APRA's Income Protection intervention - what does it mean for pricing?

Recent and significant regulatory changes within the Australian life insurance industry have left incumbent insurers scrambling to adjust their products and pricing on a very tight schedule. With a certainty of increased regulatory oversight from The Australian Prudential Regulation Authority (APRA), life insurers have a lot to consider as they tread carefully and quickly to comply with a number of new requirements.

Insurance pricing expert and actuary Matt Ralph digs into the heart of what’s at stake behind APRA’s recent requirements for Australian life insurers, their customers, and their position in the market.

Background to APRA’s IP intervention

Over the past several years, the Australian life insurance industry incurred billions in individual income protection (IP) insurance losses. The industry’s inability to stem these losses, despite significant price rises, reached a head in 2019.
Many theories as to the underlying causes have been presented, including uninsurable product designs, hyper-competitiveness, poor claims management and underwriting, overly generous benefits, underpricing, and more. The hard reality is, whatever the underlying causes, the industry now finds itself in an incredibly difficult and delicate situation.

Due to spiralling losses and mounting concern about the sustainability of the system, The Australian Prudential Regulation Authority (APRA) commenced a review of the IP market in 2018. The regulator consulted reinsurers, insurers, and additional stakeholders in an attempt to understand the underlying issues and determine if any action should be taken. Ultimately, the answer was yes.

APRA addressed the life insurance industry in May 2019, outlining several concerns, demanding action from insurers, and suggesting regulatory intervention may be needed if there wasn’t rapid progress. The market’s expectation was that intervention was likely but would be limited to APRA imposing additional capital requirements, but ultimately that wasn’t the case.  

APRA wrote again in December 2019, criticising the industry for its lack of progress and detailing interventions that, in addition to the anticipated capital charge, included several new requirements in relation to product design.

Product Design Impacts of APRA’s Intervention

APRA proposed a number of requirements it plans to enforce (noting it has asked for industry feedback on these proposals prior to finalising the details):

From 31 March 2020

Insurers are expected to cease offering Agreed Value policies, meaning benefits can’t be locked in at policy inception and must take into account income in the period prior to the claim.

In its simplest form, this requirement means insurers must stop allowing agreed value policies to be sold - they will already have an alternative indemnity-style product in the market that meets APRA’s requirements.  However, this proposal probably has additional implications for insurers, including providing an alternative that best meets the needs of customers who previously would have opted for an agreed value policy and advisers who have built their risk proposition around agreed value.

When a typical product launch timeframe is 12 months or more, the March deadline to comply with this requirement is incredibly tight, leaving insurers unable to focus on much else.

From 1 July 2021

Insurers are expected to further limit the claim amount to being based only on earnings in the 12 months prior to the claim. The replacement ratio must be restricted to 100% of pre-claim earnings for the first six months of the claim and the lesser of 75% of pre-claim earnings and $30k p.m. thereafter. 

If not already addressed in March 2020, this will require further adjustments to the on-sale indemnity-style IP product, as well as to claim processes, which are already notorious for the difficulty in determining entitlements and will now also have a regulated maximum.

Insurers are also expected to only offer new policies that allow terms and conditions, as well as non-medical underwriting, to be reviewed every five years. At each review, the insurer must only offer the same terms and conditions as its current new business product. 

This removes the standard guarantee that customers can keep renewing their policy until retirement on the original terms and conditions - with only price being reviewable by the insurer. It creates a number of legal, practical and philosophical challenges for insurers, who must now pass back any changes in T&Cs to their existing customers within five years. Insurers will need to take into account the likely lapse impact of these reviews when determining what changes to make to their on-sale product. Additionally, they will need new processes in place to ensure T&C changes are properly communicated and implemented.

Insurers offering long benefit periods (i.e. products which allow benefits to be paid for over five years) are expected to have additional controls and performance metrics in place.

APRA stopped short of mandating what these additional controls and metrics might be, but insurers should anticipate the regulator to monitor long benefit period products very closely and to use its new capital charge or other interventions to force change if insurers fail to respond appropriately.

Pricing decisions

Pricing implications for new contracts

APRA’s interventions do not specifically address IP premium rates. However, it has clearly outlined that pricing of Income Protection is a concern, saying that “the industry’s ongoing failure to design, price and manage IDII in an appropriate manner has resulted in material losses” and that “life companies have been keeping premiums at unsustainably low levels”. APRA will be monitoring insurers’ pricing responses - pricing teams, actuaries and insurance executives will know if they don’t get it right this time they face the potential of further regulatory intervention in future.

Pricing teams’ immediate focus will be new indemnity policies sold from 31 March 2020.  At a minimum, they need to take into account the additional capital charge imposed by APRA and any anticipated change in claims cost due to the change in customer mix within indemnity products. They’ll also want to second guess their competitors’ pricing in order to position themselves appropriately. 

With limited data to draw on to better understand the claims impact, and an obvious lack of competitor information, pricing teams will be hard pressed to finalise their position by March, especially given the extended lead times required by some insurers’ admin systems to implement any price changes.

One thing that is certain is this: once claims and market information begins flowing from April 2020, insurers who are monitoring closely will find their initial pricing assumptions were wrong.

Managing this uncertainty will be difficult. The traditional approach of thorough but infrequent reviews in an attempt to get pricing ‘right’ will be challenged. Successful insurers will adopt approaches that allow them to monitor all sources of information, learn from mistakes, and adjust pricing quickly. Apart from being important in the current IP context, these more nimble approaches offer long-term benefits for the industry.

The further changes to product design mandated from July 2021 will bring two additional pricing challenges:

  1. The anticipated lower replacement ratios will impact claims cost. Insurers will either price this from day one in anticipation of a reduction in costs, or wait for new information to emerge before adjusting. Both strategies present risks; early movers may overestimate the impact and find themselves underpriced, whilst waiters risk losing market sentiment and finding themselves rebuilding once they do make changes.
  1. The removal of guaranteed terms and conditions presents another pricing challenge. The existing guarantee has typically been priced implicitly, with no specific allowance being made.  Consumers and advisers will expect a lower cost for a non-guaranteed product, but without an explicit allowance it is hard to know what this adjustment should be. Understanding the cost of guarantees is tricky and doesn’t lend itself to life insurance actuaries’ typical approaches, so this is an opportunity for the profession to implement better practices.   

Insurers pricing these new reviewable contracts will also be concerned that future changes to policy conditions may lead to higher lapses, with the five-yearly review providing a natural trigger point for customers to review alternative options or whether cover is even necessary.  These additional lapses are likely to be selective - with healthier customers either seeking a better value new business policy or cancelling their cover altogether, whilst customers with health conditions stay put to avoid underwriting with an alternative insurer.

Selective lapsation is not well understood by insurers and their actuaries, and has often been dealt with superficially.  This lack of understanding may even be one of the roots of the IP problem, with experience deterioration being countered with price increases which, for selective reasons, end up not delivering the expected value. The reviewability of new contracts, and closer regulator oversight, may force insurers to be more deliberate when allowing for selective impacts in their valuations and pricing.

Competitive Positioning

Some insurers already have a strong focus on the competitive position of their new business policies. They use this information to manage growth and make informed choices about volume versus margin tradeoffs.

As insurers update their products in March 2020, and again in July 2021, competitive information will be more limited and only available after launch. Even then, the pricing upheaval these new products will generate may render competitive data irrelevant very quickly, making it harder for insurers to target a particular position in the market. Old assumptions about the impact of competitive position on volume may be upended, with completely different customer dynamics potentially entering the market.  

Insurers must find ways to efficiently track competitive data in real time, form and update their assumptions about the impact their position has on their sales, and feed this information back into the pricing process.

Repricing of new business

Beginning in 2020, insurers will experience increased uncertainty in their new business pricing.  Product changes will lead to uncertain claims impacts. Changes in customer and adviser behaviour will lead to unpredictable and selective lapses. Competitive data will be unavailable in advance of a product update and likely to change more frequently after it. The interplay of all these factors won’t necessarily align to current assumptions. At the same time, APRA has told the industry that it expects life companies to set pricing assumptions based on the most recent experience.

As a result, insurers continuing the current approach of long pricing cycles informed by highly complicated analysis and based on well-worn assumptions risk not meeting the requirements of APRA and are likely to fall behind insurers who iterate their pricing quickly as more information comes to hand. In a chaotic market, failure to act will cost insurers dearly, and those who misestimate claims costs or competitive positioning may see a whole year’s results undone before they can rectify the situation. Rapid pricing cycles are commonplace overseas and ambitious insurers in Australia need to do the same.

In a scenario where the market has significantly underestimated the cost of claims for new IP contracts, insurers who can increase their pricing quickly can cut their losses (albeit with lower volumes) and wait for the market to follow suit, then build market share once others catch up.  Slower insurers will see their market share spike at exactly the wrong moment and once they reprice, see their share fall behind their more nimble competitors - at the same time as trying to manage an unprofitable back book and deal with a dissatisfied prudential regulator.

Pricing impacts for existing contracts

Whilst insurers address the pricing of new contracts directly impacted by APRA’s intervention, they must also consider the indirect impact on current policies, where customers retain their existing rights indefinitely.

Many existing customers will feel their current terms and conditions are too good to give up (especially once new contract terms are limited to five years) and will effectively be locked into their existing contracts, reducing lapse rates. While this may superficially seem like a good outcome for incumbent insurers, this may not be the case. Rather, it’s reminiscent of the ‘lifetime benefit’ IP policies, now unavailable in the market, where higher retention simply led to greater financial losses. For insurers, this caused a spiral of increasing premiums, selective lapses, and even higher claims. Avoiding a similar impact for old-style IP policies should be a top priority.

Relative Pricing of New Business and In Force

For insurers who have a material book of in-force business and are also seeking to grow their new business sales, an important question will be how their on-sale prices stack up against the current premiums of their existing customers. Many admit their current product is underpriced, yet need to price the revised product sustainably and attractively. Getting this right is central to retaining healthy customers, reversing losses, and maintaining the inflow of lives to the book.

Some insurers will favour maintaining as many customers as possible in the current product, whilst others will favor customers transferring to the new offer, and will price the back book and front book accordingly. Advisers will have a big role to play in forming a view on how they satisfy their best interest duties, and how they factor in differences in features and price. For those customers who do decide to change products, competitor pricing will be a big factor.

How can Montoux help?

Montoux is the global leader in pricing transformation for life insurers. Operating in numerous markets around the world, and working with six of Australia’s largest life insurers, we have a deep understanding of how pricing impacts business processes and performance in the market.

One of the keys to success in a volatile market will be the ability of an insurer to rapidly review, refine and update their IP pricing, taking into account the latest available information.  Our expertise in life insurance pricing development means Montoux is ideally placed to help insurers achieve this and address the pricing complexities that will dominate the life insurance market in the coming years.  

Insurers who are able to rapidly reprice can

  • respond to underestimated claims costs - reducing the chance of making losses by up to 25% over the first three years of the new regime;
  • respond to overestimated claims costs - achieving up to 30% greater sales volume over the first three years whilst achieving target profitability;
  • manage profitability in a volatile claims environment - making them more likely to achieve market-leading growth, stable profits and preferred market position;
  • maintain market position and achieve sales targets in a stable but competitive market 

Actuarial analysis

Montoux’s actuarial tools and capability can help you understand the possible financial implications of the capital charge, business mix changes, selective lapsation, the five year limit on contract terms, and possible changes in competitor, adviser and customer behaviour - and quickly develop your strategy for dealing with them.

Competitive positioning

Montoux’s Customer Analytics module is there to help you visualise and make sense of changes in market pricing as soon as the information becomes available. We make it easy to answer competitive positioning questions like where are we now, where would we be if we were to make these changes, and what would happen if our competitors move.

Price sensitivity

Using existing knowledge about how new business and lapse volumes depend on price, we can help you understand the potential impact you and your competitors’ pricing strategy have on your business - and quickly refine these forecasts as more market intelligence becomes available.

Price optimisation

With knowledge of your competitive position, price sensitivity, and actuarial modelling of the impact price has on your business, you can harness the full power of Montoux to consider the full range of possible pricing strategies to find the one that maximises your chances of success in a volatile market.

This allows you to answer questions about how to position the rates for your new IP product as well as your in-force book to deliver on your strategy and maximise sustainable growth as well as quickly update these answers as you learn more about the market.

If you would like to chat further about how Montoux might be able to help your business to deal with APRA's Income Protection intervention;
Please contact Matt Ralph, directly:
Phone: +61 410655916
Email: matt.ralph@montoux.com