In the crosshairs: Product design for superannuation trustees and life insurers

Life insurers and superannuation trustees should be considering the design of their products and the commercial outcomes for policy holders and members along with their target market determinations.

Whilst the Australian Securities & Investments Commission (ASIC) had previously announced its strengthened focus on product design and distribution, issued a slew of interim stop orders against Australian Financial Services licensees ^[1] and even commenced civil penalty action in the Federal Court against one licensee, ^[2] it has signalled more recently that it will be turning its attention to superannuation trustees and life insurers. 

In addition to their prudential obligations and the regulatory action taken by both ASIC and APRA to prompt the remediation of existing products design and ensuring sustainable and value-driven future product solutions, issuers must also comply with:

• product design and distribution obligations ^[3] which came into force on 5 October 2021 as part of the regulatory reform coming out of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry; and
• the unfair contracts (UCT) regime, which came into force on 5 April 2021 and has required insurers to rethink contract drafting for the products that are impacted to ensure the additional obligations are met.

On 3 November 2022, ASIC announced its enforcement priorities for 2023 and, at the very top of the list was:

‘Enforcement action, targeting poor design, pricing and distribution of financial products

including in relation to insurance, superannuation and other investment products and credit.’

Whilst this particular priority has been the subject of enforcement action for Australian financial services licensees in 2022 (outlined above), the objects of ASIC’s attention have been primarily managed funds and investment companies. The explicit inclusion of insurance and superannuation in its latest enforcement priorities announcement may foreshadow the turn of ASIC’s gaze towards these industries in 2023 and beyond.

Life insurance

ASIC’s increased its concentration on product design features for group insurance through Report 498 ‘Life insurance claims: an industry review’ (Report 498) ^[4], Report 633 ‘Holes in the safety net: a review of TPD insurance claims’ ^[5] (Report 633), Report 696 ‘TPD insurance: progress made but gaps remain’ (Report 696),^[6] and Report 760 ‘Insurance in superannuation: Industry progress on delivering better outcomes for members’ ^[7] (Report 760).

As a result of Report 633 and its findings on the inherently poor outcomes flowing from particular features of total and permanent disablement (TPD) cover, such as ‘Activities of Daily Living’ (ADL) definitions, many insurers and superannuation trustees were required to consider the design of the insurance products offered through superannuation. In its follow up, Report 696, ASIC noted that insurers ‘should continue to review TPD policies that include restrictive definitions and consider removing them or appropriately redesigning the product’ and ‘should continue to improve the design of their products to meet consumer needs – including products that are fit for purpose in meeting mental health needs. ^[8]  Report 760 noted that for cover provided through superannuation, there had been an decrease in the number of claims assessed against the ADL definition.

Next, in letters sent to the industry in 2020, APRA expressed concerns over the sustainability of individual disability income insurance product and required insurers to implement a variety of measures (including relating to product design) to address those concerns. ^[9] APRA has more recently commented that a balance needs to be struck between sustainability and profitability in product design in the individual disability income insurance context. ^[10]

Last, on 8 December 2022, APRA and ASIC jointly wrote to the CEOs of all life companies to expressing their concern relating to premium increases applied to life insurance policies, particularly relating to level premium policies. Insurers were required to review past and current disclosures on premium increases and  examine, amongst other things, 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. Responses were due to ASIC on 31 March 2023 and in-person consultation will commence with insurers in April and May. This review will cause insurers to carefully consider the design of their current and future products to ensure that the product is sustainable from end to end.

Superannuation trustees

The regulatory landscape for superannuation has been refocussing incrementally on the adequacy of product design for some time. In addition, to its existing legal and regulatory obligations, in 2018, APRA created a new prudential requirement SPS 515 ‘Strategic Planning and Member Outcomes’, which causes superannuation trustees to annually review its business planning and the outcomes achieved through its product offering for members.

A further example of product design under the spotlight for superannuation is evident in the recent amendments to the Superannuation Industry (Supervision) Act 1993 which inserted a retirement income covenant, ^[11] which came into force on 1 July 2022. At its core, the covenant requires that a trustee must formulate, review regularly and give effect to a retirement income strategy for beneficiaries who are approaching or are in retirement. This goes to the very heart of product design as it requires a superannuation trustee to examine its retirement objectives (including maximising retirement income and expected risks) against its membership demographics to interrogate whether those objectives are met for their members. After such an assessment, trustees may reach the conclusion that their product offerings are not sufficient and that they need to issue new products to address the gaps. Where trustees choose to develop their own inhouse innovative income products to achieve this, they may utilise the “Cross-agency Process for Innovative Retirement Income Stream Products.” This is a process developed by the government to encourage the development of new income stream products with early input from the ATO, APRA, ASIC and DSS. Product developers can use this to test concepts with, seek high-level guidance from and provide input to these regulatory bodies on new products.

More recently, ^[12] Treasury released a consultation paper proposing to embed in legislation an ‘objective of superannuation’, being ‘…to preserve savings to deliver income for a dignified retirement, alongside government support, in an equitable and sustainable way.’ Amongst other things, this proposed initiative highlights the renewed focus of the government on ensuring that the purpose of superannuation remains front of mind for policymakers, regulators and superannuation trustees alike.

Last, in March 2022, ASIC served 15 superannuation trustees from across the industry with compulsory notices to determine what actions had been undertaken to improve their insurance offerings. ^[13] As a result of those notices, ASIC published (in March 2023) Report 760, which focusses heavily on product design. The priority given by the regulator to product design is evident in its introductory remarks in that report:

‘The design and delivery of insurance cover, especially default insurance, has a powerful influence on member outcomes. Where insurance cover is not well designed, it puts members at risk of paying for insurance that does not meet their needs, is excessively costly (eroding their superannuation balance), or cannot be claimed on.’ ^[14]

As for the results, ASIC observed that:

• most of the 15 trustees had taken action to modify or remove restrictive TPD definitions, including ADL and inserting mental health specific criteria;
• all of the trustees had made changes to the design of the insurance offered, including terms and conditions or pricing structures to improve member outcomes and reduce the risk of low-value outcomes;
• many trustees made changes to simplify insurance arrangements to keep premiums at an affordable level; and
• the target market determinations (TMDs) of some of the 15 trustees were too broadly described and triggers for the review of the appropriateness of those TMDs were not sufficient.

In the crosshairs

Stepping back and examining the journey so far, all signs point towards superannuation trustees and insurers being squarely in the product design enforcement crosshairs of the regulators for 2023 and beyond, and particular care should be taken by product issuers to tread carefully, including:

• a thorough review and challenge of all TMDs relating to their products currently on the market;
• regular review of the features, benefits and cost of their products currently on the market to look for deficiencies in value or outcomes for policyholders or members;
• maintenance of high quality data about their policyholders or members which can be well extrapolated and synthesised so that they are in a position to measure products on offer or planned against their customer base;
• ensuring compliance with all of their legal and regulatory obligations;
• robust due diligence (including legal and risk) and planning of product specifications for new offerings, including long-term financial sustainability and benefit outcomes testing; and
• ensuring that any distribution networks used adhere to the policies and principles of the product issuer so that products are not issued to customers for whom that product is not targeted nor for whom it is appropriate.