Posted: 16 Oct. 2020 05 min. read

Disability Income Insurance & the Future of Life Insurance

APRA’s thematic review of individual disability income insurance is driving product change into the industry – but is this enough? This introductory blog is the starting point for our discussion of the future of life insurance in Australia.

Individual Disability Income Insurance (IDII), otherwise known as Income Protection (IP) is a core product included in Australian life insurance offerings – and is often bundled together with other products. IDII generates around AUD$4.2bn[1] in gross revenue annually – but has also generated AUD$3.1bn[2]  in losses over the past five years.

Life companies have continued to report losses on IDII since 2008 – as APRA began to report IDII results as a separate product line. These losses were despite life insurance companies’ preventative measures in re-pricing and other risk management initiatives and have contributed substantially to the reduction in the overall profitability of the sector.

Source: APRA Quarterly Statistics as at 30 June 2020[3]

These continued losses throughout the decade reflect that a radical change must occur in life companies and the product.

Thus, due to serious concerns about the product’s sustainability and a threat to the overall stability of the life insurance industry, the product has received increasing scrutiny from insurers and regulators.

Challenges faced by life insurers

IDII providers have been stuck in this loss-making environment for a variety of intertwined and well-known reasons – e.g. by entering into a product features arms race[4], grading of products from rating houses being used in the sales process as a proxy for an assessment of the “best interests” of the policyholder and increasing mental health insurance claims.

So, given that insurers and regulator were already aware of these problems, why hadn’t they made any changes to their products? The main concern appears to be the potential first-mover disadvantages of replacing their current IDII products with a sustainable version. 

What has APRA done?

APRA conducted a thematic review of IDII and, in May 2019, issued an industry letter stating that insurers should focus on four areas – strategy and risk governance, pricing and product design, data, and resourcing.

With the industry making over AUD 1 billion in losses from January to September 2019, APRA intervened again in December 2019. In this letter to the industry, APRA imposed an additional capital requirement (delayed to 1 October 2020 due to COVID-19), suggested clear changes to “riskier product features” and set out its expectations for an industry-wide improvement in data.

APRA has just released its “Final individual disability income insurance sustainability measures”[5] on 30 September 2020, which covered three key areas:

  • Consequence management: the supervisory adjustment was confirmed to be applied from 1 October 2020; the amount of additional capital for each company was communicated in late 2019. The capital adjustment will be increased or decreased based on APRA’s assessment of each company’s progress in addressing these issues.
  • Product features: APRA summarised the feedback received and its final measures:
    • Agreed value: insurers are required to have ceased sales of these products since 31 March 2020.
    • Income at risk: product benefits must better reflect the claimant’s income at the time of claim.
    • Replacement ratio: is limited to a maximum of 90% of income at risk for the first 6 months of benefits, and 70% thereafter. Indexation is limited to inflation rates, and there is an allowance for superannuation contributions into a super fund. Recognising the importance of rehabilitation and retraining, these costs are allowed in addition but must be paid directly to the providers (and with regard to regulations).
    • Contract terms: are limited to 5 years with provisions being made for the policyholder to enter a new contract (based on updated T&Cs) at that time with no medical review but allowing for changes in occupation, financial circumstances and dangerous hobbies.
    • Benefit term: no limits to benefit terms are imposed but companies must set benchmarks and have effective controls to manage the risks from longer benefit terms.
  • Data: finally, APRA re-iterated the importance of timely and detailed data being available for both individual companies to understand their experience and risks, and also for APRA and industry experience studies.

APRA finished this letter by noting that the principles should also be applied to all life insurance products as these issues were not limited to IDII and stated that the “onus is now on individual life companies, and the industry collectively, to move IDII to a sustainable state and thereby deliver better outcomes for policyholders.

How has the actuarial community responded?

On 25 September, the Actuaries Institute released[6] its Disability Income Taskforce’s provisional findings and recommendations[7], a sustainability guide[8] and an IDII reference product[9] for consultation. The Taskforce made 45 recommendations across all aspects of the insurance system – community interests, customers, the market, governance, regulations, financial advice, underwriting, claims management, risk management and the professional responsibilities of all actuaries.

The taskforce’s Reference Product Individual Disability Income Insurance” (for consultation) was designed for stakeholders to use when considering their own IDII products. This is not intended to be a standardised product that insurers should offer; rather it provides a reference against which a company’s specific design and terms and conditions should be considered in terms of management of risk and sustainability of the product terms and pricing.

Finally, the Taskforce also released a framework for measuring and governing the sustainability of insurer’s IDII products (again, for consultation).

We would encourage all interested parties to respond to these consultations to ensure their views are reflected in the final papers.

Where to from here?

Currently, life insurers are bleeding from the IDII product and most have started to respond to APRA’s final sustainability measures. The perceived first-mover disadvantage is disappearing and in fact, the last mover disadvantage may emerge for those offering less sustainable products.

The solution is complex and requires life companies to create and price simpler IDII products and devise a strategy to transition inforce business to these new products. It is also clear that insurers will also need to enhance the services they offer (e.g. claims management, wellness initiatives, early intervention, rehabilitation programs etc.), and review all products (not just IDII).

Disability Income Insurance has a valuable product role in meeting consumer needs to protect against key risks. It is clear there is a role for all of us in the insurance industry to drive the changes that are required to continue to be able to offer this, and all life insurance products, sustainably – indeed, with almost 30%[10] of revenue being generated by IDII, the very survival of our industry may be dependent on our efforts.

Stay tuned for Deloitte’s upcoming blog posts and our insights into the life insurance industry.

References:

[1] APRA Quarterly Statistics as at 30 June 2020, Table 3a - Product group performance - total statutory fund

[2] APRA Quarterly Statistics as at 30 June 2020, Table 3a - Product group performance - total statutory fund

[3] APRA Quarterly Statistics as at 30 June 2020, Quarterly life insurance performance statistics - highlights

[4] As quoted in http://news.munichre.com/imgproxy/cont/686017347/

[5] See https://www.apra.gov.au/final-individual-disability-income-insurance-sustainability-measures

[6] See https://actuaries.asn.au/Library/MediaRelease/2020/MediaReleaseIDIITaskforceReport250920Final.pdf

[7] https://www.actuaries.asn.au/Library/Reports/2020/IDIIDocumentA.pdf

[8] https://www.actuaries.asn.au/Library/Reports/2020/IDIIDocumentB.pdf

[9] https://www.actuaries.asn.au/Library/Reports/2020/IDIIDocumentC.pdf

[10] APRA Quarterly Statistics as at 30 June 2020, Table 3c - Product group performance - class of business - ordinary business

More about our authors

Raymond Bennett

Raymond Bennett

Principal, Consulting

Raymond is an Actuary with over 20 years of experience, primarily working as a consultant. He enjoys the variety and challenge of helping clients tackle business issues using his actuarial background. His experience covers M&A due diligence, Solvency II, capital, financial reporting, risk management and actuarial modelling. He has worked in Australia, South Africa, the UK and South East Asia. Raymond is active in the actuarial industry and in the Actuaries Institute in Australia (organising committee for Financial Services Forum 2018, IFRS17 working groups and assignment writing for life subjects). Raymond also "virtually lectures" on the Institute and Faculties' online Professionalism Course. Previously he was a member of the Institute and Faculties' Financial Reporting Group, primarily analysing developments in IFRS 4 Phase 2 (now IFRS 17) and also had active roles in the Actuarial Society of South Africa.

Alan Merten

Alan Merten

Partner, Consulting

Alan is a Financial Services Partner and part of the Actuaries & Consultants group.  With a background including corporate general management roles in financial services in various countries, he leads multi-disciplinary teams to help clients improve performance of their businesses.  His main area of focus is life insurance and his 30 years’ experience in broader financial services includes leading or consulting on the full value chain from customer and distribution, through to product and operations as well as the financial aspects of running businesses.