Under the microscope: Disclosure of premium increases

Introduction

Over the last few years, the insurance industry has faced unprecedented regulatory reform, changing claims experience and broader economic, environmental and social factors which have resulted in substantial increases to premiums. APRA has also written to the life insurance industry raising its concerns about the sustainability of certain types of individual disability income insurance and implementing measures to counteract these.

The combination of these factors has resulted in a surge in customer complaints to insurers, regulators and the Australian Financial Complaints Authority (AFCA).[1] Whilst AFCA will not consider complaints relating to the quantum of the premium itself, it can and has considered whether the increases have been correctly applied, and whether there has been a breach of any legal obligations of the insurer, including the adequacy of its disclosures about the insurer’s ability to increase premiums. These disclosures include those made at the time of acquisition, such as Product Disclosure Statements (PDSs) and any subsequent disclosure, including renewal notices and any “significant events notices” sent by insurers to satisfy their obligations under section 1017B of the Corporations Act 2001 (Cth) (Corporations Act).

On 8 December 2022, APRA and ASIC jointly wrote to the CEOs of all life companies expressing their concern relating to premium increases applied to life insurance policies, particularly relating to level premium policies. It expects all life companies to review:

• past premium increases, including for legacy products, to determine whether increases or repricing decisions were applied in accordance with the relevant policy terms;
• disclosure and marketing material to determine whether policyholders were provided with sufficient clarity about future premiums, including changes to premiums over the life of the policy;
• the appropriateness and clarity of disclosures and marketing material for future premium increases;
• existing product labels, especially relating to the appropriateness where describing a product as having a ‘level premium’ if there is not a high degree of confidence regarding premium stability; and
• how policyholder expectations are being managed regarding premium increases.

Life companies must have written to ASIC by 31 March 2023 outlining:

• their findings in relation to that review;
• what steps are planned to report, rectify and remedy any issues identified; and
• what actions are being proposed to meeting ASIC’s and APRA’s expectations about future product design.

If a life company will not be able to complete the review by 31 March 2023, it must update ASIC by 28 February 2023. ASIC will arrange meetings with individual life insurers in April to May 2023 to discuss their responses.

This issue is a clearly critical one for both regulators and life insurers as it can trigger large-scale remediations and have potentially devastating capital implications on an insurer.

There are a variety of factors which an insurer should consider when assessing their disclosures- discussed below.

The backdrop – tension between the outcomes for the many versus outcomes for the few

The whole of the insurance industry is grappling with sustainability and rising costs. APRA, charged with the role of promoting financial system stability in Australia,[2] has been active in carrying out its objectives. In recognition of the need to be able price life insurance policies so that life insurance companies are sustainable APRA recently intervened in relation to individual disability income insurance policies, publishing a letter titled “Final individual disability income insurance sustainability measures,” dated 30 September 2020, in which it required a series of measures to be taken by life insurers. In that letter, it states:

“APRA wants to ensure that there is an appropriate mechanism to keep products in step with changing circumstances, both in respect of changes in the circumstances of individual policyholders and broader societal and economic changes. Such a mechanism should moderate the extent of premium increases that may otherwise be needed.”

As the terms of the benefits provided by these long-term policies cannot be altered to the detriment of the policy owner, it is the premiums that need to be altered to reflect “broader societal and economic changes.”

AFCA has also acknowledged the link between sustainability and the ability of an insurer to increase premiums:

“Firms rely on sufficient premiums being paid to cover potential claims. If the number of claims increases, then the firm may need to adjust its premiums to cover that increase. If a firm does not do this, then its ability to pay future claims may not be sustainable. Whilst customers do not want their premiums to increase, they generally do need their insurer to be in a financial position to pay benefits when they need them. 

Losses sustained by life insurers have been widely reported. APRA, the prudential regulator for life insurers, has published statistics showing large losses in income protection insurance, and has said it is concerned about the sustainability of this kind of insurance. Other kinds of life insurance have had similar problems. 

This means many insurers have had to increase their premiums.”

Notwithstanding its acknowledgement, AFCA’s mandate is fairness of outcome in all the circumstances for individual complainants, and whilst it takes legal principles into account, it can depart from those in order to make a determination which it believes is fair[3] - something which is clear in its determinations on premium increases.

When information that was disclosed to policyholders is considered, we consider that it is important to bear in mind that the policies under consideration are often long-term policies, some of which may have been taken out under disclosure regimes that pre-date PDSs. For example, under the disclosure regime immediately prior to the Financial Services Reform of 2001, a Key Features Statement was required to state that “any changes in fees and charges will be advised at least three months prior to the change occurring” but at that time there was a distinction made between premiums on the one hand and fees and costs on the other. Context is important especially when considering such long term policies.

AFCA’s determinations are binding on an insurer. Complying with a determination to re-price individual policyholders’ cover or an entire book may cause an insurer to fall foul of its other obligations and place stress on the stability of the statutory fund from which the insurance benefits are paid.

The tension is real and insurers can find themselves between a rock and a hard place on the subject of premium increases!

Interpretation of the policy – legal principles and applicable industry codes or guidance

Insurance contracts are interpreted in accordance with the principles that apply to the construction of commercial contracts. The seminal legal principle in the interpretation of an insurance policy was stated by Gleeson CJ in McCann v Switzerland Insurance Australia Ltd (2000) 203 CLR 579; [2000] HCA 65 at [22]:

A policy of insurance, even one required by statute, is a commercial contract and should be given a businesslike interpretation. Interpreting a commercial document requires attention to the language used by the parties, the commercial circumstances which the document addresses, and the objects which it is intended to secure.

This requires an assessment of the language of the policy and what would make business common sense as well as consideration of its various components so that, as a whole, it makes sense.[4] Each of these elements are considered briefly below:

• the language of the policy itself: the meaning of a written contract should be determined by reference to what a reasonable person in the position of the parties would understand by the language used.[5] If there are ambiguities, extrinsic evidence of objective facts known to both parties at the time the contract was formed may be admissible to assist in interpretation.[6]
• different parts of the policy: the interpretation of particular terms of a policy cannot be constructed in isolation from other relevant parts of the contract but must be considered in the context of the policy as a whole.[7] The resulting interpretation may be clearer on this basis or there may be inconsistencies which create ambiguities. Where there are ambiguities of meaning:
  • the contra proferentem principle will mean that ambiguity may be construed against the party that drafted the contract noting that this principle has been described as a rule of construction of last resort. There is some uncertainty surrounding the application of this principle which could influence an outcome for an insurer from AFCA or the Courts;[8] and
  • the duty of utmost good faith can prevent an insurer’s ability to rely on a term of an insurance contract if doing so would mean that the insurer is not acting consistently with this duty – see below for more detail on this duty.
• a businesslike interpretation: in order to ensure that insurance benefits can be paid by the insurer, the statutory funds from which those benefits are drawn must be sustained. This is particularly crucial for guaranteed renewable policies which cannot be cancelled by the insurer and are intended to be long term policies.

Accordingly, it is imperative that an insurer can change its premiums to reflect the risk it bears as issuer of the policies. For life insurance, the Life Insurance Act 1995 (Cth) (Life Act) recognises that pricing of policies will change over time for policies through its regulation of changes to the pricing in section 9A(5). This section contains an important consumer protection, by allowing unilateral alteration of premiums in the terms of the policy only if that alteration is made for policies of the same kind on a simultaneous and consistent basis and also a statutory recognition that the pricing of continuous disability policies will need to be altered on a unilateral basis by a life insurance company to appropriately reflect the risk that an insurer is taking on by issuing the policy and to ensure the sustainability of the statutory fund so that the insurer is able to pay any benefits that may become payable under the policies.

The duty of utmost good faith

Section 13 of the Insurance Contracts Act 1984 (Cth) (ICA) imposes on an insurer a duty to act with the utmost good faith in relation to any matter arising under or in relation to the contract of insurance. That obligation is owed to policyholders and insureds who are not themselves parties to the insurance contract but for whom the insurance is held (for example, in the case of insurance provided through superannuation products). The duty incorporates notions of fairness, reasonableness and community standards of decency and fair dealing,[9] requires more than honesty and that an insurer pay due regard to the interests of an insured.[10] It is not, however, fiduciary in nature and does not require an insurer to subjugate its interest to that of the insured.[11]

On the basis of this duty, an insurer can be prevented from relying on a term of a policy that is inconsistent with disclosure about that term.[12] Accordingly, while a combined product disclosure statement and policy document can be drafted so that some sections contain policy terms and others contain disclosure wording, an insurer’s duty of utmost good faith may require that it applies a particular policy term in a manner that is consistent with the disclosure of that term.

Ultimately, it is crucial that the key policy terms are properly disclosed to policyholders and insureds and to the extent that this is not the case, an insurer may not be able to apply those terms.

As it stands, the duty of utmost good faith is not capable of exhaustive definition and there is a degree of ambiguity surrounding its application which could influence an outcome for an insurer from AFCA or the Courts.

Other risks

Insurers who are considering the efficacy of their disclosures of premium increases should note the following risks:

• misleading or deceptive conduct: the concept of conduct that is misleading or deceptive or likely to mislead or deceive is relevant to legislative provisions such as section 12DA(1) of the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act) and section 1041H(1) of the Corporations Act.
  
  The concept of a disclosure document or statement being misleading or deceptive arises in provisions such as section 1021B(1)(a) (in the definition of “defective”) and 1022A(1)(a) (in the definition of “defective” – see next point for further discussion on defective PDSs) of the Corporations Act.
  
  It is important to note that pursuant to section 1041H(3)(c) of the Corporations Act and section 12DA(1A) of the ASIC Act, conduct in relation to a disclosure document or statement within the meaning of section 1022A does not contravene section 1041H(1) or section 12DA(1) respectively.  The effect of this being that misleading or deceptive representations in a disclosure document or statement (within the meaning of section 1022A of the Corporations Act) are regulated exclusively by Part 7.9 of the Corporations Act.[13]
  
  What constitutes a statement that is misleading or deceptive is not defined in the Corporations Act, but the following factors are relevant:

• failure to draw attention: a document which, when read as a whole, is factually true and accurate may still be capable of being misleading if it contains a potentially misleading primary statement which is corrected elsewhere in the document but without the reader’s attention being adequately drawn to the correction;[14] and
• qualifying statements: failure to qualify a statement may be misleading.[15]

Insurers considering this risk as part of their reviews should carefully review current and legacy PDSs (and other important associated disclosures) to ensure that their right to increase premiums has been preserved.

• defective PDS: to the extent that there are any misleading or deceptive statements, a PDS will be “defective” as defined in sections 1021B(1)(a) and 1022A(1)(a) of the Corporations Act. Section 1021B(1)(a) is the definition for criminal offences and has the additional element that the statement must be materially adverse from the point of view of a reasonable person considering whether to proceed to acquire the relevant policy.
  
  The provision of a defective PDS is generally prohibited under the Corporations Act[16] and accordingly is a potential breach of “financial services law.”[17] Determining the offence which could apply to the provision of a defective PDS will depend on the relevant circumstances. There is potential civil and criminal liability in relation to a “defective” PDS under sections 1022B (civil liability) and 1021E (criminal liability and civil penalty) of the Corporations Act but both have a potential “due diligence” defence that are on identical terms, which is that the person took reasonable steps[18] to ensure that the disclosure document or statement would not be defective.
  
  Whether a PDS is defective or not and if so, whether there are any available defences and to whom those will be available will depend on the circumstances of each case. As part of their review, Insurers should carefully consider current and legacy PDSs to ensure that their disclosure on increase premiums does not render the document defective and ensure robust compliance processes for the roll-out of future PDSs, continuous disclosures and online updates.

• “efficiently, honestly, fairly” obligation: issues with disclosures, especially where they are systemic, may leave an insurer open to a potential breach of its obligation under section 912A(1)(a) of the Corporations Act to do all things necessary to ensure that the financial services covered by its licence are provided “efficiently, honestly and fairly.” As this phrase cannot be comprehensively defined, the circumstances of each matter will be key to its application.[19] This obligation in particular gives legislative force to social and commercial norms of behaviour, something which was heavily emphasised during the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. ASIC may, therefore, also pursue AFS licensees for conduct which it perceives to be a breach of community expectations or commercial norms. This means that as part of its review, an insurer will need to examine not only the terms of the policy itself but its surrounding conduct in light of community expectations and commercial norms.
  
  A breach of this obligation could result in significant civil pecuniary penalties,[20] including:
  • $11.1 million (current equivalent to the prescribed 50,000 penalty units noting that the amount of a penalty unit will increase from 1 January 2023);
    
  • three times the benefit derived and detriment avoided; or
  • 10% of the annual turnover of the insurer and their related bodies corporate capped at $555 million dollars (2.5 million penalty units noting that the amount of a penalty unit will increase from 1 January 2023).

Insurers considering their risk in relation to this obligation can reduce that risk going forward by issuing clearer wording in policy renewal documents to ensure that policyholders are aware of the possibility of changes to the level premiums under the policy.

• reinsurance: issues relating to an insurer’s ability to increase its premiums may trigger obligations and potential liabilities to its reinsurers. There may be reporting obligations and any retrospective and prospective adjustment of premiums may crystallise rights of the reinsurers under the relevant treaties in respect of warranties, recoveries already paid, indemnification for loss and other matters. Insurers should carefully consider and understand these obligations and regularly monitor so as to comply with them in a timely manner. Although exempt legislatively,[21] it is worth noting that many reinsurance treaties enshrine a duty of utmost good faith as between the insurer and reinsurer.
• future product design: the design of sustainable future products in the life insurance space is clearly a key concern for APRA and ASIC. Life companies should carefully consider the design of products in the future, especially relating to what have been traditionally referred to as ‘level premium’ options to ensure that the product is sustainable from end to end, including the clarity of the policy and any disclosures at formation and throughout the life of the product.
• regulatory action: insurers with sub-standard disclosure and policy wording should anticipate that regulatory action may be taken against them by ASIC or APRA. This may ultimately result in the acceptance of an enforceable undertaking by ASIC under section 93AA of the ASIC Act or, more increasingly, the commencement of civil and criminal proceedings for contravention of obligations under the Corporations Act. In respect of APRA, it has a range of formal and informal enforcement tools available to it,[22] including the acceptance of enforceable undertakings and the imposition of licence conditions on an insurer.

The issue of disclosure and premium increases is now under the regulatory microscope and cuts to the very heart of the sustainability and stability of the insurance industry itself. The tension between the known protective value of insurances to the community and the cost of obtaining that protection is greater than ever. As part of the review required by APRA and ASIC, Insurers will need to carefully consider their current and legacy PDSs and other important documents to assess their right to increase premiums, and strengthen due diligence compliance processes around the development and amendment of important disclosures to reduce the risk that any changes made will erode those rights going forward.

The KWM team have deep experience advising on this issue and are happy to assist you in conducting your policy and disclosure reviews.