The Australian Prudential Regulation Authority has launched an intervention into the life insurance market in response to ongoing heavy losses in respect of individual disability income insurance.
The regulator announced a series of measures, including capital charges, which will require life insurers to address flaws in product design and pricing that are contributing to unsustainable practices.
"Life companies have collectively lost around $3.4 billion over the past five years through the sale of DII to individuals (rather than through superannuation). APRA wrote to the industry in May requesting urgent action to address the problems," APRA said.
"Since then, insurers have reported further losses of $1 billion, prompting APRA to escalate its response."
With at least one major reinsurer indicating it was no longer prepared to reinsure individual DII, APRA executive board member Geoff Summerhayes said there is now a genuine risk insurers may start withdrawing from the market.
"Disability income insurance plays a vital role in providing replacement income to policyholders when they are unable to work due to illness or injury," Summerhayes said.
"In a drive for market share, life companies have been keeping premiums at unsustainably low levels, and designing policies with excessively generous features and terms that, in some cases, provide a financial disincentive for policyholders to return to work."
In response Zurich said it welcomes the comments made by APRA.
"Zurich...welcomes efforts made to ensure the long term sustainability of a product that is vital for protecting the financial security of Australians," Zurich said.
"Zurich will comply with all regulatory changes, and will review and consider all recommendations made. We are strongly committed to providing our customers with access to a range of affordable, high quality life insurance cover."
APRA said it will impose an upfront capital requirement on all individual DII providers, effective from 31 March 2020.
The capital requirement will remain in place until individual insurers can demonstrate they have taken adequate and timely steps to address APRA's sustainability concerns.
"In instances where individual insurers continue to fail to meet APRA's expectations, APRA may also issue directions or make changes to licence conditions," the regulator said.
APRA said it expects life insurance companies to better manage riskier product features by ensuring DII benefits do not exceed the policyholders income at the time of claim, avoiding offering DII policies with fixed terms and conditions of over five years and ensuring effective controls are in place to manage the risks associated with longer benefit periods.
The regulator said it will collect and release better insights into marker trends and developments by implementing individual DII data collection, due to be released next year.