think it is imperative that insurers and advisers are united in making it very clear to customers the fundamental basis of the contract,” he says. “This applies not only at point of sale but should also be during the duration of the policy.”

But for some this conclusion is inadequate, representing a failure to address a fundamental design weakness that damages the product itself.

“ADLs damage the reputation of income protection,” says Pioneer’s Nick Jones. “The most important aspect of income protection is that it should be designed with a claim in mind. It must be designed to be used. This is probably one of the reasons why the industry has failed to grow as much as people would have liked.”

“The perception has got be dispelled that insurers are making it difficult to claim,” agrees McLoughlin.

Lakey is scathing about the failure of insurers with “larger treasures chests” not to match the approach demonstrated by the friendly societies.

“My honest opinion is that it involves a major product redesign and it also means that companies are going into an area where they are competing with smaller companies and perhaps they do not want to do it,” he says. “The honest truth is that there are plans out there that are very badly designed.”