Raising premiums is not always the best solution to increased life insurance claims, the Australian Prudential Regulation Authority (APRA) warns.

It follows the regulator’s stress-testing of life insurers and reinsurers last year.

APRA Executive Member Geoff Summerhayes says premium increases are an acceptable and logical step, but are not without risks.

“Repricing poses challenges such as the speed in which to expect benefits and ease of implementation,” he said. “Another difficulty is understanding how competitors would be responding to both the scenario in general and their own specific business needs.”

Mr Summerhayes says not all insurers choose the premium-increase option when undertaking the regulator’s stress-testing. Other actions include reduction or suspension of dividends to shareholders and capital injections.

It was APRA’s first stress-testing exercise on the life industry.

It used a three-year time span with economic parameters based on a downturn in the Chinese economy, a decline in global growth and recession in Australia, with GDP falling 5% and unemployment increasing to 14%. 

The testing particularly examined the impact on disability income insurance and total and permanent disability cover.

Mr Summerhayes says, without allowing for management action, the testing showed insurers experiencing significant losses and a material decline in their capital. The impact on the industry’s profitability in the first year was a combined loss of about $900 million. This blew out to $1.6 billion in year three of the testing scenario.

“Profitability improved once insurers were able to factor in the application of various mitigation strategies, including repricing. But unsurprisingly given the extent of the adversity, this would be insufficient to return the industry to anything like the baseline position.”

Mr Summerhayes says APRA will undertake the exercise again in 2018, this time involving all of the life insurance industry.

“The stress test was not without its challenges, but it was highly worthwhile. Not only did it shine a light on areas of concern, such as disability income insurance, it reinforced and set expectations for continued advancement of stress-testing capabilities in the industry.”

He says the exercise shows the need for recovery planning.

“Recovery planning is inherently linked to stress-testing and we must ensure the insurance industry remains vigilant, has well-considered actions to deal with adversity and can exercise those actions effectively if needed.”