In his recent speech at the Insurance Council of Australia Annual Forum ASIC’s Peter Kell delivered a scathing commentary on the state of the add-on insurance market, saying that the industry had made insufficient progress towards delivering better consumer outcomes in the area and sounded a warning: if ASIC is still raising similar concerns in 2017, ASIC’s focus will be on stronger enforcement action. As Mr Kell said, “It’s time to get your houses in order”.
The speech followed the release of two reports into the sale of add-on insurance products through car yards. The findings in those reports were critical of the nature of add-on insurance products, the manner in which they are sold and the lack of oversight of distribution channels. The findings are discussed below.
ASIC’s focus on consumer outcomes
The consumer protection recommendations of the Financial System Inquiry (FSI) signal a philosophical shift from a disclosure-based regime, based on ensuring consumers have sufficient information to make informed investment choices, to one aimed at ensuring that the financial services environment promotes positive consumer outcomes.
Two recommendations are particularly pertinent for the insurance sector. The FSI recommended imposing an obligation on product issuers and distributors to consider and monitor a range of factors to ensure that financial products meet the needs of their target market. The purpose of the obligation is to ensure organisations are responsible for ensuring that products are designed and distributed in a way that does not create consumer detriment. The FSI also recommended that ASIC be granted a product intervention power, to enable it to take a more proactive approach to reduce the risk of significant consumer detriment. This would allow ASIC to modify, or even ban, products that are considered harmful for consumers. The Australian Government has taken on these recommendations, and intends to consult further on their implementation by the end of 2016.¹
Ahead of their likely implementation, ASIC has been approaching its market surveillance with an eye to product design and development, with a strong focus on consumer outcomes rather than issues surrounding disclosure or misleading sales practices.
In early 2015 ASIC identified ‘add-on’ insurance products as a key area of concern due to the poor outcomes they generate for consumers, and has called on the insurance industry to improve practices and standards in this area. Add-on insurance is offered to consumers in a range of transactions, from taking out a credit card to buying a car.
To demonstrate the need for reform, ASIC has recently released a report that details the deficiencies of life insurance products sold through car yards. These products commonly provide a lump sum payment of the outstanding car loan balance upon the death of the insured. The report calls on the insurance industry to take significant steps to address the low value offered to consumers, and ensure that the product is targeted only to consumers for whom it is appropriate.
ASIC performed a review of 5 major life insurers offering car yard life insurance, estimated to make up over 90% of the market, from FY10 to FY14. The report concludes that car yard life insurance offers poor value for consumers and is often sold to consumers who have limited knowledge of, and need for, the product.
The study found that car yard life insurance is on average 50% more expensive than life insurance sold through other distribution channels. It concluded that this is likely due to the impact of ‘reverse competition’, which has taken effect in the absence of demand-driven competition. Reverse competition causes insurers to compete on the basis of the commissions paid to intermediaries, rather than the premium costs, thereby increasing the cost to consumers. In some cases, intermediaries were found to have received commissions of up to 50% of the premium payable.
The review also found that car yard life insurance has a low claim-to-premium ratio; only $6 million was paid in claims during the FY2010 – FY2014 period, which equates to 6.6% of the total premiums paid. In his speech to the ICA, Mr Kell noted: “Low claims payouts relative to premiums was another important and concerning finding. Does this audience think that any alarm bells should ring about a product with a claims ratio of 6%?”.
The report found that car yard life insurance also offers less value than traditional life insurance, because the insurer’s liability decreases over time; as the insured makes repayments under the loan, the claimable amount decreases. Further, because the premium is generally paid upfront as a lump sum, funded by the consumer borrowing more from the lender, the consumer incurs interest on the entire premium, once again increasing the total cost of the product.
Similar concerns over low claims ratios and funded up-front premium were key concerns of the UK regulator during the course of addressing the payment protection insurance (PPI) “scandal” which resulted in over AUD$40 billion of premiums being refunded to consumers. The regulatory attention in the UK has led most distributors to cease the sale of single premium PPI altogether.
Poor investment decisions
These findings indicate that car yard life insurance often offers poor value for consumers, which begs the question: why do consumers buy the product?
The report concludes that the context in which car yard life insurance is sold contributes to poor decision-making by consumers. Most consumers enter a car dealership with no awareness that they will be offered add-on life insurance, and therefore have limited capacity to assess the value of the products or seek an alternative. They are not provided with advice as to whether the product is suitable for their circumstances. Indeed, the report found that 11% of policies were sold to consumers aged 21 and under, who do not have dependents, and therefore arguably have no need for the product. Further, some consumers were found to lack an understanding of the product purchased. There is also evidence of the use of unfair tactics to increase sales.
Again, recent UK experience is relevant. In addressing similar concerns, the UK regulator has imposed a range of restrictions on the sale of add-on insurance products through car yards, including imposing a 24-hour deferral period from the time of purchase of the vehicle before GAP insurance can be sold to the consumer. The intention is to separate the purchase of the car from the insurance and allow the consumer time to shop around for alternative products.
Another relevant area of focus for ASIC is on intermediaries. In his speech, Mr Kell noted that many insurers were unaware that they were underwriting certain add-on products because they were sold through wholesale channels, or white-labelling. He said, “[i]nsurers cannot simply reach wholesale agreements with other insurers or underwriting agencies and ignore what happens next…the days of washing your hands when it comes to the actions of distributors is over”.
A call for change
ASIC has now done a lot of work in the add-on insurance space.
Along with this current report, ASIC has conducted a consumer research study to further understand customer experiences when purchasing add-on insurance², and is currently conducting a similar review of general insurance sold through car dealers.³
The report calls on insurers to proactively improve the design and distribution of add-on insurance products, as well as their procedures for monitoring the conduct of intermediaries. If they fail to do so, ASIC has indicated, not only in the report, but also through industry briefings, that it will increase its enforcement action. It has also flagged regulatory changes to promote better consumer decision-making, such as the introduction of more detailed pricing disclosure or comparative value measures.
If the consumer protection FSI recommendations are implemented (as is expected over the next 18-24 months), ASIC will have a broad power to actively intervene in the design and distribution of these products, including amending marketing material, restricting distribution, or even banning certain products. If the industry fails to act on this call to action before the FSI recommendations are implemented, this report, coupled with findings from related surveillance conducted by ASIC, may well provide the evidence ASIC requires of significant consumer detriment, allowing ASIC to use its new powers without delay.
Please contact Matt Ellis for further information on product governance and regulatory compliance in respect to add-on insurance products.
 Improving Australia’s financial system – Government response to the Financial System Inquiry, released 20 October 2015.
 ASIC Report 470: Buying add-on insurance in car yards: Why it can be hard to say no
 ‘Regulatory update to general insurance industry’, Speech by Peter Kell, Commissioner, Australian Securities and Investments Commission, Insurance Council of Australia Annual Forum 2016 (Sydney, Australia), 4 March 2016