The Australian Prudential Regulation Authority’s (APRA) increased focus on the operational risks of large group insurance contracts is understandable, and unlikely to be a surprise for Australian group insurers. Trustees of large superannuation funds need to assess the operational risk involved in changing insurers.
APRA confirmed in its 2010 annual report that the focus of its supervisory activities in group insurance concerns the risks associated with the consolidation of larger industry superannuation funds and the size of their group insurance contracts which are “testing the capital and operational capacity of the life insurance industry, giving rise to operational risk when these contracts are won”.
From the superannuation industry’s perspective, such scrutiny on operational risk from APRA should be welcome, as it has at its core the maintenance of the viable group insurance market and the protection group insurance provides for superannuation fund members.
From the life insurance industry’s perspective, APRA’s scrutiny is unlikely to hold many surprises as the operational risks associated with winning and losing these large insurance contracts will be well known to the life insurers active in this market. APRA’s scrutiny may, however, lead to increased visibility within the group insurers around the risk management considerations inherent in bidding for these large insurance contracts.
With the largest group insurance contracts expected to exceed $200 million in annual premium, the concentration of buying power in these contracts is real, and with further consolidation of superannuation funds likely, the concentration will only continue.
This increasing concentration is, however, nothing new for the group insurance market, which has seen the number of potential superannuation fund clients for group insurance fall steadily over the last decade. This trend has not, however, seen a reduction in the number of group insurers active in the Australian market, with eight to ten well-established group insurers remaining who are actively tendering for group insurance. Added to this, there is strong reinsurance support for the local insurers, contributing to a group insurance marketplace that is competitive and growing.
Concentration of operational risk from superannuation fund consolidations is not isolated to insurance. Similar concentrations exist in other outsourced fund services such as administration, custody, and investment advice. The operational risks associated with moving a large administration contract are arguably much greater than those in moving group insurance. Nor is concentration risk isolated to the superannuation industry, with industries such as the grocery industry much more highly concentrated than super.
With the growth in the size of superannuation funds has come growth in the sophistication and depth of analysis involved in the insurance tender process. Towers Watson believes that operational risks involved in any move of a large insurance contract must be part of the trustee due diligence process in assessing prospective new insurers. This in turn has forced potential insurers to detail their operational transition plans, and trustees shouldn’t appoint a new insurer if they feel the insurer is unlikely to cope with the size of the insurance mandate being offered.
Similarly, the group insurers active in the largest end of the superannuation market are acutely aware of the operational risks that are involved in the very large insurance contracts, and are factoring these risks into decisions to tender for particular insurance mandates.
While the size of group insurance mandates has increased, the size of the group insurance market as a whole is still only half the size of the retail insurance market when measured by in-force annual premium, with some obvious commonality of operational support in areas such as underwriting and particularly claims assessment. The operational risk of winning or losing the large superannuation fund mandates can to some extent be spread across the broader retail insurance business.
While the loss of large insurance mandates is a significant business issue for the insurer, the mandates are still not of a size which is likely to jeopardise the viability of an Australian insurer.
In summary, APRA’s supervisory activities in this area are only reinforcing the issues that both superannuation trustees and life insurers are well aware of, that the operational risk aspects of the large insurance contracts are, and will increasingly be, a major factor in the minds of both trustees and life insurers.
