At first glance, the recent string of gains reported in the Individual Disability Income Insurance (IDII) market looks promising for an industry that has been plagued by sustainability issues, the Australian Prudential Regulatory Authority (APRA) said in a statement. says.
The industry reported net profit after tax (NPAT) for five consecutive quarters from mid-2021 to September 2022.
Life insurance companies have been selling this product for decades, providing income when policyholders are unable to work for an extended period of time due to injury or illness. However, in recent years, the future of this product has become less certain.
Intense competition, rising claims, and declining insurance affordability will cause long-term losses, greatly undermining the sustainability of IDII products and their continued availability to meet community needs. was questioned.
For example, in the five years to 2019, total losses from IDII totaled A$3.4 billion ($2.3 billion). This included a significant increase in reserves for future payments on claims that were significantly higher than originally anticipated. Exacerbating the situation is that life insurers will redesign their products to make them more sustainable, as this will involve reducing the benefits offered and/or increasing prices. We were reluctant to take the risk of incurring a competitive disadvantage as a result.
To address these concerns, APRA intervened in 2019 and implemented a series of measures, including additional capital requirements. This prompted the life insurance company to address product design and pricing flaws in his IDII and strengthen its risk governance and data quality capabilities.
To understand what the recent turnaround in financial results means for IDII’s future sustainability, it’s worth taking a closer look at what’s driving its recently reported earnings.
By way of background, insurers hold reserves for current and anticipated claims and expenses. If these reserves exceed future premiums, it means that the insurer expects future losses. Insurers should recognize these losses immediately and hold additional capital to ensure they can meet expected claims. As such, the accumulated losses associated with IDII through 2020 were often a reflection of the fact that insurers expected to incur losses in their business in the future.
An analysis of industry results shows that three main factors have contributed to the recent recovery in earnings: bond yields, repricing, and the release of COVID-19 reserves.
Insurance companies typically rely on stable and predictable returns from government bonds to manage financial risk and meet obligations arising from claims.
As government bond yields rise, insurers’ future liabilities are discounted at a higher rate, reducing their value. This downward adjustment in liabilities will make a positive contribution to insurer earnings.
Rising bond yields also affect bonds held by insurance companies. This is because the bond is discounted at a higher discount rate, reducing its value. As a result, life insurers suffer unrealized losses on the bonds they hold, adversely affecting profitability.
Many insurers aim to match expected claims and investments. However, changes in credit spreads and differences in the durations of liabilities and bonds may cause the two to no longer be perfectly aligned, so any gains from reducing liabilities will always be fully offset by investment losses on assets. is not limited. This has been a major factor in IDII’s improvement in recent quarters. However, there are other factors such as the COVID-19 reserve release and price changes that have a positive impact on liabilities and therefore earnings.
Insurers should prepare for a reversal in this trend as 10-year bond yields could return to low levels in the coming years. For example, interest rate volatility liability valuation benefits began to decline in the September quarter as interest rates slowed.
Pricing activity expected to continue
Pricing is another factor that contributed to the improved performance, as premiums are key to an insurer’s profitability. Life insurers that hold reserves for expected future losses can release those reserves at repricing.
Continued increases in average premiums due to various repricing activities across the industry contributed to lower cumulative losses and were expected to improve future profitability for most insurers.
Pricing is expected to continue as many insurers expect future losses from current IDII portfolios to increase. Insurers need to repricing existing policies to meet rising claims, with bad consequences for consumers. APRA expects insurers to balance the need for higher premiums with providing policyholders with affordable and fit-for-purpose insurance. In the future, new IDII products launched after APRA’s IDII intervention should have much more stable premiums over the long term than pre-intervention products.
In the early stages of the pandemic, insurers set aside increased reserves to meet potential liabilities arising from the expected surge in claims costs related to COVID-19.
So far, the industry has seen lower levels of COVID-related claims due to lower-than-expected impacts on stringent lockdowns, government support measures, high vaccination rates, and younger demographics. increase. As a result, most insurers released some of his COVID-19 reserves, resulting in a further increase in reported earnings for the year.
Risks remain from mental health, the prolonged COVID situation and the economic downturn. Mental health outcomes have been adversely affected by the pandemic, and it is unclear how long this will last. Long-lasting COVID conditions such as joint pain, fatigue and memory impairment could further increase IDII claims. We encourage policyholders to ensure they are protected and supported.
looking to the future
IDII’s sustainability challenges have been well documented and the premium increases that have been required given rising claims costs have been very difficult for policyholders. APRA’s IDII measures aim to bring products back from the brink and prevent these problems from reoccurring in the future.
IDII’s return to profitability is a positive sign of product sustainability. However, net gains from improved bond yields and the release of COVID-19 reserves, which contributed to recent gains, are cyclical events and may decline or reverse. Premiums can be raised further to meet future deterioration in profitability, but this reduces affordability and worsens consumer outcomes. This will be exacerbated by lower household incomes and spending in a high inflation environment.
Overall, the industry continues to project future losses (albeit less than before), indicating that there is still a long way to go before anyone can conclude that IDII has returned to a sustainable state. It is therefore important that the industry maintains discipline when it comes to product design and pricing in order to strike the right balance between sustainability and profitability.