Has APRA’s tough move on agreed value DII changed the game for good?

For almost A decade the Australian Prudential Regulation Authority (APRA) was signaling to Australia’s major life/risk insurers that disability insurance income (DII) insurance products had become a problem and that they would need to act.

The insurers, variously and severally, acknowledged those problems but apart from seeking to raise premiums and to change the wording of policy documents, they did not act to face up to the problem. Thus, for six years from 2014 to the end of 2019, DII remained alarmingly unprofitable.

The problems had nothing to do with the practices or risk advisers or even market demand. It had a little to do with changing social norms and tighter economic circumstances but, bluntly, it mostly had everything to do with the strategies of the major life companies themselves and their preparedness to use DII to gain market share.

When APRA finally and decisively moved on the issue in December, last year, APRA commissioner and former insurance company executive, Geoff Summerhayes, summed it up succinctly stating: “In a drive for market share, life companies have been keeping premiums at unsustainably low levels, and designing policies with excessively generous features and terms that, in some cases, provide a financial disincentive for policyholders to return to work.

In the barely three months which have passed since Summerhayes laid down the law on behalf of APRA, signalling an end to the sale of fixed value policies, few of the participants in the life insurance industry have seen fit to question the regulator’s rationale.

From some of the most experienced dealer group executives in the life/risk space, to life insurance consumer advocate, Col Fullagar and ClearView chief executive, Simon Swanson, all agree that the situation around DII had become unsustainable and that APRA was right to act.

As Fullagar makes clear in a column elsewhere in this edition of Money Management, it was better that the regulator acted to ensure continued access to disability insurance than for it to be lost to advisers and consumers entirely.

“DII has protected countless Australians and their families since its genesis more than 50 years ago,” he said. “It would be an unimaginable tragedy if access to it was lost.”

One of the principals of risk-focused dealer group, Synchron, Don Trapnell acknowledges that what APRA’s move on agreed value DII has done is disrupt the market and created some headaches for advisers, but he argues it was made necessary by the past actions of the insurers.

“It was about time it happened,” he said. “Agreed value disability insurance was no longer a supportable product and unless APRA stopped the arrangements we would have had a problem.”

Trapnell also suggests that, perhaps, APRA should not have stopped at DII and that it might also have looked at trauma insurance.

“We also need to look at trauma insurance. It is under-priced and unless insurance companies do something, it will become a problem as well,” he said. “The problem with agreed value disability insurance is that you can only run something as a loss-leader for so long.”

ClearView was one of the first of the insurers to announce that, in compliance with APRA’s December edict, it would be ceasing offering agreed value DII on 1 April, this year.

However, as Trapnell made clear, the relative absence of legacy business within ClearView made the company’s action on the issue far less difficult than was the case for other insurers with major legacy issues such as AMP and TAL.

ClearView’s Swanson has little hesitation in declaring that the company was and is supportive of the APRA move, agreeing that the situation around DII had become unsustainable.

This is hardly surprising on the part of the ClearView boss in circumstances where the company in January, 2019, issued a white paper examining the sector and highlighting its problems, noting that “retail income protection profit margins have been on a steady decline for roughly a decade.

The white paper included a chart which showed the annual industry profit margins (pre-tax) for Retail Income Protection (also known as Disability Income) over 12-month rolling periods; showing substantial losses in the last five years.

In doing so, the ClearView white paper also cited, point by point, the reasons for the problems.

“Examples of design features that have contributed to rising claims costs include:

• The 10 hour or 20% income rule, where policyholders can work up to 10 hours per week or generate 20% of their usual income with no reduction in benefit payable. This is even more prevalent in the case of part-time workers where reduced thresholds apply;
• The one duty rule which says that the life insured is considered to be disabled where they are unable to perform at least one major income producing duty of their occupation. Alternatives include expanding the stipulation to where one or more duties of a person’s regular occupation can’t be performed and they are under the care of a medical practitioner; 
• Generous built-in benefits such as the ability for policyholders to work for a certain timeframe during the waiting period; day one accident options; and more flexible claims options. Day one individuals to receive income protection payments immediately, rather than after a defined waiting period, if the life insured suffers disability due to an injury;
• The occupational drift phenomenon, whereby policyholders change their mode of employment after policy inception. For example, shifting from desk-based to manual work. The rise of the gig economy could be implicated here; and
• There has been a move towards a three-tier approach to disability definitions which has now been largely endorsed by providers.

The bottom line according to Swanson in 2020 is that both premiums and terms will have to change, and that is what will be happening at ClearView and doubtless with respect to the other major insurers.

Precisely how insurers intend to move has been made clear by MLC Life in its messaging to advisers being that there are timeframes within which they can operate with respect to agree value policies, even extending to the end of the financial year.

MLC told advisers that the last day for Agreed Value Income Protection digital quotes and applications would be 19 March, 2020, with the last day for paper applications to be submitted and received being 30 April, 2020, where the application was signed and dated on or before 31 March, 2020.

“For transition customers who submit their application to us before the above submission dates, APRA will allow us to finalise the assessment and issue the Agree Value insurance up until 30 June, 2020.”

What is clear is that APRA will be closely monitoring the process, and this raises questions about just how lenient the regulator will be with respect to any rush by advisers to push through agreed value policies before the regulator’s deadline.

Synchron’s Trapnell questions whether pushing to close agreed value business ahead of the deadline will ultimately prove to be wise.

APRA’s determination on the issue was underlined by Summerhayes in December when he acknowledged the importance of DII in terms of providing replacement income to policyholders when they were unable to work due to illness or injury. 

“In a drive for market share, life companies have been keeping premiums at unsustainably low levels, and designing policies with excessively generous features and terms that, in some cases, provide a financial disincentive for policyholders to return to work.

“Insurers know what the problems are, but the fear of first-mover disadvantage has proven to be an insurmountable barrier to them making the necessary changes. By introducing this package of measures, APRA is forcing the industry to better manage the risks associated with DII and to address unsustainable product design features – or face additional financial penalties.”

APRA’s statement said that, to underline the urgency of the situation, it had decided to impose an upfront capital requirement on all individual DII providers, effective from 31 March, 2020.

“The capital requirement will remain in place until individual insurers can demonstrate they have taken adequate and timely steps to address APRA’s sustainability concerns. In instances where individual insurers continue to fail to meet APRA’s expectations, APRA may also issue directions or make changes to licence conditions.

“APRA also expects life companies to better manage riskier product features, including by: 

• Ensuring DII benefits do not exceed the policyholder’s income at the time of claim, and ceasing the sale of Agreed Value policies;
• Avoiding offering DII policies with fixed terms and conditions of more than five years; andEnsuring effective controls are in place to manage the risks associated with longer benefit periods.

In other words, life/risk insurers are on notice and have little room to manoeuvre.

What drove the APRA decision was the data, exemplified by the regulator’s most recent report.

It stated that, for the 12 months to September 2019, risk products reported a combine after-tax loss of $417 million, a significant reduction from the $654 million profit for the previous 12 months. 

Individual Lump Sum remained largely the same pre-tax while other risk products deteriorated, particularly Individual Disability Income primarily driven by loss recognition as adverse claims experience persists.