In crisis comes opportunity

With consumer needs, economic recovery and future sustainability now in sharp focus, has the global pandemic presented the Australian life insurance industry with a timely opportunity for fresh thinking?

I believe the COVID-19 crisis has in fact handed us a prompt to reassess past dynamics of the sector, and a chance to work towards building a stronger and more sustainable life insurance industry.

Last year $12 billion was paid to 101,821 insured Australians in the form of life insurance claims. This would have gone largely unnoticed. However, as the pandemic threw the industry and its claims and premium practices into the spotlight, many people began taking a closer look at their income protection and life insurance cover.

The crisis has also forced insurers and reinsurers to respond to a range of unprecedented issues. It has been very pleasing to witness the way in which the Australian retail insurance industry has risen to the challenge. Insurers smoothly transitioned their operations after enacting business continuity plans, reassured clients who held individual policies that there were no exclusions for pandemics, continued to offer frontline healthcare workers cover without a COVID-19 exclusion and put in place measures to assist customers experiencing financial hardship.

However, this action during the COVID-19 crisis contrasts sharply with a questionable track record before the pandemic hit Australia’s shores. Insurers have been chasing market share by engaging in poor practices such as lax underwriting, takeover terms, and special deals for favoured advisers. This has eroded the quality of risk pools and led to poor books of business and anti-selection. More recently the introduction of front loaded discounts for new business premiums have also featured as part of the ‘old normal’ environment.

As a result, life insurers last year (2019) lost $1.3bn, lapse rates for traditional life insurers remain stubbornly high at about 17% and policyholders have had to endure significant and repeated increases in premiums (in some cases by more than 35%).

Many of the issues the industry is currently grappling with are a function of the macro socio-economic environment. An environment of Covid 19, dramatic reductions in interest rates, and a rise in mental health claims, among other issues, is proving to be challenging. However, an historic and aggressive chase for market share by various insurers must also share the blame for the poor outcomes being experienced by consumers.

We must also not allow the inevitable criticism for poor risk management and product design to be sheeted back to advisers.  Short-sighted insurer practices, like front loaded discounts, should not become another rod on the back of advisers.

All too often financial advisers have borne the brunt of these outcomes when the blame should have been laid squarely at the feet of insurers.

I believe the crisis should act as a turning point to right these wrongs and it was therefore, in this context (i.e. pre-COVID-19) that we commissioned market research from Rice Warner on Front Loaded Discounts in the retail insurance market.

I have thought for some time that the discounts were problematic. The research proved to confirm what we have always known – that front loaded discounts are emblematic of all that should be fixed by the retail life insurance industry today.

What we found was that whilst policies with front loaded discounts can increase affordability in first-year premiums, they are less affordable over the medium to long term. For example, front loaded discount policies with stepped premiums have on average lower premiums in the first policy year, but higher premiums from the third policy year onwards.  Similarly, while non-true level policies are on average cheaper in the first policy year, true level policies consistently and significantly rank as more affordable on aggregate premiums over 20 years.

In over 5–20 years, policies with front loaded discounts have significantly higher premium increases relative to the first policy year.  By way of example, customers of one insurer offering a 25% up-front discount could face increases of 50% plus in premiums in the second year once you also consider age-based increases and indexation.

The effect that these sharp premium increases have psychologically on a client, and the increased likelihood the client will lapse as a result, should not be underestimated.  Indeed, ASIC have noted that the steep increases in stepped premiums are one of the key factors in policy lapses.

Policies with front loaded discount are likely to increase lapses for three reasons. Firstly, they encourage customers to switch to a policy with a lower first year premium in the first instance. Secondly, they mostly have higher premiums on average from the third policy year onwards. Lastly, they will also differ even more markedly to new business quotes (even for the same policy) where the first-year discount still applies.

Similarly, level premiums are more affordable than stepped premiums over the longer term. Level premiums can also be used strategically with stepped premiums to offer a ‘base level’ of cover that will be needed long term.

The report also highlighted  the significant saving over the medium and long-term in opting for true-level premiums rather than non-true level premiums. For a typical case, the range of premiums over time for true level and non-true level policies overlaps almost entirely for the first five policy years, but by the eleventh policy year the most affordable non-true level premium is higher than the least affordable true level premium. By the twentieth policy year, non-true level premiums are approximately 44% higher on average, despite being 6% lower on average in the first policy year.

With interest rates experiencing significant declines and at historic lows, however, there is once again more pressure on level and particularly true level premiums across the industry. A major insurer has even recently stopped offering a level premium option.

We believe it is the existing ‘in-force’ clients at insurers who are paying for the new business client discounts. Insurers have an opportunity to correct this practice and instead reward loyal clients before prospective clients.  After all, the new business client of today is the legacy client of tomorrow.

It is worth noting that lapse rates also have a large impact on sustainability of premiums.  This is the case whether the company is owned by shareholders or a mutual which is owned by its policyholders.  Mutual companies typically use the profits emanating from lower lapses to either reduce premiums or pay profits to Members.

As the long-term nature of policy coverage makes life insurance a medium to long term purchase, we recommend the findings of this to licensees (particularly those working in compliance) and advisers to help provide advice that balances the need for quality cover and sustainability with short-term affordability.  Along with factors such as the insurer’s philosophy, product definitions and features, and claims payment track record – price is one factor in determining what is the most suitable product for a client.  Recommending one product over another based on the first year’s premiums, is simply taking the path of least resistance Advisers recommending policies with front loaded discounts should also be cognisant that they could be ‘selling a lapse’.

Ultimately, the COVID-19 virus has put insurers front and centre. I hope to see the industry not shy away from this and instead take the opportunity afforded by the crisis to correct past dubious behaviours mentioned in this article. The industry is losing trust not gaining trust from these sort of practices. They are also detracting from the important role that our industry plays in giving people financial security at a time in their lives when they need it the most.

As the well-known saying goes: it is important to do what is right and not what is easy. Developing a ‘new normal’ would benefit all Australians and will require leadership from all industry stakeholders. The spotlight is on us, consumer expectations have been set, let’s not disappoint.