Cost of Consumer Expectation

'Community standards and expectations' has emerged as one of the game-changing phrases in the Australian financial services sector. Whilst not a legislated term, the idea is that financial service companies (including insurers) need to align their business model with what consumers expect and not just the letter of the law.

As APRA's recent review of CBA highlighted, 'At its simplest, conduct risk management goes beyond what is strictly allowed under law and regulation ('can we do it?') to consider whether an action is appropriate or ethical ('should we do it?').' This in itself is a fundamental shift for our industry as it proposes that the intent and not the technically correct terms and conditions should be the primary driver of decision making. Coupled with this is the future reputational pressure felt by life insurance companies, which we might name the 'Orr factor', which will influence how life companies will treat anything grey. The last few years of media coverage, culminating in the Royal Commission report in February this year, will drive a change in attitudes to paying claims, across all segments of insurance.

One benchmark to consider are the UK's Treating Customers Fairly regulatory requirements, which began in 2004. This is similar in theme to community expectations and provides a useful precedent for the broader areas of consideration underlying insurer and superfund business functions in Australia.

Similarly, actuaries will also need to consider the extent to which our professional standards will need further adapting to strengthen the current policyholder reasonable expectations theme, perhaps creating an opportunity for actuaries to take a broader role across organisations as custodians of customer outcomes.  

For pricing actuaries, the potential cost impact can be described via eight trends, along with a one-off mechanical adjustment to unwind previously declined claims:

• Claims transparency trend - The impact on pricing due to the public pressure of increased transparent reporting. In the early 2000's, UK insurance companies began public reporting of claims outcomes. For trauma insurance as one example, the percentage of claims paid was 93.1% in 2015 (92% the previous year). This had increased since 2005 when it was 80%.
• Performance normalising trend - The compression of margins across product and channels going forward as transparency and competition increases.
• Reviewability trend - The extent to which future reviewability will be able to capture changes in experience and impacts on capital and management action. The UK went through a remediation exercise to refund premium increases applied to reviewable policies due to the uncertainty of the wording. The ability of Australian insurers to recoup losses or change expense assumptions within pricing (as opposed to pure claims experience changes) may need to be considered.
• Non-disclosure trend - The degree of change in non-disclosure. The Royal Commission Report proposed a significant shift whereby consumers cannot misrepresent in their applications, which is a change from the current onus on the consumer to inform the insurer of anything reasonably relevant to their risk. Pre-existing conditions or retrospective underwriting will likely no longer be accepted.
• Orr trend - The extent to which consumers and other stakeholders are able to exert pressure on insurance companies to pay claims for fear of reputational damage.
• Expense trend - Coupled with recent legislative changes that will reduce industry premiums and result in an anti-selective impact for policyholders opting back into coverage, there will be additional expenses due to new processes and resources required.
• Product shift trend - Changing product structures and unwinding of cross subsidies will need to be considered.
• Behaviour trend - The extent to which consumer and organisational behaviour may shift will have material bearing on outcomes.

These are difficult to quantify, but the cost of these changes were the subject of a recent paper by my employer Retender, estimating an aggregate (illustrative) one off impact on industry claims cost of c2% for lump sum products and c5% for disability income products, and an aggregate (illustrative) trend impact of between 2% and 3% p.a. The key is to what extent different organisations have moved towards this future model already (i.e. this may be a source of competitive advantage for some life companies, depending on their starting position).

More broadly, there is a reliance on the reviewable nature of life insurance policies which allows repricing if claims experience emerges worse than expected. However, overlaying an updated community expectations test suggests that consumers paying for cover today do not expect that their future cost will increase by more than the age-based increases and allowance for CPI. Potentially, one could go so far as to question whether reviewable policies are in line with community expectations, particularly reviewability which effectively passes the risk onto the consumer without their knowledge.

What is clear is that actuaries will need to consider some of these potential impacts and the extent to which, as is taught on our first class at University, the past is sometimes not a good guide to the future.