The final report of the Productivity Commission's inquiry into the financial system, titled: Competition in the Australian Financial System was released on 3 August 2018. The report looks at the provision of financial services and the interaction of market participants, issues facing the consumers of financial services and the functions and activities of regulators.
Section 14 focusses on general insurance providers and products and makes a number of observations about the structure of the industry and competition in the sector, and the implications of these for consumers who purchase insurance. The report also makes a number of recommendations which are summarised below.
Of particular interest to the Insurance Monitor is the recommendation that general insurance products should transparently include the previous year's premium and the percentage change to the new premium. This supports the Insurance Monitor's previously published requirement (made under a notice issued under section 30 of the Emergency Services Levy Insurance Monitor Act 2016, and published in the NSW Government Gazette on 11 August 2017) that insurers who are insuring against loss or damage to property in NSW, must include this year's and last year's premium amount on renewal notices issued from 1 July 2019.
Finding and recommendations
The Productivity Commission made the following findings and recommendations in relation to general insurance:
14.1 - Market power in general insurance provision
General insurance markets are concentrated. In the home insurance, domestic motor insurance, travel insurance, lenders mortgage insurance and reinsurance markets, the largest four firms (which are not always the same four) hold market shares in excess of 70%. This concentration has increased slightly in recent years, mostly as a result of consolidation activity.
The domestic motor insurance, travel insurance, lenders mortgage insurance and reinsurance markets are particularly concentrated, and while the domestic home insurance market is less concentrated, the two largest firms still account for more than half the market. But because many insurers supply their products under multiple brands, consumers may see more an illusion of robust competition than a reality.
14.1 Comparative pricing information on insurance renewal notices
Renewal notices for general insurance products should transparently include the year’s premium and the percentage change to the new premium. This policy should commence by the end of 2019 and be enforced by ASIC.
14.2 Transparency on insurance underwriting
In addition to specifying which insurer underwrites their products, each insurance brand should specify on their website any other brands that are underwritten by the same insurer, for that particular form of insurance.
Insurers should provide an up-to-date list of the brands they underwrite to ASIC. ASIC should transparently publish this information as a list on its website.
14.3 Phase out distortionary insurance taxes
Consistent with the Productivity Commission’s 2014 Natural Disaster Funding Inquiry 4.8), state and territory taxes and levies on general insurance should be phased out.
Key points - General insurance
• As with the banking sector, the general insurance sector is dominated by big four providers, followed by a long tail of much smaller companies. In the markets for home insurance, domestic motor insurance, travel insurance, lenders mortgage insurance, reinsurance, and the overall market for general insurance, the largest four insurers (which are not always the same companies) hold in excess of 70% of market share.
Concentration has increased in recent years, driven primarily by consolidation activity.
• General insurers tend to underwrite many different brands, creating the illusion of more competition than actually exists.
The two largest insurers underwrite more than 25 different brands between them and two smaller insurers underwrite more than 50 brands between them (with one underwriting 23 brands of pet insurance alone).
• Prospective entrants face high barriers to entry. Thirty insurers have entered the market since 2007, including foreign insurers, insurers with links to banks and other large retailers, and niche providers that specialise in particular insurance lines. But none have seriously challenged the dominance of the ‘big four’ insurers.
• While prices of general insurance products have risen over the past decade, these price rises have been cost-reflective and are not, in the main, indicative of weakening competition.
• Australia appears to be lagging behind other countries in terms of insurance product innovation. While there have been some recent innovations to general insurance products, they appear mostly limited to the relatively less concentrated home and contents market.
• As a consequence of excessive product and brand proliferation, consumers struggle to compare the vast array of products in front of them or to exert competitive pressure on insurers.
• Providers should be required to include the previous year’s premium on insurance renewal notices to improve pricing transparency for consumers.
• Insurance brands should provide a full list of the other brands underwritten by the same insurer on their websites and ASIC should publish a list of each insurers’ brands in order to increase transparency.
• State and territory stamp duties on general insurance are inefficient taxes that discourage consumers from purchasing insurance and should be phased out.
Insurance is a risk management tool designed to protect policy holders from financial loss when things go wrong. Policy holders pay premiums to an insurer, which entitles them to compensation (a claim) if an insured event occurs (box 14.1).
Box 14.1 Insurance, reinsurance and retrocession are tools used to pool, transfer and spread risk
Insurance works by pooling and spreading risks to mitigate their impact. An insurer collects (relatively small) premiums from each of its policyholders and pays out (relatively large) claims if insured events occur, and in this way insured risks are mitigated. Insurers also earn investment income by investing funds that are not required to cover their expected liabilities from claims.
Policyholders can decide how much risk to take on by adjusting the terms and conditions of their policies. By agreeing to pay an excess out of their own pocket when making a claim or by excluding certain risks from the policy (such as windscreen replacement from their motor vehicle insurance), they can opt to take on more risk themselves and reduce the premium they pay for the insurance.
Insurance business is defined in the Insurance Contracts Act 1973 (Cth) as follows.
The business of undertaking liability, by way of insurance (including reinsurance), in respect of any loss or damage, including liability to pay damages or compensation, contingent upon the happening of a specified event, and includes any business incidental to insurance business as so defined, but does not include [12 exemptions including life and health insurance business].
Insurance lines are often delineated according to the usual time taken between the insured event occurring and the policyholder making a claim.
• Short-tail liabilities — claims are usually known and settled within 12 months of the event. Examples include motor vehicle insurance and home insurance.
• Long-tail liabilities — claims are usually known and settled more than 12 months after the event, and sometimes many years later. Examples include employers’ liability and professional indemnity insurance.
Insurers need to hold capital reserves in order to meet their claim liabilities. Minimum capital holdings are established by regulation, although many insurers hold more capital than required by law. In order to minimise the risk of significant losses through related claims (and hence maximise their profits), insurers seek to diversify the risks they insure and minimise the correlation between risks.a For example, when offering insurance against losses caused by catastrophic weather events, an insurer may seek to insure a geographically diverse pool of policyholders or also insure risks that are not related to weather events.
Insurers can also transfer their risks by purchasing reinsurance — effectively insurance for insurers. Most reinsurance is provided by very large global reinsurers that can diversify their risks across countries. Access to reinsurance can enable insurers to set a cap on their maximum possible loss. Reinsurance also allows insurers to specialise in niche markets and allows smaller insurers greater scope to pool risks.
There is a further level — retrocession is reinsurance for reinsurers. Reinsurers offer reinsurance to other reinsurers to further diversify the risks they hold.
a An exception is mutual insurers, which do not operate on a profit maximisation basis.
There are three broad types of insurance in Australia: general insurance, life insurance and health insurance. This Inquiry focusses solely on general insurance, which protects the value of things that individual or business policyholders own, consume or invest in, and excludes life and health insurance, as:
• more than 70% of life insurance policies are provided through superannuation (Rice Warner 2016), and the Commission is undertaking a concurrent review of the competitiveness and efficiency of the Australian superannuation system
• an investigation of health insurance would need to consider issues that extend well beyond the scope of this Inquiry.