I have just completed my fourth financial year-end as an Appointed Actuary to several friendly societies. Over that time, I’ve had the privilege of helping guide these APRA regulated life insurers through a period of extreme financial and operational environments. These challenges have also been felt across the wider financial services industry. Reflecting on the industry, there are a number of key themes, which are mirrored in APRA’s areas of focus:
Members’ best interests and best outcomes
The dominant theme in financial services in recent years has been the need for providers to put the needs of the customer first to ensure the best outcome for not only them, but the industry as a whole. That must always be the core driver so we can rebuild the trust needed to repeatedly deliver the right services to the right people at the right price. The Hayne Royal Commission demonstrated vividly the damage to customers and providers, including board members and senior management, when this doesn’t happen. It has unleashed forces that are reshaping the wealth management industry ownership and distribution for the better.
In superannuation, APRA’s Prudential Standard for Superannuation, SPS 515 Strategic Planning and Member Outcomes, has spelt out expectations. The recent ‘Your Future Your Super’ legislation has strengthened this focus, adding the word financial to the pre-existing cornerstone of best interest duty requirement for trustees.
The 1995 Life Act states that a life company in the investment, administration and management of the assets of a statutory fund, must give priority to the interests of owners and prospective owners of policies referable to the fund. This is not a new concept!
A huge challenge for friendly societies has been capital guarantees, which have become increasingly costly to support in an era of historically low interest rates. Where funds are invested short in order to match policyholders’ ability to withdrawal without notice, earnings are less than management fees due to cash rates at 0.1% pa and short term returns not much higher. As a result, solutions such as management fee reductions, drawing on past accumulated surplus, and/or seed capital are required to ensure policyholder account balances do not reduce. With the RBA promising not to raise short term rates until 2024, such products offering nil or close to nil bonus rates are no longer meeting the needs of their policyholders and are thus not sustainable for either policyholders or the societies.
The investment situation is exacerbated by the fact that many of these products are legacy products, with society benefit funds featuring a complex mix of past products often from several since merged friendly societies. They are more costly to administer than modern products not least because they often have old administration systems. These higher costs make it more difficult to provide value to policyholders compared to modern, more easily and better administered policies on modern, more flexible systems.
There is strong competition on fees from newer and wider field competitors in the non-guaranteed / investment linked space. Achieving scale by increasing funds under management through new sales and retention is critical to industry and society sustainability.
The difficult environment explains APRA’s strong interest in recovery planning.
Risk management and capital adequacy
At the heart of insurance risk management is the ICAAP – the Internal Capital Adequacy Assessment Process. APRA Standard LPS 110 sets out the requirements for life insurers. The calculation of the prudential capital required applies stresses to the insurance and investment elements, to ensure that policyholders are protected against a 1 in 200 year event. The societies must fund this capital which can be substantial. This needs to be priced into capital guaranteed products, which worsens their current lack of sustainability.
Check list for product and entity sustainability:
- Simple, easily understood and administered
- No low value to member options
- Close / convert capital guaranteed to investment linked
- Low capital requirements
- Efficient and effective service
- Address investment and insurance
- Profitable to insurer/society
- Reserve historical tax benefits
- Rationalise / terminate existing funds
- Retain and grow profitable business
- Increase competitiveness – survival of the fittest: costs, fees
- Increase competitiveness
- Build scale – Retain and grow profitable business
- Enhance volume and efficiency of distribution
- Reduce costs and reduce fees
- Fintech & Regtech – smart use
- Partner; Outsource.