Recent failures in general insurance underwriting and pricing in Australia: Learnings and considerations for risk management – Part 1

In the first article of this series, I’ll examine recent issues and explore what uplifts may be required in risk management and controls going forward.

This article will review a list of key underwriting and pricing issues in Australia based on publicly disclosed information that has recently arisen. The objective is to learn from costly past failures to understand the implications to risk management processes to mitigate such risks in the future. Discussion on preventative steps and uplifts to risk management and controls will be explored in the next article.

Review of Failures in General Insurance Underwriting and Pricing

The risk management and governance of underwriting and pricing of general insurance have never been more in the spotlight in Australia.

Since 2018, a significant number of pricing breaches have been reported by general insurers to the Australian Securities and Investments Commission (ASIC) ^[1]. The issues identified dated back several years across products and have resulted in hundreds of millions in remediation payments to thousands of Australian customers. The breakdown in sound risk management and culture was further exposed by the business interruption (BI) insurance coverage issues arising from the COVID-19 pandemic ^[2].

Two test cases ^[3] were eventually brought to the High Court of Australia to provide clarity on the interpretation of BI policies, and the resulting BI provision was estimated to total over $600 million^[1]. In the meantime, community discussions and regulatory developments in Australia and internationally raise additional implications on industry underwriting and pricing practices relating to discrimination and fairness, data privacy, affordability, taking advantage of customers’ behaviour vulnerabilities (sometimes via pricing techniques known as “price optimisation”) and to ensuring insurance products meet customers’ needs ^{[4, 5, 6,7]}.

Some Key Underwriting and Pricing Failures in Australia

1.   Unintentional Coverage in Policy Wording

At the outbreak of the COVID-19 pandemic, many BI policies sought to exclude covers for pandemics by an exclusion referring to the Quarantine Act and its subsequent amendments. However, the Quarantine Act was repealed in June 2016 and the Biosecurity Act came into force. The NSW Court of Appeal judgement found that the words “subsequent amendments” do not extend to or include the Biosecurity Act and COVID-19 was not excluded from the coverage ^[8] even though it was determined to be a listed disease under the Biosecurity Act.

In a later risk self-assessment required by the Australian Prudential Regulation Authority (APRA), many insurers acknowledged their awareness of the legislation change, however, they had not adjusted their wordings for assorted reasons ^[2]. As highlighted by APRA, it is likely that there are vulnerabilities other than legislative updates in the wording ^[2]. From the perspective of underwriting and pricing, the author believes the BI issues represent a broad category of risk management breakdowns, i.e., a failure to exclude unintentional covers due to issues in the policy wording. The BI coverage issues cost the industry more than $600 million, according to the latest financial reports of major insurers released as of 24 February 2023.

2.   Failure to Deliver Pricing as Promised to Customers

A considerable number of breaches in relation to failures to honour price promises have been unearthed and reported to ASIC since 2018 ^[1]. As of September 2022, industry-wide failures had resulted in over $800 million in refunds or provisions for customer remediation ^[9]. The failures had occurred due to various underlying causes that were often interrelated.

Problems in Pricing Algorithms

A probe into two breaches ^[10 11] illustrates classic instances of issues in algorithms. In the first case, a cupping mechanism^[2] within the price calculation algorithm caused promised discounts not to be fully passed on to customers without disclosure of this mechanism to customers ^[10]. In the second case, some pricing discounts were not applied to additional premiums of optional extras because the algorithm first calculated pricing discounts and then added additional premiums for optional extras ^[11]. Therefore, the pricing practice was inconsistent with disclosures made to customers about how their premium was calculated. In both cases, the design of the pricing algorithm, which is often a complex set of business rules and calculation logic, had overlooked nuances with respect to what was communicated to the customer.

Problems in pricing governance and controls

A customer not being provided pricing as promised by an insurance company reflects a breakdown of internal controls and processes that could have prevented such issues from happening in the first place. There are a diverse range of issues that have happened in the past and no single fix could have prevented these, showing a need for stronger pricing governance. For example, premium reductions for home policyholders who turned 50 years old and for fuel-efficient vehicles were promised but not fulfilled ^[12]; in an earlier breach, senior cardholders were not provided discounts on home and content policies as promoted ^[13]. These issues exemplify disconnects between different functions of an insurer’s product management process. APRA has called for improvements in product life cycle management from a recent insurance risk self-assessment thematic review ^[2].

Data Quality and Operational Issues

Some breaches were caused by issues in data used for pricing, e.g., premiums were calculated based on incorrect claim history ^[14]. In many cases, data quality issues were associated with operational issues, i.e., insurers didn’t ask for data that would have made customers eligible for lower premiums, or the data was not recorded in the system properly.

3.   Inappropriate Sale Practices and Selling Products that Provide Little Value to Consumers

Several breaches involved selling insurance to customers who received little or no value or were ineligible to claim ^{[15, 16, 17]}. The sale practice often involved misconduct, such as pressure selling ^[16] and over-insurance ^[15]. In most cases, it also involved unfair pricing (i.e., sale of policies on distribution partners’ websites for premiums that were higher than those for standalone policies) ^[17]; or incorrect charge for covers ^{[15, 16]}. The breaches resulted in refunds of $130 million for add-on insurance ^[15], $160 million for customer credit insurance ^[16], and $10 million for travel insurance ^[17].

4.   Others

Other reported breaches in relation to pricing and underwriting based on ASIC disclosures come from a variety of issues, such as inadequate communications, or misrepresentations ^[16]. The author also analysed determinations on individual customer complaints to the Australian Financial Complaints Authority (AFCA). Some examples of identified breaches included: incorrect premiums ^[14]; failed communications ^{[18, 19, 20]}; cancellation or renewal without consents ^{[21, 22]}; or unclear and unsubstantiated significant premium increases ^[23]. These were not necessarily systemic issues but highlighted important themes that insurers need to be aware of when building strong underwriting and pricing processes.

Conclusion

To summarise, this article reviewed a list of key general insurance underwriting and pricing issues in Australia in recent years. The second article in this series will discuss preventative steps and explore potential uplifts to risk management and controls going forward.

Acknowledgement

The author would like to thank Mudit Gupta for his valuable comments and feedback during drafting of this article.

References

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