Phil Anderson, Acting CEO and GM Policy and Professionalism at the AFA, talks with Riskinfo about a range of changes that will likely impact the life insurance and income protection market as insurers react to intervention from APRA…
This CPD quiz is based on a March 2021 interview conducted by Riskinfo with Acting AFA CEO and General Manager – Policy & Professionalism, Phil Anderson. Scroll down for the full transcript.
We’re talking with Phil Anderson about APRA’s intervention with the income protection market. Can you give us a bit of background with regard why APRA intervened into the income protection market?
It was kicked off in a regulatory sense in 2019 off the back of a number of years of poor profitability, or significant loses being made, in the individual income insurance and disability insurance market.
And what happened was that earlier in 2019 APRA basically issued the life insurers with a warning.
And they put it to the insurers that they needed to come up with solutions.
By December of 2019, APRA lost patience with the industry and decided to intervene. And this is what we call the APRA IDII intervention.
What APRA did was basically say to life insurers ‘you are going to need to put more capital into this product, and we are going to give you a set of expectations, and if you don’t comply you are going to have to put even more capital in’.
APRA split it into a few areas. It removed agreed value, said that income-at-risk needs to be assessed at the time of claim, or at most the last 12 months, and it put caps on income replacement ratios. It also put in place a requirement that contracts cannot last for more than five years. And this is one that we are very interested in and we still haven’t seen the details of how that is going to work out.
And they also talked about the need for improved risk management programmes within the businesses to take account of long-term claims.
That was a reasonably high-level outcome. The dates were going to be April 2020 for agreed value to go. Then 30 June 2021 for the other changes to be made.
Covid got in the way, agreed value was removed, but the other changes are not now due to start in October 2021. [Since this interview was recorded, APRA has given the insurers an additional 12 months to address issues associated with the maximum term for an IP contract.]
I think this is now in the hands of the life insurers to design the new products that are going to meet those expectations. We have also had the Actuaries Institute actively involved in this space, making another set of recommendation around the future of the IDII market. They are talking about sustainability guides, they are talking about reference products, and new risk management regimes.
They are due to finalise their recommendations in the next month and when we see that we are going to see some further prompts for change in product design.
And they are talking about things such as own occupation, that it should be only for the first two years. They’re talking about how benefits should only be paid to the age of 60 and cutting back further on income replacement ratios. So, there is a lot happening in this space and it is driven by profitability concerns and the expectation that products will need to change to ensure that sustainability is improved.
So, when you talk about profitability concerns I guess the extrapolation from that is effectively the sustainability of the entire income protection product market?
We have seen APRA come out with profitability numbers and it has divided the market into four: individual versus group; and lump sum versus disability income.
Three of the four markets have lost money in the last 12 months. It is only the individual lump sum market that is making a reasonable profit.
APRA is the prudential regulator so it needs to make sure that the life insurers are adequately capitalised and is saying that the life insurance industry needs to address those issues.
Losses in the IDI market in the last five years has been more than $1 billion, that is a significant loss and APRA is saying they have to fix it.
With the new range of products that life insurance companies are starting to release, will the pricing be more expensive for these new products?
I think that agreed value is no longer an option in the market. The whole construct of this is that products will be simpler, and therefore they will be cheaper to provide. But we need to assess that in the context of an appreciation that existing products were already under-priced, which is why they are losing money – in that the benefits exceeded the premiums insurers were receiving.
We are in this situation where we have the old products where they need to bring them back to a more profitable level, which is why we are seeing these huge premium increases come through – in contrast with the new products – which will be priced from the start to make sure they are sustainable.
So, the comparison of the two is probably going to lead to some interesting outcomes, and I think the evidence is already there, that the new products are not going to be cheaper than the existing products because the process to re-price the existing products is not yet complete.
With regard agreed value policies, and the fact that they are no longer available to be offered to the consumer, do you think that will make advisers’ conversations with their clients more difficult with regard to the value of income protection insurance?
I think that it is going to certainly impact the discussions that are being had with small business operators.
There is no question that agreed value was an attractive proposition for people who did not have a fixed income, and what it did do is give them certainty.
They knew what their cover was and they didn’t have to prove it at the time of claim, and that made the claims process much more straightforward. And it also took out of play the fact that there might be variability in income from one year to the next – and they would not want to be assessed on the income at the time of the claim if it was a poor year.
We also need to take into account the fact that when someone incurs an injury or an illness they may struggle through for a period of time.
And as a result, during that period their income may decline. So, it seems unfair that they would be assessed on that basis.
So, I think it’s going to have a material impact in the small business market, and in the salary market it will have less of an impact. If you’re in government jobs, long-term security, then it’s going to have less of an impact.
But it was always an important feature of the Australian market that was very attractive. Advisers are going to need to have different methods of advising and encouraging Australians to take out income protection insurance, but it will be a factor.
Australia is very much a stepped premium market compared to lots of other countries in the world, where level premiums are much more popular. Do you think there is an opportunity in the introduction of new IP contracts to encourage level premium business in order to perhaps retain more products as and when clients approach the time when they really need the cover?
Some insurers have stepped back from offering level premiums in the income protection market, and when we’ve seen such significant premium increases in the level premium space it certainly has undermined confidence in level premiums.
We’ve seen very material increases and it has been very challenging for advisers to convince their clients to stay in those products.
If you had a very substantial 70% premium increase in a level premium agreed value product, the advisers have to work hard to convince their clients to understand the value of holding that product.
So, I think level premiums are probably more vulnerable than they have been in the past, but we will need to wait and see how this five-year issue plays out, and whether we end up having level premiums that go for five years and then be subject to a refresh – which is more the international market, where you are insured for a certain period of time with no guarantee of renewal.
Do you think APRA’s intervention will actually create an opportunity where there will be genuine innovation in Australia’s insurance market and limited duration policies?
We will have to wait and see. The Actuaries Institute has put together a reference product and it will be interesting to see how, and if, it gets implemented. But we think it probably has the support of APRA and the life insurers in pushing in that direction.
So, if you have a reference product, and there are risk implications any time you move away from that product, then we are probably going to see more standardisation of products.
I’m not sure that initially we’re likely to see a great deal of innovation, but we will wait and see what these products look like when they come out.
There’s a lot of change in play, and there’s going to be a necessity to update products to reflect the requirements of APRA, but there’s also a range of other legislation that’s coming in this year that’s going to impact product design: unfair contract terms, which starts on 5 April. We’ve got the APRA intervention from October. We’ve also got the design and distribution obligations from October.
So, there’s a lot in play at the moment and how that impacts the way products look in the future, we will just be having to wait and see. There’s a lot of decisions that need to be made by life insurers at this point in time.
Phil Anderson, thank you for your time.
Phil Anderson is the Acting CEO and General Manager – Policy & Professionalism at the Association of Financial Advisers. [ https://www.afa.asn.au/] Phil is an experienced financial services executive with skills in financial advice, regulatory change, risk management, compliance, project management, operations and finance.
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In 2019 what did APRA issue to the life insurance industry:CorrectIncorrect
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According to Phil, new financially sustainable products that replace unsustainable ones, are likely to:CorrectIncorrect
Phil says there is a possibility that level premium policies could one day be:CorrectIncorrect
APRA’s intervention in the life insurance and income protection markets could, says Phil, lead to:CorrectIncorrect