Life insurers could be hit with more penalties if they fail to “take the necessary actions” to improve the pricing and sustainability of individual disability income insurance (DII) products.

The Australian Prudential Regulation Authority (APRA) has left the door open for additional measures in its inaugural Year in Review report on the financial services industry.

The report says DII policies are still poorly designed and unsustainably priced – a situation that has led to more than $3 billion in losses in the past five years.

Most recently, in the nine months to September, sales of DII policies produced $1 billion in losses, prompting APRA to impose an upfront capital requirement on all DII providers. The capital measure will take effect at the end of next month.

“This action is intended to incentivise industry to overcome ‘first-mover disadvantage’ and take the necessary actions to address the risks associated with DII,” APRA says in the report.

“Years of intense competition in the individual DII market segment, where policies are sold to individuals rather than embedded in their superannuation, have resulted in substantial losses for insurers, jeopardising both the viability of the DII product and the protection it offers to the Australian community.”

When APRA announced the capital intervention in December, the regulator warned it stood ready to escalate its actions if it was not satisfied with the industry’s response.

“The capital requirement will remain in place until individual insurers can demonstrate they have taken adequate and timely steps to address APRA’s sustainability concerns,” Executive Board Member Geoff Summerhayes said.

“In instances where individual insurers continue to fail to meet APRA’s expectations, APRA may also issue directions or make changes to licence conditions.”