The Australian life insurance industry faces lower margins amid potential regulatory changes, according to Standard & Poor’s (S&P).

“The main risk… lies in the medium term in relation to potential for changes in the industry’s structure and regulation,” the ratings agency says in a new report.

“While it is clear-cut there will be more, not less, regulation, how much more, and at what cost to margins, remains a significant unknown.”

This uncertainty is expected to affect merger and acquisition activity, despite the sale of MLC’s life business and Macquarie leaving the sector.

“The uncertainty over the likely regulation and structure of the sector suggests such activity is likely to be more subdued for the remainder of the year. We believe possible buyers may be reluctant to engage until a greater level of regulatory certainty emerges.”

S&P believes big banks will hold on to their insurance businesses, despite NAB’s deal with Nippon Life for the insurance component of MLC.

“We currently equalise our ratings on all major Australian bank-owned insurance subsidiaries with our credit view of their respective banking groups, largely because of our belief they are highly unlikely to be sold,” the report says.

“They remain of very high strategic importance to the wider banking groups.”

The agency will review these links if it looks like an insurance business will be sold or its importance within the bank has weakened.

Despite the uncertainty, S&P says the Australian life insurance industry’s profitability is favourable when compared with global markets.

It notes some concerns regarding the group life market, due to higher claims and lapse rates.

“We expect the Australian life insurance sector to continue to stabilise during the coming 12 months following a number of particularly challenging years of heightened claims and lapse rates. We believe a combination of factors, including material targeted price rises, a tightening in underwriting standards and reforms to adviser commissions stand the industry in a solid position to modestly improve performance during the medium term.”