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Building blocks of premium construction

Against a backdrop of increased industry commentary regarding the sustainability of the income protection market and trends in pricing, it's important advisers appreciate the forces at play. This includes the changing trends in claims, medical advancements, technology innovations and competitive market forces.

These factors are contributing to the changing face of insurance and improving the customer experience, however many industry commentators are acknowledging that there is an equilibrium currently being sought across the industry that seeks to balance the IP offer and the sustainability of that offer. After all, long term sustainability of the insurance industry is critical to the nation's health.

The other element worth exploring and understanding is the actual dynamics of premium construction. There are quite a few dynamics at play and at any point in time, each one can have a different level of impact.

The first is the very nature of risk pricing and the fact that it's cyclical. As providers become more efficient in running their businesses and competition grows, prices tend to fall. Sometimes they can fall to unsustainable levels for a period of time before market forces bring them back to a level that's more sustainable over the long term.

We have certainly seen the competitive landscape of the insurance market proliferate in the last few decades. Go back to the 1970s and pre-deregulation, the insurance industry was heavily concentrated with the five largest insurance firms accounting for more than 85 per cent of premium income. These days, Rice Warner research shows there are 17 life companies offering retail insurance products, each offering up to 13 types of cover and varied coverage (from low cost to premium).

The legislative and economic events that took place in the 1980s to open up the financial markets to greater competition has definitely produced greater convenience and choice for customers, and a new competitive environment for industry participants.

The second element to consider when it comes to premium construction is the changing profile of IP claims. Everyone is well aware that the claims pool is no longer dominated by short term injuries from "blue-collar workers". The awareness and acceptance of mental health, especially among professionals, is a growing trend and most importantly, we are seeing significant benefits in disability duration by working with health professionals and support networks on rehabilitation strategies in this area.

In addition, the focus on returning customers to "wellness", rather than returning to work as a first priority, and making sure they are not financially penalised is a positive and significant "broader lens" that we - at CommInsure - are applying to rehabilitation. Similarly, the general professionalism of the advice industry and the code of practice in proactively identifying benefits is producing shifts in the number and type of claims.

Both of these elements, combined with the changing nature of claims, are very different to decades ago. They produce significantly better customer outcomes and need to remain a mainstay of the industry. They are also a factor of premium construction that needs to be considered in respect to our long term sustainability goals.

Finally, the interest rate environment and the income earned to support the product itself - particularly in the case of level premiums - is a significant dynamic of premium construction.

At its most simplest, as level premium policies age the cost of paying claims is higher than the premiums being received. As a result, product providers build reserves to account for those future claims and as policies age, those reserves need to build up. As interest rates fall from previous levels, providers earn less interest on those reserves and therefore, more is needed to be put aside today to get to the same position in the future.

What often happens in alignment to this - which can create confusion - is a general misconception that a level premium never goes up, instead of appreciating that while a level premium doesn't go up with age it is still subject to the vagaries of the claims experiences and interest rate environment.

These dynamics of premium construction, alongside others, are creating a new environment for the IP market.

We all know the importance of the IP product and most of us have seen the enormous value and benefit it provides to clients who have claimed. Having confidence to continue recommending this protection to clients comes from greater understanding and simpler explanation, and this is something every participant in the industry can control and play a role.

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