APRA has followed its May warning that insurance providers need to improve the profitability and design of income protection insurance products with an open letter outlining a raft of “sustainability measures” to be enforced 31 March 2020.
The prudential regulator’s note addresses the “poor performance of individual income disability insurance (IDII)”, which reportedly lost Australian insurance companies $3 billion in the last five years, and outlines a “consequence management framework” aimed at returning the sector to sustainable profitability.
Summarised, the four major changes are:
- The discontinuation of contracts with agreed value and endorsed value benefits, in favour of contracts based on annual earnings at the time of claim.
- Total insurance benefits can no longer exceed 100% of the earnings at the time of claim for the first six months, or 75 per cent of earnings thereafter (with a $30,000 maximum).
- Initial contracts cannot exceed five-year terms. Policy owners can renew contracts without a medical review, but on the terms set by the insurer.
- Insurers must have “effective controls” to manage the risks of longer benefit periods, ie stricter disability benefit definitions for long benefit periods.
Additionally, APRA will impose a capital charge on insurers “to ensure appropriate focus” on meeting its expectations. The amount charged will be in proportion to each company’s relative IDII exposure, “with some adjustment to account for each life company’s current state as reflected in its response to APRA’s May 2019 industry letter”.
After a thematic review into income protection insurance dating back to 2017, APRA’s May notice exhorted providers to improve risk governance, pricing and product design, data capabilities and resourcing levels.
“Failure to address these action items will risk APRA increasing its supervisory intensity of that life company,” the regulator warned.
Actuary Rice Warner backed APRA’s stance, stating in a subsequent web post it was “critical” that insurers and reinsurers cease writing unprofitable new business. “Doing nothing,” Rice Warner continued, “simply locks in further losses and closer APRA attention.”
The admonishment, however, went largely unheeded by insurance providers intent on improving market share in 2019 by offering discounted policies on favourable terms.
According to Sue Laing, a founder and technical manager at The Risk Store, APRA was left with no option after providers spent years “paying lip service” to sustainability.
“After many expressions of concern APRA said to companies in May ‘this is your last chance, you’ve got to do something’,” Laing says. “Since then, and completely contrary to what APRA envisaged, they have undergone a new business price war that is most irresponsible.”
The IDII price war took place on several fronts, most notably in first-year discounts to policy holder premiums. Laing reckons the practice of enticing clients with cut-price entry deals has not been welcomed by advisers.
“Advisers are fed up with these first-year discounts that shoot up in the second year,” she says. “It just invites churn.”
Kris Mason, a partner at MBS Insurance, says the price movements have made things difficult for advisers.
“The pricing has been bouncing around a lot,” he says. “It leads to a lot of unnecessary work that could otherwise be dedicated to advice and strategy.”
Mason is reluctant to blame insurers, however. He points out that many advisers sell fundamentally on price which leaves the insurers no choice but to compete on that level.
“These insurers are in a tough spot with all sorts of front-end pricing pressure,” Mason says. “They’re kind of damned if they do and damned if they don’t.”
Insurer Clearview has been a notable detractor of introductory deals and clearance offers, with CEO Simon Swanson saying he is “unapologetic” about not offering first year discounts to new customers in an email sent to advisers on November 26.
“Once the honeymoon period is over… customers are inevitably hit with steep premium increases, particularly for IP,” Swanson said, adding that short-term discounting “makes it difficult for advisers to identify products that represent long-term value.”
The industry has gradually drifted from the principle of ‘insurable interest’, Swanson added, and claimants were actually profiting from “overly generous” terms.
Compounding these issues is that insurers are earning less on the capital they hold due to record low interest rates, which they are obliged to primarily invest in defensive assets such as cash and fixed income.
Some say the real catalyst for APRA’s move, however, was the increasing reluctance of reinsurers to take on risk from the flawed policies direct insurers were providing.
“Reinsurers were particularly badly affected in 2014 initially masking the position of direct insurers,” Rice Warner stated in May. “Now it is evident both groups are struggling with continuing losses.”