Income protection insurance has a $450 million problem.

Insurers seek to avert affordability crisis for 650,000 policyholders, writes Rob Stock.

Insurers are under pressure to make changes to income protection policies before they face the kind of affordability crisis which prompted Australian regulators to intervene. There are around 650,000 income protection policies on issue in New Zealand, earning premiums of more than $450 million a year for insurers, figures from the Financial Services Council show.

Income protection insurance pays out in the event illness, or injury not covered by ACC, results in the loss of work.

Insurers at the FSC conference this month discussed concerns that people relying on the policies could soon find they become unaffordable due to rising claims costs and rising premiums.

Across the Tasman, consumers being ‘‘priceforced’’ to cancel their policies led regulator Apra to ban insurers from offering policies which would replace more than 70 per cent of policyholders’ incomes should they be forced to make a claim.

Apra concluded such high income replacement ratios meant policyholders, especially ones with significant investment wealth, had little incentive to work again, and stayed ‘‘on claim’’ for as long as they could, driving up claims costs, which were passed on as premium rises to other policyholders.

Australian insurers were making such big losses on income protection, the regulator concluded they had miscalculated the risks of issuing their policies, and ordered them to hold more capital.

It also concluded that it had to intervene because all insurers feared being the first to make changes.

Apra also banned the sale of ‘‘agreed value’’ policies where self-employed policyholders could choose the level of payments they would get if they were unable to work, Kimberley Robinson of reinsurer Swiss Re told the conference.

Shami Shearer, director actuarial insurance services at Deloitte, said New Zealand was ‘‘not immune to some of the underlying causes of problems in Australia’’.

‘‘We’ve seen escalating claims costs that end up being passed on to customers through price increases,’’ Shearer said.

While income protection affordability has been big news in Australia, the issue has not made headlines in New Zealand in the same way that affordability of health insurance for over-65s has.

It took insurer Partners Life to break the silence last month when it revealed a brave plan to start publishing the content of discussions with the Financial Markets Authority.

In doing so, it revealed it lifted its income protection premiums by 12 per cent in the past year, and had made policy changes, including no longer allowing self-employed people to select an ‘‘agreed value’’ of income to be covered, instead limiting cover to actual loss of earnings.

Partners Life’s chief marketing officer, Kris Ballantyne, said the company was a ‘‘first mover’’ on income protection, driven by wanting to provide policies customers could afford to keep as long as they needed it.

It was a big challenge as there were a lot of agreed-value policies covering self-employed people, and owners of small businesses.

Neither of its two big rivals, AIA nor Cigna, was expecting to make such large premium increases, though AIA had stopped selling new policies where the income covered automatically increased by 5 per cent a year.

AIA chief product officer Len Elikhis said that over time, ‘‘the insured’s benefits would creep up and approach the insured’s income’’.

‘‘If I’m earning $100,000, and my income protection benefit has increased to $100,000, I will be less financially motivated to return to work than if my income remained at about the $65,000 mark,’’ he said.

Agreed-value policies remained on sale in New Zealand, and other policy features were red flags, Swiss Re told insurers.

This included some cases where policyholders could collect income protection payments as well as ACC, resulting in very high levels of income replacement in some cases.

Swiss Re senior underwriting consultant in Australia, Shane Burdack, said that in New Zealand, insurers gave little thought to the net wealth of policyholders.

Yet people with significant wealth – sometimes through investments, sometimes because of payouts from other insurance policies – had a low incentive to go back to work, and stayed ‘‘on claim’’ for longer, driving up costs.

Insurers at the conference also discussed whether there should be a move away from selling new ‘‘own occupation’’ income protection policies, which pay claims to people who could no longer work in their own occupation, even if they could work in others.

Peter Doherty, chief customer officer from Fidelity Life, said the industry did not want to disadvantage customers.

‘‘There are things that we can do to try and make sure we are treating everybody fairly, and drive some degree of sustainability back into the product,’’ he said.

The focus of income protection should be on helping people get back to work.

‘‘If it was called ‘back to work’ cover, would it have a difference on the mindset of people using it?’’

Once a policy was issued, it remained in force unless the policyholder cancelled, or moved on to another policy.

Burdock expected new, lower-cover forms of income protection insurance would emerge in Australia, and people who could not afford their current policies would switch.

Insurance adviser Katrina Church, from Insurance People, said it was important to keep products affordable.

‘‘If you’re sitting with a cancer survivor or someone who’s had a shoulder surgery declined by ACC because it’s degenerative, or someone’s got a long-term illness like Parkinson’s or MS (multiple sclerosis), they will see income protection as being gold,’’ Church said.

‘‘It gives them a chance to heal. It gives them a chance to reset. It gives them a chance to protect their assets.’’

High payments mean policyholders stay ‘‘on claim’’ for as long as they can, driving up claims costs, resulting in premium rises to other policyholders.