Introduction

The Australian Government’s Financial Systems Inquiry (the Inquiry), led by the Hon. David Murray AO was formed with the overarching  goal of examining Australia’s financial system and how it may be best positioned to meet Australia’s needs and economic growth. The result of the Inquiry will be a set of policy recommendations which will impact the entire Australian financial system, including the insurance industry.

To this end, the Inquiry recently released its Interim Report (the Report) on 15 July 2014. The Report does not make recommendations but points to key issues identified by the Committee of the Inquiry and seeks further information, comments and submissions regarding those issues. While not to be taken as a draft set of recommendations, the Report may provide insight into areas identified by the Committee for intervention and some of the actions being considered.

The Australian insurance industry was not a particular focus and commands only a fraction of the Report’s some 460 pages. However, some key points relating to the insurance industry can be drawn from the Report. We provide our summary and some further points to consider below.

Competition

Like the banking industry, the Australian insurance market is characterised by its high level of market concentration. The Report provides statistics confirming extreme market concentration, especially in personal lines general insurance and commercial insurance. The life insurance industry retains a higher level of market fragmentation than its counterparts.

The Report also notes a number of new insurers have entered the market, alongside banks and retailers selling insurance products (generally by white-labelling, but some underwriting). As expected, the main barriers to market entry are commercial advantages held by incumbents including established brands, customer bases and distribution networks.

Despite the level of concentration, few submissions have raised concern about the general level of competition in the insurance sector. However, the following issues were identified by the Report:

  1. Aggregator Services – Aggregators are a common service allowing comparison of different products. Submissions have raised concerns regarding lack of access for aggregators to information for the general insurance industry. Reluctance by general insurers to share product information with aggregators has limited the effectiveness of those services in Australia. Accordingly Australian consumers face a relatively difficult task in comparing insurance products. There is concern that consumers not being able to adequately compare products may result in reduced price competition.

    Submissions from general insurers have argued that information is difficult to provide, as insurance products are tailored to individual circumstances. There are also concerns that providing information access to aggregators could lead to disclosure of sensitive pricing information used by insurers. Other concerns include the idea that aggregators may cause undue focus to be placed on price, at the expense of considering other relevant factors such as the level of cover, with an overt price focus possibly contributing to underinsurance.

    Relevant to those submissions, the UK’s Financial Conduct Authority (FCA) released its report on price comparison websites almost immediately following the release of the Report. The FCA reported that the operation of aggregators in the UK general insurance market had been less than ideal. The FCA pointed to problems in providing consumers appropriate information to make informed decisions, and lack of information for consumers regarding the role and position of the aggregator.

    However, given the perceived success of aggregators in other insurance markets (life, private health, travel), the Report notes that there may be scope to improve aggregator involvement and simplify the exercise of purchasing insurance for Australian consumers.
     
  2. Statutory Insurance Schemes – certain statutory insurance schemes in Australia are not open to private sector competition, such as statutory workers compensation and personal injury motor accident schemes.

    It has been noted that some of these schemes essentially operate as government regulated monopolies and that consumers could  benefit from competition from the private sector.

In respect of aggregator services, the Report invites submissions on three options being considered by the Committee:

  1. retain the status quo;
  2. allow aggregators to use automated processes to quote from insurance websites; and
  3. to develop consumer ‘categories’ for which insurers must provide their premiums.

The Report notes drawbacks of each option, including the possibility that option (b) could provide a means of discovering insurers’ pricing information and that for (c) it might be difficult to create categories and provide a meaningful comparison between policies with different levels of coverage.

The Committee also invites submissions on how opening up statutory insurance schemes to private competition could benefit consumers.

Underinsurance

Underinsurance in Australia is the other main area in which the Inquiry considers whether policy intervention is required. There were several initial submissions to the Inquiry on the topic, generally referring to underinsurance in the general insurance and life insurance sectors:

  1. General Insurance – the Report identifies underinsurance and non-insurance in the general insurance sector as being associated with affordability issues, a lack of consumer understanding of adequate insurance, and general consumer behavioural issues.

    Affordability issues may manifest in underinsurance where a consumer chooses to purposely underestimate the value of their risk in order to attract a discounted premium. Consumers may also not perceive value in insurance, leading to partial or complete ‘self-insurance.’ Consumer-group submissions have raised issues with products such as low-value contents insurance, where premiums are expensive in proportion to the sum insured, due to fixed costs to the insurer independent of the sum insured. The Report notes that insurance can be also prohibitively priced (or not offered) where property is subject to a high risk of natural disasters.

    Lack of consumer understanding regarding the amount of coverage required also contributes to underinsurance. For example policyholders may fail to update policies to reflect building improvements, new contents and valuables, leading to underinsurance. Consumers may also find administration of their policies too much of a burden. It is also noted that often, options to purchase cover for “unlikely risks” such as flood cover are not taken out by consumers.
     
  2. Life Insurance – The Report notes positively that a significant number of Australians now hold life insurance due to group insurance policies provided by superannuation funds. It is estimated that 90% of the working population now holds some form of life insurance.

    Nevertheless, some submissions posit that the amount of life and disability insurance meet only a fraction of the amount of cover ideally required. It is noted that a policy response may be required to meet the “underinsurance gap”, to avoid potential consequences to consumers and associated costs to the government and non-government organisations. Policy solutions are considered, such as tax incentives for those who take out their own disability insurance cover.
     
  3. Risk-based Pricing – The increased use of technology may allow consumers better access to products and services. In the insurance sector technology may allow underwriters to more accurately price products according to risk. This has been identified in the Report as a continuing development which could contribute to underinsurance.

    As insurers employ more sophisticated calculations and use more comprehensive datasets, prices can be more precisely tailored to individual risks. Accordingly, higher risks may see a corresponding increase in price and lower risks would be subject to lower prices accordingly. It is noted in passing that “price signalling” through insurance may benefit efficiency and competition or influence consumer behaviours.

    Risk based pricing may increase affordability for some consumers, but decrease affordability for others. The individualised pricing may lead to underinsurance where prices become prohibitive or insurance is not offered. For insurers, a failure to adopt risk-based pricing models may lead to the acquisition of risk at a price not commensurate with the risk borne.

The consideration of underinsurance by the Committee is in its early stages. The Inquiry is concerned with gathering information to confirm that underinsurance in Australia is an issue which requires addressing. Possible solutions such as consumer education programs have been mooted.

Accordingly, the Committee has sought further information and submissions regarding the level of underinsurance in Australia and available data on the topic. The Inquiry is also interested in data relating to underinsurance caused by risk-based pricing and possible approaches to mitigate underinsurance if policy intervention is warranted.

What’s Next?

By its nature, the Report is part of the Inquiry’s engagement process with interested stakeholders, designed to elicit comments and form the basis for future consultations by the Inquiry. Formal submissions are sought by 26 August 2014.

The consultation process presents a rare opportunity for organisations to be involved in and influence the course of Australian government policy in the areas noted above and take early steps to prepare their businesses for, and to take advantage of policy shifts affecting the industry.

Given the benefits of being involved in this process we recommend that interested parties give serious consideration to the issues above and prepare submissions so as to be as actively involved as possible in the Inquiry in the lead-up to the release of November’s final report.