The road to recovery
Good morning, and thank you for the opportunity to address you today.
In preparing for this event, I reviewed past speeches APRA has delivered on private health insurance (PHI) seeking some insights on how our areas of focus have changed over time. What struck me, however, was a remarkable consistency in terms of the issues and messaging covered. Every speech emphasised the importance of increasing resilience and sustainability in PHI in the face of worsening affordability and adverse selection. It’s not that nothing has changed in PHI, or that everything has become worse: APRA’s PHI roadmap has provided a platform for the industry to enhance its risk management and governance, while measures to finetune and strengthen the capital framework are underway; and Government reforms have helped to make the system more efficient and easier for consumers to understand. But the direction of the fundamental forces undermining the industry’s long-term sustainability have not been halted, let alone reversed.
In such circumstances, some may have predicted a global pandemic would threaten, if not the PHI industry, then at least some of the more vulnerable health funds. Yet the industry has stood strong under challenging conditions – supporting policyholders financially through premium freezes and hardship provisions, and medically to the limited extent possible due to COVID restrictions. Remarkably, the proportion of Australians with hospital cover has risen slightly for each of the past three quarters after falling almost continuously since 2015, while further important Government reforms designed to address the affordability conundrum are either underway or under review.
Optimists might be tempted to suggest PHI has turned a corner, or at least slowed down and flicked on the indicator, but the reality is that none of the key challenges facing the industry have fundamentally changed. And while PHIs remain well capitalised and policyholders can have full confidence in every insurer’s ability to pay all legitimate claims, that paradigm will not continue indefinitely while these trends persist.
Boards are ultimately responsible for steering their PHI through these challenges in an environment where they don’t have their hands on all the levers of control. APRA understands this predicament, and has developed a PHI Industry Strategy to help navigate the terrain. The strategy is effectively our updated roadmap aimed at increasing the industry’s strength, resilience and long-term prospects, so it can continue to successfully serve its members. What I’ve found in my conversations with PHI CEOs and boards, however, is that this strategy, and how it’s intended to support insurers, is not always well understood. So, what I’d like to do today is provide some insights on what the strategy is, where we are up to, and what role PHIs need to play to ensure its success.
The COVID test
Before moving to look at where we are headed, I’d like to first touch on where we are now with regards to the impact of the pandemic.
COVID-19 is described as both an economic and medical crisis, and PHIs – sitting at the axis of the financial and health systems – have been exposed to both impacts. Despite Australia’s success in supressing the pandemic and limiting its economic cost, PHIs have still faced significant financial and operational challenges. On the whole, we think the industry has dealt with these commendably.
APRA estimates that insurers’ actions to defer premium rate rises delivered savings to policyholders in the order of $450 million. While these and the other support and relief initiatives were necessary and welcomed by policyholders, the cumulative financial impact of these decisions led to the industry reporting revenue lower than would have been the case in a “normal” operating year. Premium revenue in the six months to September 2020 was 1.4 per cent lower than in the same period the previous year. To give some context, the average premium revenue growth for the five previous years for the same period was 4.3 per cent.
Restrictions on elective surgeries and physical lockdowns during 2020 have also had an unprecedented impact on claims and claiming patterns across the industry. Elective surgeries were limited to create capacity in the health system to deal with COVID, and access to “extras” such as dental and optical was blocked due to social distancing measures aimed at curbing the rate of community transmission. This also had a direct financial impact driven by a sizeable reduction in claims.
PHIs and APRA faced the challenge of estimating how claiming patterns would alter in response to the government-imposed restrictions – both as they were imposed, and as they are relaxed – and, therefore, what level of reserving PHIs would need to ensure they were prepared. Fundamentally our question was this: would cancelled or postponed claims be foregone, or were they simply deferred?
These issues were complex and unprecedented, and we appreciated the positive engagement with industry and other key stakeholders, including the Department of Health the Australian Securities and Investments Commission and the Actuaries Institute. The consensus view that emerged was that policyholders who needed medical treatment pre-COVID were still likely to need medical treatment, as delaying treatment does not mean the underlying condition has been addressed. In light of this, APRA issued guidance to PHIs in June 2020 about the establishment of a Deferred Claims Liability (DCL) – essentially money set aside as a contingency against the likelihood that cancelled or postponed treatments would be carried out at a later date.
Given longstanding community resentment about rising PHI premiums and the difficulties some policyholders have faced accessing health services during the pandemic, it’s understandable that this is a sensitive issue. I’d like to make a few points today so APRA’s position on the DCL is clear.
Firstly, APRA fully endorses the view that insurers should not profit from COVID, and therefore the DCL is not a means of increasing or protecting insurer profits. It is not, as one newspaper recently described it, a “pot of gold”. Rather than gouging policyholders, the DCL has been established as a means of protecting them by reducing the risk of PHIs being caught short of funds as a result of a surge of deferred claims, and unable to meet their financial obligations. It would be unhelpful to everyone, particularly policyholders, if no provisions were held, and future policyholders faced a substantial increase in premiums, or a material reduction in benefits, as “catch up” claims emerged.
Secondly, we have made clear that, as we emerge from the worst of the pandemic, the issue of how long PHIs hold on to their DCL, whether it should be reduced, returned to policyholders or otherwise invested, is a matter for PHI boards based on their view of likely claim patterns. As of March 2021, APRA relaxed its guidance to allow insurers the option of determining the value of their DCL as reported in their APRA returns. This means PHIs can consider unwinding the DCL over the rest of 2021 and beyond. Of course, APRA expects PHIs to make such financial decisions in accordance with the appropriate accounting requirements and with proper governance, including consideration of their risk and financial position. I note that some PHIs are currently using their own valuation for the DCL and more insurers are likely to do this as more data becomes available and experience stabilises. As at 31 March 2021, PHIs held $1.75 billion DCL in their balance sheets, up from $1.41 billion when it was initially established in the June quarter 2020.
APRA urges PHIs to remain prudent in their treatment of the DCL. It’s unclear how the longer-term health of Australians will be affected by COVID-19. We don’t yet know the impact on underlying health conditions due to deferred health screening and delayed preventative health treatment. As a result, there is a significant degree of uncertainty with regards to future claims activity and the overall economic and social impact of COVID-19 on membership mix, profitability and capital. It is therefore important that insurers continue to adopt a prudent approach when considering factors that determine the size of the DCL, and the timing of future releases.
Time for change
the industry’s COVID response is a positive story, the long-term trajectory of the industry remains substantially unchanged: premiums continue to increase faster than wage growth; underlying costs in the system are still accelerating more quickly than premiums, further squeezing profits, service delivery and policy features; the recent increase in policyholders is dominated by older members, rather than the younger, healthier demographic needed for a sustainable community rated system; and existing policyholders keep downgrading their cover.
All PHI stakeholders recognise this is not sustainable, and over the past year in particular we have seen some genuine progress in finding long-term solutions to the structural issues at the heart of the affordability dilemma. These include Government reforms such as modernising the prosthesis list, as well as reviews of Risk Equalisation and Lifetime Health Cover loading. We are seeing greater momentum in expanding out-of-hospital and online care, which has the potential to deliver substantial cost savings to insurers, and reduce upward pressure on premiums.
All of this is welcome, but very little of it is immediate in terms of impact. Determining and embedding the kinds of whole-of-industry reforms, policies and regulatory settings needed to fix the root cause of problems that have been building for decades is likely to take years. What PHIs need is time, both to better utilise existing tools, and also develop new tools to maximise the impact of reforms.
This brings me to APRA’s PHI Industry Strategy.
The strategy is designed to build entity and industry resilience through three key priorities:
- Strengthening the PHI legislative and prudential framework
- Intensifying our supervisory focus of PHI; and
- Reducing the risk of disorderly failure.
Compared to other industries that APRA regulates, there is a case that the PHI legislative and prudential framework can be strengthened and modernised, particularly in terms of crisis management powers1 and the application of the capital standards being contained to the health benefit fund rather than the registered PHI.
Reviewing the capital framework is the third and final phase of APRA’s multi-year resilience-building roadmap2. The proposed capital framework for PHI seeks to ensure that all material risks arising across the entire regulated institution are recognised, that a more standardised approach to setting capital requirements is applied, and there is greater confidence that components making up the capital base are readily available in a stress situation.
Intensifying our supervisory focus of PHI is the second key priority in our plan, with a specific emphasis on the affordability challenges, and further strengthening risk management and governance.
Earlier this year we recommenced our strategy to work with industry to discuss progress against APRA’s expectations, as outlined in our letter of 3 June 2019, regarding the need for insurers to put in place credible strategies aimed at mitigating affordability challenges. To date we have met with a number of insurers and key industry bodies to broaden our understanding of the types of strategies they have in place to manage this risk. We also continue to liaise with the Department of Health and other stakeholders to ensure there is a shared understanding of the challenges of affordability, and its prudential impact on the industry.
APRA will shortly be issuing a questionnaire to all PHIs examining issues such as:
- how are they resourcing their affordability strategies;
- how are they monitoring key metrics;
- what do they see as the future of PHI; and
- how can APRA help with the management of these risks.
The answers will be another key input as to how APRA will shape its supervisory activities in the foreseeable future.
We are also stepping up our focus on operational resilience across all APRA-regulated industries. For insurers, the pandemic has been a sharp reminder that they need not only adequate financial capacity, but also the ability to prevent, absorb and respond to shocks to ensure they can deliver core services at all times. The growing reliance by PHIs on third-party service providers creates risks here that are becoming more complex to manage, and of which APRA often has little-to-no visibility. Material service providers such as HAMBS, AHSA, HICAPs, to name just a few, are critical and important parts of the industry, and problems with any of these providers would have a material impact on PHI service delivery. APRA will therefore continue to push PHIs to strengthen their control over this significant service provider risk.
Preparing for Plan B
The third leg of the strategy is to reduce the risk of disorderly failure by requiring insurers to have a credible recovery plan to survive a shock, and restore themselves to a sound financial health, without public sector support.
APRA’s recovery planning initiative for PHIs was launched in 2019, and I am pleased to say that we’re now in a position where every PHI has a recovery plan in place that APRA has provided feedback on. PHIs are now significantly more prepared to face severe stress than they were two years ago. The industry has invested energy and resources and improved its resilience to benefit its policyholders and the Australian community, and this is a credit to the effort that has been put in by management and boards of insurers, many of whom are no doubt in the audience today.
There is still room for improvement, and APRA wants to be assured that recovery plans are embedded and credible, especially where there is a greater chance an entity will need to enact the plan. For some entities, enacting their recovery plan will mean consideration of a range of recovery options – such as raising capital, realising asset sales, or adjusting the cost base – that could be chosen to relieve the stress position, but for others it will be limited to a handful of key options, such as a merger.
As part of improving preparedness, APRA expects that insurers will engage others in the industry when developing their merger option, and I’d like to see these discussions normalised, as there has been a sense of taboo or reluctance in the past. Engaging with other insurers and industry players will help insurers to understand their own options, and potential impediments. Is the other party even interested? What’s the best approach to a for-profit open fund taking on a not-for-profit restricted entity? Do the systems and fund rules align? You’re only going to know if you have the discussion.
Addressing the “m” word
By even mentioning the possibility of mergers, APRA is often accused of having a consolidation agenda in PHI.
Let me take the opportunity to debunk this by making three points.
Firstly, APRA is stepping up its focus on recovery planning and resolution preparedness across all its regulated industries.
Secondly, we are not at, or close to, the point where a PHI may need to be wound up or forced into a merger.
Thirdly, rather than a consolidation agenda, APRA has a financial safety agenda aimed at creating a stable, resilient and sustainable PHI industry. We are perfectly happy to achieve this with the existing PHI mix, but if consolidation becomes necessary to protect policyholders’ interests, then so be it – the industry will be better off if we are all prepared, and actions are orderly.
Expecting PHIs to have actively considered merger options as part of their Plan B preparations doesn’t indicate an intention to merge. Having said that, we do expect plans built on prospective or potential mergers to be credible. Let me echo a remark APRA Deputy Chair Helen Rowell delivered recently to the superannuation industry that is equally relevant to PHIs. If two vulnerable PHIs merge, we may simply be left with a larger but equally vulnerable new entity, which is not a long-term solution.
At the same time, APRA is progressing its own resolution preparedness internally in case entity-led actions are not effective, the situation deteriorates and we need to step in to prevent an entity failure from becoming disorderly. This is not a position APRA wants to be in, but we are investing effort so we can confidently know when to act, what to do, and what resources would be required.
In for the long haul
As devotees of pop music would be well aware, roads are frequently long and winding, and so it is with the one leading to a sustainable PHI industry. Despite considerable effort over many years to make health insurance more affordable and health insurers more resilient, the journey still has a long way to go. Without further changes to lower costs in the system and attract younger, healthier policyholders, sooner or later some PHIs will need to seriously consider their future sustainability.
While all major industry stakeholders recognise the problems and are genuinely committed to fixing them, getting agreement on the solutions and reaping the benefits won’t be simple or quick. APRA’s PHI Industry Strategy is designed to keep PHIs on the road as long as possible by making the industry stronger and more resilient against the challenges it faces.
1 A stronger set of legislative powers was a recommendation of the APRA Capability Review.
2 Phase 1 covered risk management and Phase 2 dealt with governance.