In April, a major change hit the financial planning industry from a surprising source, which greatly alters one strategic option planners can recommend to their clients.
APRA’s instruction to insurers to abandon agreed value income protection policies, as well as subsequent changes APRA wants implemented on July 1 2021, warrant a closer look to determine what they mean for consumers.
Letters and numbers
Last December, APRA wrote to all life insurers, obligating insurers to make major changes to new income protection policies from March 31, 2020. While a surprising and somewhat unprecedented move, APRA’s concern over insurers wearing major losses on this type of insurance should not come as a shock.
In May 2019, APRA wrote to insurers requesting that they proactively move to prevent the large losses they had experienced on their income protection products. At the time, APRA identified $2.5 billion in losses on such policies industry-wide in the preceding five years. The lack of insurer response to this first letter gave rise to December’s more prescriptive missive.
While it may seem counter-intuitive for a regulator to be concerned about insurers losing money on insurance (or, to look at it another way, consumers making money from insurance), the logic is sound. APRA has expressed concern that these losses will result in consumers receiving nasty shocks when premiums are reviewed (and dramatically increased).
On the more extreme end of the scale, the prospect of an insurer being unable to pay claims under the weight of income protection losses would be disastrous for consumers and the industry overall.
So, what has APRA requested insurers do?
Agreed value dismissed
APRA stated that it expects insurers to no longer offer agreed value income protection policies from March 31, 2020. Any income protection claim on a new policy from that date will rely on income not older than 12 months before the date of claim.
What does this mean?
The days of a client proving their income at the time of underwriting and not having any burden of proof come claim time, are over (for new policies, at least). Some insurers accepted applications for agreed value policies right up to the cut-off date. Some even accepted paper applications after that date, provided they were dated and signed prior to April.
Clients with agreed value income protection policies put in place, or applied for, before April can maintain such policies, subject to contract provisions and insurer policy. Strategically, the change means grandfathered agreed value policies may become more valuable.
That said, such policyholders may find their premiums rise more steeply than expected. Insurers will have little incentive to keep the premiums competitive when the insured can no longer purchase a comparable product. Furthermore, if insurers are making the level of losses identified by APRA in their correspondence, insurers will need to lift their premiums on agreed value policies to shore up their bottom lines.
A simplified marketplace
The question of whether a currently uninsured client would be better suited to an agreed value or indemnity income protection policy will be gone. Issues around agreed value policies in super and whether they fully meet the temporary incapacity condition of release (and whether the premiums are fully deductible), will also slowly disappear, as grandfathered policies end and indemnity policies predominate.
Other pseudo-income protection insurance types may also be altered. Business expense insurance is usually issued as a monthly, income protection-style, benefit. Before April 2020, business expenses were often established at the time of underwriting only. Under APRA’s new rules, such a policy could only be written if the business expenses were verified in the 12 months prior to the claim.
Similarly, living expense insurance, commonly used to insure against disabilities suffered by a non-employed member of a couple, could also only be issued if living expenses were verified in the 12 months prior to a claim. Prior to April, these policies were usually issued under an agreed value model.
For business expense and living expense cover, insurers are likely to find alternate solutions, such as providing lump sum benefits, and have already started to do so.
An unintended consequence
The 12-month income verification period may cause some unintended consequences for the insured. For those with irregular income, a major bonus or income spike may come after the date of claim, and hence be excluded from the income verification period. This issue may capture a wide range of people, from farmers who have income spikes depending on seasons and markets, to members of a sales force who typically have the potential to receive large bonuses at set points in the year.
The 75 per cent ceiling
APRA has also stated that it expects insurers to limit income protection benefit amounts from July 1, 2021. New policies written from that date will not be permitted to pay more than 100 per cent of earnings for the first six months of claim, and 75 per cent of earnings thereafter (up to a maximum of $30,000 per month).
What does this mean?
The limit for the first six months will likely not have a great impact. Few insurers would offer such a high percentage of income as a benefit – commonly, insurers have kept benefit amounts below 100 per cent to provide an incentive to the insured to go back to work. Whether one or more insurers see an opportunity to beat the market and offer a 100 per cent payment for the first six months in line with APRA’s permissible amounts, is yet to be seen.
The 75 per cent limit, thereafter, would cause most insurers to reduce the insured amounts they offer on their income protection policies. Currently, benefits of over 80 per cent are available in the marketplace.
The wording of the APRA letter uses the term ‘earnings’ rather than ‘income’, which could be interpreted as including things like employer superannuation benefits and non-cash payments.
Many insurers offer add-on benefits, such as a superannuation guarantee benefit that pays an additional 9.5 per cent on top of the standard percentage. If limited to 75 per cent of earnings, such a benefit would need to be reduced or restructured.
Beryl earns $100,000, plus $10,000 in superannuation guarantee contributions from her employer, per annum in 2021/22. If her earnings, including super, are $110,000 (and APRA interprets earnings to include superannuation), the maximum 75 per cent income protection benefit would be $82,500 per annum.
Similarly, automatic benefit indexation during a claim could result in the 75 per cent rule being breached shortly after a claim commences. Insurers may need to remove such indexation from their terms on new policies, unless it is specifically allowed by APRA.
Carl earns $100,000 in the 12 months up to his temporary disablement. His income protection policy pays 75 per cent of his pre-disability income, with an annual indexation of benefit payment. For the first year of payment, Carl’s benefits will not exceed APRA’s 75 per cent limit. On the first anniversary of Carl’s claim, his benefit will increase by CPI. This will result in his benefit payment exceeding APRA’s limit of 75 per cent of pre-disability earnings.
Under APRA’s new rules, Carl’s insurer would not be allowed to issue such an indexed policy.
No guarantee of renewal
APRA will also require insurers to limit contract terms on income protection policies from July 1, 2021. Initial contract terms will be limited to five years, with those insured able to renew the contract for a period not exceeding a further five years on updated terms offered by the insurer.
What does this mean?
Currently, most insurers offer income protection policies on terms that allow the insurer to amend the premium each year, but allows the insured to accept that premium on the same contractual terms as the year before. This can be a good or a bad thing for both the insured and the insurer, depending on whether the updated terms used by the insurer are broader or more narrow (or a combination of both).
By removing this guaranteed renewability, APRA is making sure insurers don’t have clients on a wide range of contracts. Every five years (at the maximum), the insured’s contract will be brought into line with the insurer’s most recent set of terms.
Maximum contract terms will require the client to reassess the contract critically at least every five years. Clients, as led by their planners, should be doing so anyway, to ensure their policy remains a suitable one for them, given the alternate market offerings.
It will be interesting to see how insurers manage this five-yearly review when paying commissions to planners. If the policy contract changes, current convention would say this triggers a new upfront commission for the planner. Insurers will need to decide whether to pay such upfront commissions if this change is obligated by APRA (and presuming upfront commissions are still payable in five years from 2021).
Limit on long benefit periods
While less prescriptive, APRA also states in its letter that it expects insurers to put in place controls to limit long benefit periods on income protection policies from July 1, 2021.
What does this mean?
That is harder to say. The obvious target of this request are policies with benefit periods up to an age (be it 60, 65, 70 etc). How insurers interpret the request, and practically apply it to the policies they offer, is unknown. APRA seems to want insurers to employ definitions of disability that grow harder to meet, the longer the insured is on a claim, thus encouraging the claimant to return to work.
It is quite possible insurers will implement this request, as it could serve to limit their claim liabilities. That said, no insurer will want to be the first with a tougher disability definition. Based on prior experience of APRA asking for action in a non-specific fashion, it would come as no surprise if insurers did little until asked to do so in a more prescriptive manner that is enforceable industry-wide.
Planners need to keep up-to-date with insurers’ terms
The only way to manage these reforms is for planners to stay up-to-date with insurers’ changing contract terms. Planners need to re-familiarise themselves with insurers’ contract terms, if they haven’t done so since March 31, 2020. Similarly, they will need to go through this process again on July 31 next year.
One of the difficulties in managing this change is that APRA’s letter is not legislation, nor is it currently in the form of a regulator policy, and detailed issues will need to be addressed by the regulator itself. How APRA communicates its opinion on these detailed issues will be key to informing clients and planners about the changes.
1. From which date will insurers no longer be permitted to offer agreed value income protection insurance policies?
a. January 1, 2020.
b. March 31, 2020.
c. July 1, 2021.
d. December 31, 2021.
2. Which other types of insurance may also be affected by APRA’s ban on agreed value-style insurance policies?
a. Business expense insurance.
b. Living expense insurance.
c. Both a and b.
d. Neither a or b.
3. Erica is in sales for a drainpipe manufacturer. Erica becomes entitled to bonuses for her sales results on May 1 of each calendar year. Erica has an income protection policy that complies with APRA’s new restrictions on agreed value policies. If Erica satisfies the definition of disability under the policy on April 4, 2021, which bonuses may be included in her income for the purposes of determining the benefit amount?
a. The bonus paid on May 1, 2019.
b. The bonus paid on May 1, 2020.
c. The bonus paid on May 1, 2021.
d. All of the above.
4. Fred owns an income protection policy on his life that complies with APRA’s rules on maximum benefit payments that are to be in place from July 1, 2021. If Fred’s earnings, as defined under the policy, are constantly $80,000 per annum, what is the maximum monthly benefit APRA will allow Fred to be paid in the first six months of claim?
5. APRA has requested insurers put in place controls to limit long benefit periods on their income protection policies. What does APRA mean by ‘long benefit periods’?
a. Those to age 65.
b. Those in excess of 10 years.
c. Those in excess of 20 years.
d. It isn’t clear at this point.
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