Can individual Income Protection return to profit?

The life insurance industry has been under constant attack for high commissions (Trowbridge report), and adverse consumer experiences with direct sales and poor value products (Royal Commission into Misconduct and ASIC REP 587).  Contrasting these consumer issues, is the poor profitability in many parts of the industry, which is concerning APRA.

Following its thematic review which started back in 2017, APRA has now given notice to all life insurers and reinsurers of its expectations for addressing the sustainability of individual Disability Income Insurance (DII).

APRA is concerned that the industry has failed to design and price sustainable DII products and that this is detrimental to policyholders’ long-term interests.  Graph 1 from APRA shows that in-force portfolios have experienced significant ongoing losses, with no signs of improvement.

Reinsurers were particularly badly affected in 2014 initially masking the position for direct insurers. Now it is evident both groups are struggling with continuing losses.

Graph 1.            Individual DII net profit/loss after tax

APRA has identified four themes where greater attention and action is needed by life companies.

1. Strategy and risk governance

• Formulating and executing a co-ordinated strategy with a clearly defined long-term target state. The Board needs to own and drive that strategy with appropriate level of oversight and challenge.
• Clearly articulating risk appetites that are supported by risk and performance metrics at a product level, in this instance, specifically in relation to individual DII.
• Lifting the capacity and capability of risk functions to provide a sufficient level of oversight and challenge on individual DII associated risk matters.

2. Pricing and product design

• Greater consideration of, and transparency around, risks associated with individual DII related pricing decisions and new product developments.
• Ensuring that product designs adhere robustly to the principles of insurability.

3. Data

• Improving the quality, quantity and timeliness of data.
• Proactively contributing to the industry experience study and collaborating with APRA’s initiatives to consider options to improve the industry experience data.

4. Resourcing

• Proactively ensuring resourcing and skills in key disciplines are adequate for the workload and complexity associated with individual DII business.

Failure to address these action items will risk APRA increasing its supervisory intensity of that life company and it may impose an entity-specific capital charge.

So why hasn’t the industry already fixed this problem?

There are many stakeholders in the value chain for individual DII, including the life insurers, reinsurers, financial advisers, BDMs, rating houses, and the end customer.  All these have some influence in sales and product development.

Advisers are currently bound by the Best Interest Duty which mandates that they advise customers of the product that will be in their best interests, not just good interests. The market has interpreted this to mean that it must be the best product available – and only that.  In the wake of the Royal Commission into Misconduct, we are seeing various legal activity around interpreting this duty and the outcomes of this may have significant follow on impacts.

We have seen high product development over the last ten years, although this has stalled in recent years due to the continuing losses.  Most of the early changes focused on improving benefits, with many ancillary benefits added. Whilst these were thought to represent only a very small proportion of the overall DII claim payout, their second order impact on reducing termination rates was probably not well understood at the time, and the additions were under-priced.

As the individual products are highly complex, rating houses are a necessary part of the process to aid an adviser in comparing product features and premiums. Rice Warner has developed a robust scoring methodology in its Galaxy platform, used by advisers, which aims to accurately weight all terms and conditions, features and price.  Part of this methodology is focused on giving more value to sustainability, meaning in this context maintaining an affordable premium for the customer. This is a challenging endeavour as many features can be contradictory.

For example, is the option to have automatic CPI increases on the sum assured a positive or negative? If the policyholder wants long term cover that increases annually without underwriting it is positive.  On the flip side it is a major cause of unaffordability, especially combined with a stepped premium, and potentially misaligned to needs that generally decrease as a customer moves into their 50s.  It may therefore be argued to be a negative score for sustainability for the customer.

Rating houses must assume that the products on sale have been appropriately priced by providers. Whilst we can give weightings to guarantee periods, typically these are only offered for the first few years, and the vast majority of individual DII is sold as a long-term solution for a customer.  The responsibility for only offering a sustainable and appropriately designed and priced product lies absolutely with the insurer (and its reinsurer).

No overnight improvements

Whilst it is critical for insurers and reinsurers to cease writing unprofitable new business, it is important to realise that there are few short-term improvements likely.  For insurers with established back-books, the unprofitable in-force policies will dominate the Profit & Loss outcomes for the next ten years, until the profitable new business sufficiently grows in relative size.

Which leaves the key question as to what can be done with the back-book. A 2017 Rice Warner survey into retail insurance found that in force DII policyholders have been hit with over 30% premium increases over the last ten years. These individuals have been increased too much, and yet the new premiums are still not enough to cover the emerging claims costs. Selective lapsing is notoriously difficult to identify but surely must be already happening, contributing to the worsening claims for closed books. These lessons must be fed through into the new pricing assumptions to ensure this does not become an on-going cycle.

Is there an opportunity for a life company to break from the pack and offer a different product?

The time for innovation has arrived – doing nothing simply locks in further losses and closer APRA attention.