Readers may recall that our final Life Insurance Bulletin for 2020 shone a light on a report from the Actuaries Institute Disability Insurance Taskforce which focused on the long term sustainability of disability insurance, particularly individual disability income insurance (IDII) product offerings in both the retail and group space, which continues to be of significant concern within the industry.

The AI Taskforce report effectively echoed APRA’s previously held concerns in relation to IDII and its long term sustainability. According to APRA, the long term viability of IDII in the absence of critical reform or substantial intervention, is bleak and ‘at risk of failure’. Indeed, APRA noted in its letter to life insurers on 30 September 2020 that the ‘industry cannot afford further delays in taking decisive action.’ ¹ APRA’s message therefore was simple: IDII is in desperate need of a reset. Things must change if life insurers are going to be in a position to offer a manageable and profitable IDII cover long into the future. It has been APRA’s desire for life insurers to have ‘appropriate mechanisms to keep products in step with changing external and consumer circumstances,’ with the aim of arresting unsustainable losses year on year.

Central to the AI Taskforce report was the issue of ‘product design’, suggesting practical improvements for the industry to adopt with respect to its product offerings going forward. Among other things, the report highlighted the long-term nature of IDII cover (whether that be group or retail) where substantial monthly benefits are often paid on the back of increasingly generous policy terms (where claimants need only satisfy ‘any one income producing duty’ total disability definitions) for years on end. Put simply, claimants can easily find themselves on claim long into the future and in many cases, decades after the commencement of the claim.

To provide some context, this has been the result of somewhat of an arms race which has snowballed to the point where IDII products are now considered so complex and ‘too feature heavy’ that they have gradually strayed from attending to the customers ‘core’ disability insurance needs. Certainly, the sale of life insurance has become increasingly steeped in distribution targets, aimed at ‘optimising the advice/sales process’ which has meant that for many life insurers, in order to compete in the market, providing various ‘add-ons’ or extra features into their product design has become par for the course.

Be that as it may, the unintended consequences of this long term IDII cover is that claimants will have very little, if any, incentive to return to work. As we all know, this has long been identified as a problem, with the NSWSC noting more than a decade ago that IDII policies designed in this way, will result in a ‘disincentive to work’ unless the benefits of so doing ‘are that good that they outweigh the benefits which would be received whilst the insured remained idle’.² 

In an effort to reign in the long-term nature of IDII, the AI Taskforce referenced ‘APRA’s 2019 proposal to have 5-year contracts with guaranteed renewability on updated terms’, otherwise known as the ‘Contract Term Measure’, which reportedly resonated with many Taskforce interviewees.³ APRA’s expectation was that life insurers ‘have a framework to periodically update policy contract terms, while ensuring policyholders’ insurability rights are maintained; and manage their exposure to long benefit periods and have effective controls to manage the associated risks’.⁴ 

Understandably, such sweeping product design changes attracted some concerns within the industry, particularly around the renewal process in respect of the Contract Term Measure and the disclosure/underwriting challenges that naturally follow as a consequence. Indeed, APRA has observed that up to this point, ‘the fear of first-mover disadvantage has proven to be an insurmountable barrier to (life insurers) making the necessary changes.’

Since the release of the AI Taskforce report and the ‘Final individual disability income insurance sustainability measures’ on 30 September 2020⁵, APRA has acknowledged 'the challenges associated with implementing the Contract Term Measure, as well as the industry’s efforts to date in working to formulate viable solutions'.⁶ APRA notes that ‘life companies have considered various options, but to date have not settled on solutions that satisfy both the legal and operational constraints and without unintended adverse consequences for consumers'. Regardless, ‘APRA views this measure as an important mechanism to manage the risks associated with long contract terms. Without the policy contract term measure, it is unlikely there will be a change to the current practice that effectively locks in terms and conditions for extended periods of time, leaving premium changes as the primary (or only) lever to deal with the impact of external changes on IDII sustainability.’

However, APRA has recently decided to provide life insurers with more time to implement the Contract Term Measure, thereby postponing the implementation of the measure, among other things, to 1 October 2022. Readers may be aware that APRA wrote to all life insurers and friendly societies on 12 May 2021 to advise of its decision in this regard and otherwise confirmed its expectation that in the interim, life companies are expected ‘to intensify their efforts to explore and develop workable solutions to meet the intention of the Contract Term Measure and to proactively keep APRA informed of progress.’ In this regard, APRA has highlighted a few ongoing ‘areas of focus’ as follows:

• Life insurers are to have appropriate mitigants to manage the risks associated with extended contract terms.
• Life insurers are encouraged to challenge the status quo in formulating viable solutions to operationalise the Contract Term Measure in a timely manner, with due consideration to legislative requirements and consumers’ needs.
• Life insurers must show ‘demonstrated actions taken’ to mitigate the risks associated with extended policy contract terms.

Implications

As noted in our final bulletin of 2020, the issues associated with IDII cover will not be new to life insurers. APRA, together with ASIC continue to actively engage with the FSC and other industry stakeholders on the implementation of the Contract Term Measure, among other things, to improve the overall operating environment going forward.

Whilst APRA will be buoyed with the third quarter figures reported by the industry in relation to overall profitability, ‘APRA will continue to engage and work with industry stakeholders and ASIC to support the implementation of the Contract Term Measure and sustainable practices more broadly.’ Clearly, APRA will continue its oversight of life insurers in this regard but ultimately, ‘it is the responsibility of life companies to proactively manage the risks associated with the design of their IDII products to ensure ongoing sustainability.’ It will be up to life insurers to take that next step, and sooner rather than later, be in a position to demonstrate those actions taken to mitigate or roll back extended contract terms with a view to adopting the Contract Term Measure by 1 October next year.

We fully expect APRA to monitor the steps taken by life insurers in this regard over the course of this calendar year and into 2022. As noted in APRA’s letter of 30 September 2020, ‘APRA’s focus will shift towards monitoring the progress of life companies in meeting APRA’s expectations. 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.’

Watch this space.

¹ https://www.apra.gov.au/final-individual-disability-income-insurance-su…
² Bottrell v National Mutual Life (NSWSC 2007)
³ Actuaries Institute Disability Insurance Taskforce Report – Provisional Findings and recommended Actions for Individual Disability Income Insurance (September 2020) pg 21
⁴ https://www.apra.gov.au/sustainability-measures-for-individual-disabili…
⁵ https://www.apra.gov.au/final-individual-disability-income-insurance-su…
⁶ https://www.apra.gov.au/individual-disability-income-insurance-deferral…