Insuring Australia: Are you the best you can be?
Good morning, I am delighted to be able to speak with you today, albeit virtually, in my first address to the insurance industry since my shift to having primary responsibility for APRA’s oversight of insurance. Over the past few months since my appointment, I have had the opportunity to speak to many stakeholders across the industry and have greatly appreciated the openness with which you have engaged and the welcome you have provided.
Let me start my comments today by reaffirming the critical role general insurance plays in Australia – for the community at large and the wider economy. Similar to the other financial services that APRA regulates, insurance has a critical role to play in keeping the wheels of the economy in motion, supporting financial stability and protecting consumers. It allows businesses to flourish, economies to progress and provides peace of mind for ordinary people, contributing to consumer confidence and prosperity.
Australia is a land of unpredictable natural disasters: flood, fire, rain, hail, storm, drought and earthquakes. Through all of these events, the industry has demonstrated an ability to mobilise quickly to support people and communities under significant duress. We saw this in action a few weeks ago when a 5.9 magnitude earthquake hit near Melbourne, causing damage to buildings and infrastructure. Almost as soon as the ground stopped shaking, assessors, tradies and engineers arrived to process claims and get repairs underway.
The ICA’s Insurance Catastrophe Resilience Report documents that, since the 2019-20 bushfires, more than $6.1 billion has been paid in natural disaster claims. Insurers are also collaborating with governments and local communities on risk mitigation and providing financial and mental health support for people dealing with unfathomable personal and emotional upheaval. Amidst all of this, insurers have adapted well to the operational challenges of the pandemic and maintained their day-to-day services to policyholders.
This response exemplifies the vital role of insurance in Australia – which is why the insurance sector must be at its very best. It is this theme I want to explore today, starting by asking the question: are you the best you can be?
A challenging question perhaps – but as we all know, there is always room for improvement.
There are two particular areas for improvement that I would encourage you to focus on:
- The first is pulling into first gear and getting back to basics – or "Insurance Risk Management 101". It involves a sharpening of governance and risk management frameworks, including risk culture.
- The second is a clearer and more deliberate focus on the customer – your reason for being. In our engagements with insurers, all are adamant the customer comes first. While good progress has been made since the Royal Commission, with the significant reform agenda culminating as we speak, a customer focus starts with insurance being accessible and affordable. It is this aspect where enhanced attention is warranted.
These elements sit squarely within APRA’s sights, as articulated in our recently released Corporate Plan. The plan sets out three key outcome areas on which we are focusing: entity resilience, financial system safety and stability and consumer outcomes. And while APRA has an important role to play in delivering outcomes in these three areas, working closely with the Government and our peer regulators, the role of the general insurance industry itself is even more critical.
Back to basics
Let me unpack the notion of "back to basics".
If we reflect over the last 12-18 months, arguably the biggest issue for the industry has been business interruption insurance (BI). The involvement of the judiciary and the resultant community uncertainty suggest the existence of weaknesses in underlying risk management frameworks that go beyond a mere failure to update policy wordings. Tellingly, these issues were widespread, affecting almost all insurers offering business interruption cover. It would not be an exaggeration to term this a significant mis-step in managing insurance risk, which reflects poorly on the industry.
The judgment for the second test case released last Friday afternoon is generally favourable for insurers, although remains subject to appeal. Nevertheless, it may provide some further clarity for the industry on the parameters within which it can deal with BI claims, and may reduce uncertainty for some affected businesses and insurers.
There is no doubt, though, that BI has been both a setback and a wake-up call for the insurance sector. This is why in July, APRA wrote directly to the 10 GIs most exposed to BI, asking them to commence a review of their practices aimed at strengthening insurance risk management (IRM) across the sector.
The exercise requires them to probe what went wrong across a range of key risk management aspects for BI, and also run a lens over other products or exposures where similar problems could occur. The thematic review requires specific consideration of cyber insurance, where insurers’ understanding of the underwriting risks is evolving. This cyber-lens captures both affirmative cyber-insurance products, and any potential silent-cyber exposures1. As we saw in BI, what might be a policy exclusion in print and intent does not always turn out that way in practice.
Clarity for both insurers and policyholders over what is and what isn’t covered by insurance is absolutely critical and I’ll expand more on that later when I return to the customer focus. Strengthening insurance risk management reinforces the importance of effective product design, pricing, claims and exposure management, and – importantly – good governance.
Getting these aspects right enables a win-win: insurers provide a product that is profitable and sustainable, with a premium appropriate to the risks covered; and consumers are covered by a product that is valuable, affordable and consistent with their expectations. An appropriate balance needs to be struck.
APRA will receive the IRM self-assessments from this review at the end of next month, and once we review the submissions we will provide broader industry feedback. If any red flags are raised as a result of the exercise, it may result in a supervisory response for an insurer, but the purpose of the review is not intended to be punitive. Rather, we want to work with the industry to help them identify and address any weaknesses before they manifest in a similar way to BI. In that sense, you might consider it a form of insurance!
APRA is also focused on helping insurers improve their risk management practices more broadly. Returning to supervision of the insurance sector recently after a break of some years, I confess to feeling a sense of déjà vu. Around the time of the global financial crisis, many insurers undertook programs to uplift their risk management practices. Yet 10 years on, we still see major risk and compliance weaknesses, with further significant risk uplift programs underway in response to the Royal Commission and other issues.
I find myself wondering why the industry didn’t get more traction in embedding substantive improvement a decade ago, and what it will do to ensure the outcome is different this time. Some of the answers lie in instilling a stronger risk culture across the business. This is not just a recent issue. I mentioned the GFC, but one can go further if the memory (and the years) allow – right back to the failure of HIH.
In heightening our focus on risk culture, in March and April this year APRA asked 10 general insurers to pilot a new Risk Culture Survey, which involved APRA directly collecting risk culture survey responses from employees of those insurers. Given the survey mechanism is a new tool in APRA’s supervisory toolkit, we undertook this pilot exercise as we wanted to ensure the survey was well-implemented and appropriately crafted before we rolled it out more broadly to other APRA-regulated entities and industries.
The survey contained over 40 questions such as: Do people feel safe to speak up? Do their leaders role model good risk management behaviours? Are adequate resources and training committed to deliver continuous improvement in risk management across the organisation?
Tomorrow, we will publish an APRA Insight article with more detail about the survey and APRA’s Risk Culture 10 Dimensions framework, which forms the basis for the questions. At a high level, the three areas with the lowest scoring risk culture dimensions were:
- Risk governance and controls (which considers whether there is sufficient oversight of risk, supported by appropriate risk frameworks, policies, controls and reporting);
- Decision-making and challenge (which assesses whether diversity of thought and constructive challenge is actively sought within an organisation); and
- Responsibility and accountability (which looks at whether responsibilities and accountabilities for risk management are clearly defined, understood and discharged across the three lines of defence).
APRA will use the survey results to discuss with the participating entities areas that are impacting risk culture, as well as the behaviours needed to support a mature risk culture within their entities. The pilot survey has provided useful insights and benchmarking across the entities that participated, allowing them – and APRA – to better understand their risk culture, areas of strength and opportunities to address weaknesses.
Given the success of the pilot, APRA is continuing to roll out the risk culture survey across other APRA-regulated industries over the next 12 months, and will publish further insights and engage with entities to ensure any identified weaknesses are addressed. The enhanced benchmarking and transparency on practices and outcomes in this important area will support APRA’s strategic objective of transforming governance, risk culture, remuneration and accountability across APRA-regulated industries.
The customer, accessibility and affordability
Let me now turn to the second aspect for greater focus: the customer, and the role insurers play in the accessibility and affordability space.
Insurance is not necessarily well understood by the general public. It can come as a surprise, for example, that risks are pooled, or that insurance is predominantly a global market involving reinsurers that often pick up part of the bill after an insurance event. It can be argued that consumers do not necessarily need this detail, but what they do need is clarity over what their policy covers and confidence that valid claims will be paid when their insurance policy is called upon. This is fundamentally the charge of insurance companies and goes to their core purpose.
In recent times, APRA has been encouraged by what appears to be a more deliberate effort by insurers and the ICA to better communicate with their customers and the community-at-large. Progress in this area is incredibly important, and will help bridge what has emerged as an expectation gap between insurance companies and their customers, as was evident in the case of BI. Closing this expectation gap is an area where there is significant opportunity for the industry, and I would encourage you to step back and review past practices and consider how your products and processes need to change, particularly to provide more clarity and certainty for your customers on what is, and is not, covered by their insurance products.
Along with an expectation gap, there is a clear protection gap looming that is potentially larger than perhaps we have observed in the recent past. This is not necessarily a problem confined to Australia and is one our peer regulators offshore also grapple with. Of course, it is entirely within an insurer’s rights to decide which risks to select, and which to avoid. However, when risk exclusion and avoidance burgeon across multiple products and insurers, it leads to prices that are unaffordable, or products that are simply not available. The obvious impact to consumer confidence, the wider economy and prosperity follows.
Such pressure is not limited merely to areas with a high prevalence of severe weather events, such as in North Queensland, which helped to prompt the Government-backed reinsurance pool currently under development. It also extends to access to insurance by the business community in a range of industries and classes of insurance products. Without certain insurance protection, many businesses simply can’t operate. In these cases, insurance is not just about getting back on one’s feet – it’s a pre-requisite to standing up in the first place!
Over recent years, the impact of declining affordability and accessibility for small and medium enterprises (SMEs) has become more pronounced. The former Australian Small Business Ombudsman Kate Carnell described it as a "national crisis that is killing small businesses"2. She noted public liability insurance had become almost impossible for some small businesses to obtain due to price rises upwards of 200 per cent in a few years, and cited examples of amusement parks, caravan parks, quad bike tours or jet boating companies finding it incredibly difficult to source affordable insurance. APRA has observed similar premium rises in other commercial lines, including professional indemnity insurance, directors’ and officers’ insurance, and building liability insurance.
The factors contributing to declining affordability and accessibility are complex, multi-faceted and interconnected, ranging from the rising threat of natural disasters and other climate-related risks, to an increasingly litigious society. Insurers can’t be expected to solve such a complex problem in isolation; it requires buy-in and collective action from regulators, Federal, State and Local Governments, and policyholders themselves.
Recognising the importance of insurance to financial stability, APRA’s Corporate Plan specifically calls out insurance accessibility and affordability as one of APRA’s key priorities over the next four years. Our focus here is on building the evidence base to better understand the issues, and magnifying our influence on contributing to a solution. This includes leveraging our supervision insights and system-wide perspective to advise stakeholders on the nature and extent of accessibility and affordability issues, and the risks that exacerbate these challenges.
But you, the general insurance community, have a major role to play here. The insurance sector is in the box-seat to clearly see the problems that are emerging, and it is incumbent upon the industry to raise and respond to them positively and proactively – and at an earlier stage. This response needs to go beyond what has often been the response of insurers to deterioration in profitability in a class of insurance business: namely significant increases in premiums and/or withdrawal of cover. Some variation in profitability is to be expected over time – but not the extreme cycles we have seen in some product classes that seem to continually repeat. There is a need for a different, more innovative approach by insurers to how they design and distribute products, manage claims, and communicate with consumers to help lessen such volatility in the pricing cycle and improve accessibility and affordability for policyholders.
The ICA’s decision to commission a review of affordability and accessibility in the SME sector demonstrates the industry understands this, and is working to find answers that work for both insurers and policyholders. The Independent Strategic Review of Commercial Insurance, overseen by John Trowbridge, is a step in the right direction. As the Review noted, plenty of reports have been published on these issues, and plenty of ideas proposed, but little progress made, adding: "Practical solutions are now needed"3.
To maintain a sustainable industry and improve affordability and accessibility for business and the community, a focus on risk reduction and helping consumers to understand the risks that they are covered for are critical. As mentioned, both the ICA and individual insurers have made efforts to help customers understand both the risks they face and the policies they are purchasing, but there is more to do. Thinking innovatively about product design is important as consumer needs continue to evolve. Greater transparency on products and pricing may also help incentivise risk mitigation or prompt customers to consider what are the essentials they need to cover to carry on with their lives and run their businesses.
It will take time, but the opportunities in this space are worthy of comprehensive exploration across the industry and its stakeholders.
The collective challenge
Let me conclude with where I began: insurance matters. It matters to every Australian citizen, their families, their businesses, communities and the wider economy. A strong and sustainable insurance sector promotes financial stability and prosperity. I say this not to burden you with that heavy responsibility – rather to inspire you to be your best.
There are many positive signs that demonstrate insurers are holding true to their brief, through proactive management of claims when disaster strikes, better communication with customers, and a leaning-in to the debate around accessibility and affordability.
Yet there is still much to do. Let me repeat:
Get the fundamentals right – the basics of good insurance risk management. This might sound unsexy, but it is the bedrock of stability through which insurers can prosper and deliver on their reason for being: being there for their customer. We can’t have a repeat of the BI issues – the lessons must be heeded.
Genuinely focus on your customer – understand their needs, communicate what is and isn’t insured, and reduce expectation gaps. Design products that work for both you and your customer, now and in the longer term. Lead on accessibility and affordability with one voice, in collaboration with system-wide stakeholders, in an effort to advance collective solutions and reduce the protection gap.
APRA will support the industry as it addresses these challenges. Through our supervision, we too have a unique line of sight on better practices and can leverage those insights to help the industry improve. We also understand the balance needed between maintaining a profitable, sustainable insurance sector and ensuring that appropriate consumer and community outcomes and expectations are met.
There are no easy solutions to many of these issues and it will take hard work, dedication, collaboration, innovation and creative thinking to see progress. All of these characteristics are within the insurance industry’s means and I strongly encourage you to use them, and be the best you can be for the Australian community.
1 This refers to a scenario where a claim, for example, could be made for physical damage under a property policy, caused by a cyber-attack that is not expressly or otherwise covered under the policy.
2 Does public liability insurance need government help?
3 Insurance Council of Australia: Commercial Role of the Private Insurance Market p18.