The Australian life insurance sector continues to face headwinds from the loss-making income protection class and reputational risk, according to S&P Global Ratings.

But capitalisation levels remain comfortably above regulatory requirements and a solid return on equity of about 10% is expected over the next few years.

Analyst Daiwyn Naidoo says insurers are recalibrating income protection prices and adjusting policies after soaring claims caused the class – a “problem child” for the industry – to slide into the red in the past three years.

“We expect the repricing and amendments to policy terms and conditions over the 12 to 18 months to take some time before resulting in improved profitability for this class,” he said.

Life insurers face reputational risk after reports highlighting poor claims handling.

An industry code of conduct, which took effect this year, aims to rebuild public trust and confidence, but the sector faces risks from a number of reviews and inquiries triggered over the past two years. The Parliamentary Joint Committee on Corporations and Financial Services is due to report by the end of next month.

“We anticipate these reviews could lead to greater regulation and an increase in compliance costs, which could hurt profitability,” S&P says.

The tough environment has caused several financial services groups to review their life business. NAB has sold its MLC life business to Nippon, Commonwealth Bank is in talks with third parties about CommInsure, ANZ is looking to divest OnePath and Suncorp is weighing up Asteron’s future.

“Whatever happens, the industry dynamics will be changed,” Mr Naidoo said.

The Federal Government has mandated a lowering of upfront commissions paid to advisers from next year. S&P says the lower commission structure in a concentrated market with strong brand loyalty could facilitate further improvements in lapse rates.