November 27, 2019
Riskinfo thanks ClearView Wealth and its MD Simon Swanson for permission to reproduce an open letter penned by Simon to the adviser community.
Simon questions the merits of introductory premium discounts on new business cases and reflects on what he sees as an industry struggling under the shadow cast by unsustainable product pricing, especially in relation to income protection insurance, and what action needs to be taken – both by ClearView and also by the broader industry – to address this critical issue…
Introductory discounts? Not at ClearView
Those of you who know me know I prefer to talk about growth opportunities to take ClearView forward and see more Australians get professional advice. However, the Australian life insurance industry is currently grappling with a myriad of challenges that need urgent attention including:
- Record losses
- Rising premiums
- Soaring Income Protection (IP) claims
- Subdued new business and poor customer retention
- Prolonged, ultra-low interest rates
The convergence of these issues, against the backdrop of unprecedented regulatory and structural change, saw the retail life insurance industry record a loss of $417.9 million for the year to 30 June 2019, especially dragged down by loses on IP.
It is clear that the industry must rethink the design and pricing of IP
While the retail lump sum risk market reported a profit of $739.2 million, the IP portfolio lost $1.1 billion.
It is clear that the industry must rethink the design and pricing of IP.
ClearView has been trying to raise awareness of this issue for some time.
Even before the Australian Prudential and Regulation Authority (APRA) called on the industry in May 2019 to address its concerns about the sustainability of IP insurance, ClearView urged participants to explore opportunities for better management using data integrity, reinsurance and reserving.
The paper, Income Protection and the economic cycle by ClearView’s Greg Martin – released in early 2019 – detailed the drivers of IP profit decline and provided a fresh perspective on income replacement ratios.
Recently, I have been approached by a number of advisers to outline key industry trends, particularly in IP, and the potential client impact. This note aims to do just that. It is quite long, but I hope you will spend a few minutes reading until the end to the get a better understanding of this complex and important matter.
Why are IP premiums going up?
At a high level, premiums are increasing because the cost of IP claims are rising, and the industry is losing money on this product.
Over the past five years, the industry has collectively lost $2.5 billion through this product with no signs of improvement1.
As an insurer, ClearView exists to pay claims and meet our obligations to customers. Every ClearView LifeSolutions policy is backed by our ‘Guarantee of Claims Accountability’ which is our promise to be fair and transparent in paying claims.
However, the increasing volume and value of IP claims being paid across the industry is unsustainable.
This problem is compounded because insurers are also earning less from their capital and policy reserves due to record low interest rates.
In the same way retail investors aren’t being adequately compensated for their deposits, most insurers are experiencing depressed returns because their capital is primarily invested in defensive assets like cash and fixed income.
Attempting to boost investment returns by going up the risk spectrum requires both additional capital and speculation (or a crystal ball).
APRA requires insurers to hold even more capital the more aggressive their asset allocation.
the increasing volume and value of IP claims being paid across the industry is unsustainable
How did the industry get the design of IP so wrong?
Accurately pricing any product is challenging but life insurance is particularly difficult because life insurance companies need to price the risk for individuals whose circumstances (e.g. occupation, health) evolve over time but we can’t simply rerate them or take their cover away.
A life insurer has future claims liabilities stretching out many years into the future, through economic cycles and a changing world which they need to estimate today. They also need to hold large amounts of capital to cover the range of variability in their future liabilities, which comes at a significant opportunity cost.
There are many variables to consider including interest rates, investment returns, lapse rates and factors impacting claims like medical developments, economic conditions and mental health trends. Most of these have been trending unfavourably for life insurers over recent years. Some were unforeseeable even a few years ago.
However, more importantly in ClearView’s opinion, the industry has gradually drifted from the foundational principle of insurable interest. This is the notion that insurance should, at most, put a person or household back in a similar financial position had an accident, injury or death not occurred. But not put them in a better position.
Current product designs and insured amounts have enabled some claimants to ‘profit’ from insurance with terms becoming overly generous. Overly generous benefits compound the effects of the other unfavourable trends noted above to lead to escalating claims costs and a now unsustainable situation.
the industry has gradually drifted from the foundational principle of insurable interest
Already, we are seeing IP premium increases of 12-17% per annum across the industry.
Without a circuit breaker, it is estimated that IP premiums across the industry need to increase by 40-75% to breakeven from where we are today. That said, given the underlying trends, this would unlikely be the end of the claims and price spiral.
As such, premium affordability is fast becoming a major issue, evidenced by:
- Weak new business sales
- High lapse rates
- Advisers spending more time convincing clients to maintain cover
It is estimated that new life insurance sales could drop to just $300-$400 million in 2019/20, due to poor consumer sentiment, the decreasing number of specialist life advisers and other changes to the adviser landscape.
Many insurers are choosing to ignore the facts.
Not only are they continuing to sell IP at premiums that lose money, some are offering substantial first year premium discounts.
This is a dangerous, short-sighted strategy because once the honeymoon period is over (and for first year discounts that is just one year), customers are inevitably hit with steep premium increases, particularly for IP.
Many won’t retain the valuable cover when they need it the most, leaving themselves and their families exposed. Also, life insurance can’t simply be cancelled and reinstated at a later date without penalty or risk.
Key problems with short-term discounting
Life insurance isn’t designed to go on sale like consumer goods and commodities.
Introductory deals and clearance offers may have short term appeal, but consumers ultimately expect broad terms and benefits, steady premiums and claim entitlements paid as quickly as possible from insurers.
For advisers, short-term discounting makes it difficult to identify products that represent long-term value.
There is now a situation where the cheapest insurer in Year 1 could easily end up being the most expensive in Year 4. This makes the standard practice of comparing insurers based on Year 1 premium a misleading and futile exercise. It also exposes advisers to client complaints, commission clawbacks and potential regulatory action for inappropriate advice.
The chart below ranks ten insurance companies based on Year 1 premium from cheapest to most expensive for $500,000 of Life and TPD cover for a 45-year-old, non-smoking male, as at 31 October 2019.
Based on Year 1 premium alone, advisers could reasonably recommend Insurer 1. However, over a five-year period, Insurer 1 is among the most expensive.
Recently, Insurer 8 announced a significant introductory discount for new customers. This offer catapults them to first place for cheapest Year 1 premium but the premium increase at first renewal is estimated to be around 50%.
By comparison, most premium increases are around 12% per annum over a five-year projection or 14% including CPI indexation at circa 2% per annum.
An adviser who recommended Insurer 8 to a price-conscious client could struggle to get that client to maintain cover beyond Year 2 and risk a 60% clawback of their initial advice fee.
That loss of income would have a double-whammy effect given advisers already subsidise the cost of short-term discounts in the form of lower upfront commission earned.
There are profound ramifications for advice businesses given the maximum Year 1 commission rate will reduce to 60% from 1 January 2020.
ClearView is unapologetic about not offering first year discounts to new customers.
Our goal is not to grow market share at any cost.
Our focus is on providing exceptional service and value to all your customers. We want to be around for a really long time to meet our commitments to customers and advisers.
First year discounts don’t make economic sense. Philosophically, they don’t align with our view that customer loyalty should be rewarded.
ClearView has maintained LifeSolutions as one product series.
ClearView has not opened and closed product series to lock unsuspecting customers into outdated definitions and terms.
We are passionate about offering all our customers fair terms and rates.
We are also committed to working with APRA, other life companies and the broader industry to address the industry’s problems.
In the near term, APRA is expected to announce an intervention that will likely affect all APRA-regulated life insurers selling IP.
Currently, we are reviewing the design and pricing of ClearView LifeSolutions and assessing the viability and interest in a ‘slimmed-down’ and hopefully more sustainable IP product.
I look forward to keeping you informed on our progress so you can confidently talk to your clients about all that ClearView is doing to keep premium rates stable and secure a vibrant, sustainable future for our industry.
Simon Swanson is Managing Director, ClearView Wealth Limited.