The poor performance of the individual income protection line of business in Australia will continue to undermine earnings in the life segment, which have declined over the past three years, says S&P Global Ratings.

There are numerous reasons for the troubles with this line of business including: increasing consumer awareness in relation to policy benefits; greater lawyer involvement in the claims process; and a rise in mental illness and stress related claims. Moreover, the business line has been consistently loss-making for the past five years despite the industry's aggressive remediation actions including: price rises and the tightening of terms, conditions, and definitions; and stricter underwriting standards.

The volatile operating performance has been a key driver of divestments of life risk operations by domestic groups, a trend that is anticipated to continue, the international credit agency says in its report titled, “Australian life insurance: Tough times are set to continue”.

Impact of proposed superannuation legislative changes

In the group risk segment, the proposed Protecting Your Superannuation legislation continues to cause major uncertainty for life insurers in the group risk segment, over six months after the government first announced the proposed changes. S&P Global Ratings believes the legislation has the potential to significantly hurt the growth and earnings profile of Australia's group risk insurance business, which comprises around 40% of total life insurance premium risk inflows.

The package includes proposed changes to the current default arrangements for the provision of life insurance to superannuation members. Under the proposals, trustees will only be permitted to provide insurance on an opt-in basis to new superannuation members under 25 years old, to members with account balances under A$6,000 ($4,256) and to members with accounts that have been inactive for 13 months or more.

This is in contrast to current arrangements under which trustees provide insurance to all members on an opt-out basis.

To put the magnitude of the potential impact in context, the Commonwealth Treasury estimates that account balances of less than A$6,000 make up more than 40% of all superannuation accounts (based on 2015-16 data).

Australia's high levels of superannuation member disengagement and the tarnished image of the life insurance industry means there is a risk that affected members will not opt-in to life insurance in large numbers. This would result in a material decline in group risk premiums, which would impact significantly on the revenue of large group risk insurers. It is also expected that insurers would lose predominantly younger policyholders because of the reform, who are likely to claim less than older members and whose premiums often currently cross-subsidise older cohorts.

Royal Commission disclosures

On top of it all, there is uncertainty surrounding the extent and impact of the Royal Commission recommendations due early 2019. All these challenges reinforce the negative trend S&P sees for the sector.

The disclosures stemming from the Royal Commission have further damaged an industry whose reputation was already tarnished. Revelations include: misleading the corporate regulator, premiums being charged for deceased individuals and advice not provided, inappropriate direct selling techniques, poor claims management practices, and using outdated medical definitions.

With the Royal Commission the hot topic at both the wholesale and retail level, there is a risk that policyholders and large group (superannuation) clients lose confidence in the industry and subsequently lower or withdraw their cover. To date, there is no overwhelming evidence to suggest this is happening. In S&P's view, it is more likely that there would be an increase in switching between providers, with the beneficiaries being those insurers with good claims paying reputations, especially when it comes to the re-contracting of group schemes.

The tarnishing of an insurer's image can undermine creditworthiness due to a weakening in competitive position or deficiencies in risk management or governance. Moreover, subsequent remediation costs, penalties, fines, and legal action can further impinge on credit quality related to a weakening in capitalisation.

The Royal Commission highlighted a number of topics that may be the subject of its final recommendations that cover all aspects of the life insurance industry, including product design, disclosure, sales, claims handling, regulation, and compliance and breach reporting. The main risk to the industry lies in the potential for far reaching changes in the industry's structure and more onerous and costly regulation.

Thus, the next year will remain challenging for the Australian life insurance sector. The full extent of the difficulties are yet to play out but should become clearer once the Royal Commission recommendations (and government response) are known early in 2019 and when there is clarity as to the extent to which the Protecting Your Superannuation reforms are to be implemented.