APRA 2021 Year in Review

The ADI sector demonstrated its resilience during 2021, despite the COVID-induced disruptions. The sector remained well capitalised and profitable, with sound liquidity and funding positions. This financial health was fundamental to its capacity to navigate through recent challenges and continue to support the Australian economy.

Nevertheless, ADIs remain exposed to significant headwinds and an uncertain outlook. Although signs of deterioration in key asset quality measures were muted, the sector may face higher credit losses as the full impact of COVID on borrower creditworthiness becomes clearer. Risks in housing markets are also heightened, with rising house prices and a very low interest rate environment placing a premium on the maintenance of sound lending standards. Technology and digitisation are creating new ways to provide banking and payment services, and challenging the sustainability of many current business models.

The industry landscape

 

There were 143 ADIs operating in Australia as at end-June 2021, down slightly from 146 a year earlier (Figure 1a). This comprised 97 banks, 37 credit unions and building societies, eight other ADIs, and one restricted ADI.

Following the lifting of the temporary suspension of licensing activity that had been implemented in an early response to COVID-19, 2021 saw the entry of one foreign bank and one other ADI.  However, this was offset by the exit of three credit unions through market consolidation in the mutual ADI sector, and the exit of one foreign bank and one restricted ADI, Xinja Bank.

As at 30 June 2021, total ADI industry assets stood at $5.4 trillion, up slightly from $5.3 trillion the year prior. The four major banks hold around 73 per cent of industry assets, largely unchanged compared to prior years (Figure 1b).

Industry profitability improved over the year to 30 June 2021 due to a number of factors, including:

• lower than expected losses arising from the impacts of the COVID-19 pandemic;
• a reduction in provisions held against future loan losses; and 
• improvements to operating income outpacing the growth in operating expenses.

As a result, industry return-on-equity (RoE) rose to 9.5 per cent (Figure 1c), an increase of 1.3 percentage points from 2020. However, this remains well below the 10-year average RoE of 12.3 per cent since 2011. The aggregate cost-to-income ratio decreased to 54.6 per cent over the year to June 2021 from 56.1 per cent over the year to June 2020 (Figure 1d).

Asset quality in the ADI sector has been supported by loan repayment deferrals programs, government income support measures and the better than previously forecasted economic recovery. As a result, overall asset quality remained broadly stable, with a slight improvement in non-performing loans, down 6 basis points to 1.06 per cent of gross loans and advances as at 30 June 2021 (Figure 1e). 

The ADI industry is well capitalised, and at 30 June 2021 its weighted average CET1 capital ratio stood at 12.7 per cent – an increase of 0.9 percentage points over the year. The weighted average industry Tier 1 capital ratio rose 1.0 percentage points over the year to 14.6 per cent (Figure 1f). Both remain at historically high levels.

Key issues and initiatives

Loan repayment deferrals

In July 2021, as the Delta variant of COVID-19 took hold, a number of ADIs announced support packages in the form of loan repayment deferrals to support their customers through temporary disruptions caused by renewed lockdowns. In tandem, APRA provided regulatory relief to ADIs offering deferrals.

This relief mirrored the approach taken in 2020. For eligible borrowers granted a repayment deferral of up to three months before the end of September 2021, ADIs did not need to treat a period of repayment deferral as a period of arrears or a loan restructuring. However, for transparency, ADIs were required to publicly disclose and report the nature and terms of any repayment deferrals and the volume of loans to which they were applied.

ADIs responded quickly in reintroducing repayment deferrals programs for impacted borrowers, but the take up of these programs was significantly lower than during the first phase in 2020. At their peak during the second phase, loans subject to repayment deferral totalled $13.1 billion (or 0.6 per cent of total lending), compared to a peak of $266.1 billion (10.1 per cent of total lending) during the first phase in 2020.

 

Macroprudential policy actions

 

In October 2021, APRA announced it expected ADIs to increase the minimum interest rate buffer they use when assessing a borrower’s ability to service a loan. In particular, APRA indicated that lenders should assess new borrowers’ ability to meet their loan repayments at an interest rate that is at least 3.0 percentage points above the loan product rate. This compared to a buffer of 2.5 percentage points that had been commonly used previously.  

APRA’s decision reflected growing financial stability risks from ADIs’ residential mortgage lending, with more than one in five new loans approved in the June quarter being at more than six times the borrowers’ income. APRA’s decision was supported by other members of the CFR.

APRA Chair Wayne Byres said increasing the buffer was a targeted and judicious action designed to reinforce the stability of the financial system. He noted:

 

“In taking action, APRA is focused on ensuring the financial system remains safe, and that banks are lending to borrowers who can service the level of debt they are taking on – both today and into the future.”

To support future macroprudential responses, APRA also published a framework for the use of macroprudential policy measures. This framework gives financial industry stakeholders a better understanding of the factors APRA considers in making decisions to use these tools, the types of macroprudential measures APRA could deploy in the future, and how they might be implemented.As the same time, to support the implementation of the framework, APRA commenced a consultation on steps to formalise and embed credit-based macroprudential policy measures within its prudential standards.

 

Capital management

 

In November 2021, APRA finalised a new bank capital adequacy framework. The new framework is designed to ensure the unquestionably strong levels of capital held by the banking sector are preserved, and that Australian standards align with the internationally agreed Basel III framework. In addition, APRA sought to achieve a number of key improvements to the capital adequacy regime to enhance flexibility, risk sensitivity, competition, transparency and proportionality.

At its heart, the new capital framework is aimed at ensuring that Australian banks continue to have the financial strength to withstand future adverse economic conditions, protect depositors in times of stress and retain an ability to support lending to households and businesses.  

APRA Chair Wayne Byres noted that the internationally agreed Basel III framework is due to come into force around the world in 2023. Due to the strength of the Australian financial system, Australia will be compliant with the Basel III framework without the need for lengthy transitional periods and phase-in arrangements that will be needed in many other countries.

As noted in Chapter 1, APRA also announced in late 2021 that it had finalised requirements for domestic systemically important banks (the four major banks) to maintain additional loss-absorbing capacity to ensure they could be recapitalised using private, rather than taxpayer, funds in the unlikely event of a failure. APRA wrote to the major banks confirming that the final setting for loss-absorbing capacity would be an increase in minimum total capital requirements of 4.5 percentage points of risk-weighted assets, to be met from 1 January 2026.

 

Phasing out the Committed Liquidity Facility (CLF)

 

In September 2021, APRA announced that it expected locally incorporated ADIs subject to the Liquidity Coverage Ratio (LCR) to reduce their reliance on the CLF to zero by the end of 2022, subject to financial market conditions. This reflected the expectation of APRA and the RBA that there would be sufficient high-quality liquid assets (HQLA) available for ADIs to meet their LCR requirements without the need to utilise the CLF.

APRA advised that it would continue to review financial market conditions and would adjust its expectations if circumstances were to materially change. APRA also noted that the CLF will remain available should it be needed due to future shortfalls of HQLA, or other liquidity pressures.   

 

New approach to licensing

 

In support of a sustainable, forward-looking competitive banking sector, APRA updated its approach to licensing and supervising new ADIs in August 2021. This followed a period of consultation on a draft framework, which had been published earlier in the year.

APRA’s updated approach entails stronger requirements for being granted a banking licence and closer supervision of new entrants as they seek to establish themselves. The approach is designed to encourage sustainable competition in the banking sector by ensuring new ADIs are better equipped to succeed.

The new approach came into effect immediately, although much of the information package published was a formalisation of existing practice. The final information paper and the two guidelines released are available on the APRA website at: Licensing for authorised deposit-taking institutions.

 

Superannuation

 

Overall, the superannuation industry continued to provide strong returns to members over the year despite the ongoing economic uncertainty associated with the pandemic. The primary driver of this performance was the continued buoyancy of the financial markets, resulting in double-digit investment returns. Registrable superannuation entity (RSE) licensees have, however, continued to grapple with a number of operational challenges due to the ongoing lockdowns and challenging business environment. These have generally been managed relatively well, with minimal disruption to member services.

Across the superannuation industry, member accounts continue to be consolidated as a result of recent legislative reforms. The reduction in the number of member accounts has resulted in better outcomes for members overall, but has also resulted in cost pressures for RSE licensees. These pressures are likely to continue into 2022 and beyond.

APRA’s focus in 2021 was directed at improving member outcomes and eradicating underperformance, supported by the Government’s Performance Test and the MySuper heatmap. Over the year, this work, coupled with effective supervisory actions, has led to an increase in merger activity across the industry, with 12 mergers completed and a further 12 RSE licensees in initial or advanced execution phases.

The industry landscape

 

As at 30 June 2021, superannuation industry assets totalled $3.3 trillion, an increase of 15 per cent over the year from $2.9 trillion. This double-digit growth was driven primarily by APRA-regulated funds which grew over 17 per cent from $1.9 trillion to nearly $2.3 trillion, with these funds managing close to 69 per cent of assets within Australia’s superannuation system.

The number of APRA-regulated funds with more than four members decreased from 170 to 155 by the end of the year with 16 funds exiting the system and only one new entrant (Figure 2a). The decline in the number of super funds gave rise to a fall in the number of RSE licensees from 107 to 95 over the year. Reflecting this consolidation, concentration within the superannuation industry also increased over the year, with the five largest super funds holding 32 per cent of total APRA-regulated super assets as at 30 June 2021, up from 27 per cent five years ago (Figure 2b).

The combined effect of continuing asset growth and consolidation within the superannuation industry over the year resulted in the average fund size increasing from $12.3 billion to $15.4 billion over the year, a 25 per cent increase. The normal operating efficiencies associated with increasing fund size, observed over the longer-term (Figure 2c), continued over the year with total administration and operating expenses as a percentage of net assets decreasing from 0.37 percent to 0.34 per cent.

Contrary to the longer-term trend, net contribution flows (which represent the amount of member monies paid into the system less the monies paid out of the system), as a percentage of average net assets, increased from 0.5 per cent to 0.95 per cent between the June 2020 and 2021 financial years (Figure 2d). This rebound reflected the end of the 2020 Early Release Scheme, however the overall net contribution flow remains notably below earlier years.

Fund asset allocations shifted towards growth assets over the year, as the initial concerns brought on by COVID-19 subsided and entities took advantage of the strong performance of global markets. As at 30 June 2021, the allocation to equity was 54.8 per cent of total assets (Figure 2e) with allocations to fixed income, cash, property and infrastructure accounting for 18.2 per cent, 10.6 per cent, 7.7 per cent and 5.7 per cent of total assets respectively. Other assets, including hedge funds and commodities, accounted for the remaining 3.0 per cent of total assets.

Strong investment performance yielded an annual return of 17.0 per cent over the year to 30 June 2021, as global markets recovered from COVID-19-induced losses during the second half of the previous year. This was well above the 10-year annualised rate of return of 7.7 per cent per annum for the 10-year period ending 30 June 2021 (Figure 2f).

Key issues and activities

Eradicating underperformance

 

APRA’s strategic focus to improve member outcomes and eradicate underperformance continues to be supported by the annual release of its heatmaps. APRA’s MySuper product heatmap, first published in 2019, provides a major enhancement to industry transparency. In December, alongside its annual MySuper heatmap, APRA published its first choice heatmap covering an important segment of the choice sector. 

The APRA heatmaps supplement the Government’s YFYS reforms, which came into effect on 1 July 2021, and included an annual performance test. The performance test enhances accountability for RSE licensee performance through greater transparency and increased consequences for underperformance.

Performance test

 

As part of the Government’s YFYS reforms, an annual performance test was introduced. A RSE licensee of a product that fails the performance test must write to its members informing them of the failure. Where a product fails the performance test in two consecutive years, the RSE licensee will be prohibited from accepting new beneficiaries into that product.

The inaugural MySuper Product Performance Test outcomes were released on 31 August 2021. On the release of the performance test outcomes, APRA Executive Board Member, Margaret Cole commented:

 

“It is welcome news that more than 84 per cent of products passed the performance test, however APRA remains concerned about those members in products that failed. Trustees of the 13 products that failed the test now face an important choice: they can urgently make the improvements needed to ensure they pass next year’s test or start planning to transfer their members to a fund that can deliver better outcomes for them.”

APRA also intensified its supervision of the RSE licensees with products that failed the test and requested they provide a report identifying the causes of their underperformance and how they plan to address them. RSE licensees are required to monitor their products closely and report important information to APRA – including relating to the movement of members and outflow of funds.

As well as scrutinising the plans of the 13 funds that failed the test, APRA is engaging with RSE licensees at risk of failing the performance test next year, to ensure they take the steps necessary to improve performance and to understand their contingency plans. These contingency plans must include pre-positioning to be able to give effect to an orderly transfer of members to another fund, if required.

 

APRA's inaugural Choice heatmap

 

APRA’s heatmaps are designed to provide stakeholders with insights into the outcomes being delivered by RSE licensees, in particular for investment returns and fees and costs, by providing information that is credible, clear and comparable across products. However, to date, APRA’s heatmaps had only covered MySuper products.

Research undertaken by Chant West shows there are 568 choice products within APRA-regulated superannuation funds, offering approximately 9000 distinct investment options. Choice products are typically more complex and varied than default MySuper products, which makes comparisons between choice products more challenging.

In October, APRA published an information paper that provided some high level analysis of the choice sector, ahead of releasing its first Choice heatmap in December 2021.

The Choice heatmap focuses on multi-sector investment options in open, accumulation products (excluding platform products), representing 40 per cent of total member benefits in the APRA-regulated choice sector. This segment is also the most similar to MySuper products, enabling direct comparisons between the sectors.

APRA Executive Board Member Margaret Cole noted that the findings demonstrate the importance of exposing and addressing the varying levels of performance and the high fees within the choice sector. APRA will continue to closely monitor and take firm supervisory action on underperforming choice products ahead of the expanded performance test in 2022.

 

Driving improvements in industry practice

 

The performance test and heatmaps are necessarily backward-looking. APRA also devoted considerable resources to making sure RSE licensees have robust frameworks to make investment and expenditure decisions into the future. In 2021, APRA completed thematic reviews into three core areas of RSE licensee business operations critical to delivering outcomes to members.

The first was a benchmarking review of 24 RSE licensees with respect to their implementation of Prudential Standard SPS 515 Strategic Planning and Member Outcomes (SPS 515). This review focused particularly on business plans and business performance reviews (BPRs), to understand practice and assess how well RSE licensees have embraced and embedded the intent of SPS 515.  

The review identified areas where RSE licensees needed strengthen their practices during the upcoming BPR and business planning cycle, including consideration of member outcomes, cohort analysis, understanding drivers of performance, and testing financial soundness.

The second thematic review was of 12 RSE licensees, undertaken between November 2020 and October 2021, examined expenditure on advertising, sponsorships and promotions.

The review identified that, given the new best financial interests duty introduced in the Government’s YFYS reforms, some instances of expenditure examined did not have sufficient evidence to demonstrate that the expenditure would be in the best financial interests of members. It also identified areas where industry practices need to be improved: specifically, RSE licensees should make a significant shift from broad reliance on qualitative judgements, to applying robust quantitative analysis as a basis for justifying expenditure.

The third review, which took place against the backdrop of the heightened market volatility in early 2020 as a result of COVID-19, highlighted the importance of a prudent approach to valuing unlisted assets. Increased member switching, together with the Government’s expansion of the early release of the superannuation program, led APRA to seek information on how member equity issues were being balanced by RSE licensees during the period.

Encouragingly, APRA’s review found that most RSE licensees demonstrated a proactive approach to revaluing unlisted assets in response to the market volatility in early 2020. Areas identified for improvement included addressing inadequate revaluation frameworks (with no predefined revaluation triggers and weak or no processes for monitoring and adjusting revaluations); limited board engagement (an area of particular concern across a number of RSE licensees); and an over-reliance on external parties, including fund managers and asset consultants.

Observations from these reviews were published in October 2021, in Information Paper: Findings from APRA’s superannuation thematic reviews (PDF).

 

Policy initiatives

APRA has undertaken a number of critical reforms to the prudential standards for superannuation, aimed at ensuring that RSE licensees are acting prudently to improve outcomes delivered to members. Highlights from 2021 include:

In November, APRA finalised revisions to requirements and guidance relating to insurance in superannuation, Prudential Standard SPS 250 Insurance in Superannuation (SPS 250) andPrudentialPractice Guide SPG 250 Insurance in Superannuation (SPG 250), following extensive industry consultation over two years. In particular, the standard has been strengthened to protect members from potential adverse outcomes caused by conflicted life insurance arrangements. This includes heightened obligations on the RSE licensee to assess whether there are any conflicted provisions or business practices with respect to insurance arrangements, and whether they are appropriate and in the best financial interests of beneficiaries.

The revisions also fulfilled recommendations 4.14 and 4.15 of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.²

In September, APRA released for consultation its proposed revisions to Prudential Standard SPS 530Investment Governance (SPS 530). The proposed amendments to SPS 530 included a number of enhancements to valuation practices, stress testing and liquidity management practices. This is an important step in ensuring that RSE licensees continue to meet their obligations to prudently select, manage and monitor investments. The consultation closes in February 2022, and APRA will look to finalise the standard – and commence consultation on associated prudential guidance – next year.

In November 2021, APRA also released a discussion paper seeking information from RSE licensees on their plans to maintain the financial resilience needed to protect members’ best financial interests. This is an important step in ensuring that every RSE licensee is financially resilient to ensure the continued delivery of improved member outcomes and the ability to operate in the best financial interests of beneficiaries. In light of the continual changes to the superannuation landscape, APRA sought to better understand current approaches to the management of financial resources. In particular, this included the role and use of the operational risk financial requirement, reserving practices, and protections afforded to RSE licensees via insurance, and how these practices might need to adapt over time.

General insurance

Introduction

The general insurance industry faced a difficult 2021, with a large fall in industry profits due to higher claims costs from weather events, coupled with lower investment income reflecting ongoing financial market volatility.

In addition, the industry continued to grapple with the extent business interruption insurance (BI) claims triggered by lockdowns and other restrictions associated with COVID-19. Many insurers found themselves exposed through policy wordings that had not kept up with changing legislation. This created considerable uncertainty, which needed to be resolved through a series of test cases in the Courts.

The general insurance industry also continued to face a challenging operating environment. Rising premiums and reduced capacity in certain product lines is making some types of insurance less affordable (or in some cases unavailable) for many Australian households and businesses. Furthermore, the increased frequency and intensity of natural disasters associated with climate change will continue to add increasing challenges of accessibility and affordability of insurance for parts of the Australian community. It will require greater attention to mitigation and disaster preparedness to ensure that general insurance remains accessible and affordable to all Australians.

The industry landscape

There were 93 APRA-authorised general insurers as at 30 June 2021, comprising 83 direct insurers and 10 reinsurers. The number and composition of general insurers has remained broadly stable in recent years (Figure 3a).

Industry concentration has increased over time with the top five general insurers now accounting for 52 per cent of total industry assets (Figure 3b). This compares with 36 per cent 10 years ago.

Industry profits remained suppressed for a second successive year, with a 3.2 per cent return on net assets tracking significantly below the 10-year average (Figure 3c). The primary driver of this result was significant provisioning for COVID-19 business interruption claims. Despite the lower incidence of very large catastrophe events in 2021, gross claims costs for the householders’ class of business also remained elevated. Domestic motor claims costs also increased in the year. Overall, this led to higher net loss ratios for the short-tail property classes of business, in particular the Fire and Industrial Special Risks class (Figure 3d).

The net loss ratio for long-tail classes of business was largely unchanged over the year. Releases of claims reserves continued to positively impact underwriting profits in the compulsory third party (CTP) motor vehicle class of business, albeit these have significantly declined in recent years. In contrast, strengthening of claims reserves was notable in the public and product liability class of business. Significant premium rate increases were observed during the year for some classes of business including professional indemnity and employers’ liability.

General insurers’ investment portfolios remained heavily weighted to interest-bearing investments (Figure 3e). Investment income during the year remained subdued, with increases in bond yields causing unrealised losses on these investments. 

The quality of insurers’ capital continued to be high, with CET1 capital making up 93 per cent of eligible capital (figure 3f).

Key issues and activities

Business interuption insurance

Over 2021, a number of court cases considered the effectiveness of pandemic exclusions found in many business interruption (BI) insurance policies. APRA regularly reassessed the prudential impact of these court decisions and actively engaged with peer agencies as part of a Treasury-led BI working group on this matter (the working group also includes ASIC and AFCA), as well as with the Insurance Council of Australia and international peer regulators.

The financial and reputational impact on the general insurance industry and the uncertainty created over pandemic coverage under BI policies has been significant. The issues raised concerns for APRA about the level of robustness applied to the management of insurance risk by some insurers, and whether the weak practices that led to problems in the BI line of business could be replicated elsewhere.  

To help strengthen risk management across the general insurance industry, APRA commenced a thematic review of 10 general insurers. This exercise aims to significantly reduce the likelihood of similar problems recurring in the future. It specifically focuses on cyber-risk, but APRA expects the learnings that will be drawn from it to be applicable across all product areas and potential exposures.

APRA Deputy Chair Helen Rowell told delegates at the Insurance Council of Australia’s Virtual Industry Forum in October 2021:

 

“Once we review the submissions we will provide broader industry feedback. If any red flags are raised as a result of the exercise, it may result in a supervisory response for an insurer, but the purpose of the review is not intended to be punitive. Rather, we want to work with the industry to help them identify and address any weaknesses before they manifest in a similar way to BI.”

Affordability and accessibility

Another key area of attention for APRA was the affordability and accessibility of insurance.

The deteriorating affordability and accessibility of a number of lines of insurance is a multi-faceted problem, with varied drivers across different product classes. As APRA Deputy Chair Helen Rowell commented at the Insurance Council of Australia’s Virtual Industry Forum:

 

“Recognising the importance of insurance to financial stability, APRA’s Corporate Plan specifically calls out insurance accessibility and affordability as one of APRA’s key priorities over the next four years. Our focus here is on building the evidence base to better understand the issues, and magnifying our influence on contributing to a solution. This includes leveraging our supervision insights and system-wide perspective to advise stakeholders on the nature and extent of accessibility and affordability issues, and the risks that exacerbate these challenges.”

APRA continued to work with key stakeholders in government, other regulatory agencies and the insurance industry to achieve an appropriate balance between the financial health of insurers (thereby protecting the long-run interests of policyholders) and access to affordable and well-designed insurance for consumers. APRA also meets with consumer representatives through its Insurance Consumer Forum to share ideas, insights and recommendations on these challenges. This forum assists APRA to understand issues from a policyholder perspective.

During the year, APRA provided technical advice to the Treasury-led taskforce established to develop a reinsurance pool to cover cyclone and related flood damage. The reinsurance pool, to commence from 1 July 2022, will be backed by a $10 billion government guarantee. The detailed design parameters for any reinsurance pool are critical to ensure that, while providing appropriate benefits to consumers, the insurance industry remains robust and that it does not blunt incentives to undertake mitigation.

Capital framework

In 2021, APRA continued its work on integrating the Australian Accounting Standards Board’s new standard on insurance contracts, AASB 17, into the capital and reporting framework for general, life, and private health insurance industries. The proposed changes aim to ensure the continued resilience of the prudential standards for insurers while minimising the regulatory impact. After seeking industry feedback on proposals published in November last year, in December 2021, APRA released a number of draft prudential and reporting standards for industry consultation aimed at integrating AASB 17 into the insurance capital and reporting frameworks.  APRA expects to release final standards in Q3 2022.

Life insurance

Introduction

The life insurance industry has demonstrated resilience to the uncertainty posed by the pandemic, with financial results improving, driven by repricing initiatives and improved investment revenues. Although financial performance improved in the 12 months to June 2021, risk products remained unprofitable, owing mainly to the persistent adverse claims experience within Individual Disability Income Insurance (IDII) and recent losses in group insurance business. The risk of worse-than-expected claims experience as a direct result of COVID-19 is likely to persist over the short-to-medium term. The uncertainty concerning the longer-term impacts of COVID and delays in diagnosis of other non-COVID-related serious illnesses, including mental health-related illness, on future claims may also challenge the industry in the longer term.

The outlook for friendly societies remains challenging, reflecting the expected impacts of the prolonged low interest rate environment and weaker consumer demand for its products.

The industry landscape

At 30 June 2021, 27 APRA-authorised life insurers and 11 friendly societies were operating in Australia, with no new life insurance licences granted and one licence revoked.³ The number of insurers has remained stable for several years (Figure 4a), albeit there has been significant change in the industry’s ownership.

The life insurance industry remains reasonably concentrated. The top five life insurers accounted for 68 per cent of total industry assets (Figure 4b), up from 62 per cent in the previous year. This was owing to continued acquisition activity amongst the larger life insurers. The trend towards increased foreign ownership of the industry also continued.

The industry recorded a return to profitability in the 12 months to 30 June 2021, with the return on net assets increasing to 3 per cent (up from minus 6 per cent in the preceding year). Despite the return to profitability, industry returns remain significantly below the 10-year average of 9 per cent (Figure 4c). The main driver of poor profitability in recent years has been material declines in total profits from both investment-linked and non-investment-linked products, with COVID-19 and its related economic impacts such as the prolonged period of low interest rates, further exacerbating the decline.

There was a substantial improvement and return to near profitability in risk products in 2021. Whilst losses in IDII remain substantial owing to persistent adverse claims experience, there was a marked improvement in 2021 when compared against the preceding two years. The profitability of individual lump sum business remained relatively stable. Group business, whilst recording a lower level of losses than in 2020, is yet to return to overall profitability (Figure 4d).

As a result of a more conservative investment risk appetite post the global financial crisis, fixed-interest securities have comprised a significant and increasing share of insurer portfolios (Figure 4e). Furthermore, most insurers did not seek to increase their exposure to higher-yielding, higher-risk, fixed-interest securities to mitigate the impact of the low-yield environment.

The aggregate capital coverage ratio for the industry remained at sound levels and increased during 2020/21 to 1.9 times the minimum requirement at 30 June 2021 (Figure 4f). The quality of capital held by insurers remained strong, with CET1 capital the predominant form of eligible capital.

Key issues and initiatives

Addressing Disability Income Insurance (IDII)

Given long-standing concerns with IDII, APRA intervened in late in 2019 by imposing a number of IDII product and data expectations on insurers, as well as imposing additional capital charges that will remain in place until relevant life insurers have adequately met APRA’s expectations.

In May 2021,APRA deferred the implementation of one of its sustainability measures to improve the long-run outcomes for IDII – the policy contract term measure – by 12 months following engagement with the industry and the industry body, the Financial Services Council (FSC). The industry indicated that it was unable to finalise a timely solution for the implementation of this measure that satisfied legal and operational constraints, and without potential adverse consequence for consumers. Industry efforts on finding implementable solutions for this measure are ongoing.

The release of new IDII products by life insurers is an important milestone. However, it is early days and ultimately success in addressing IDII sustainability will depend on how these new products are received by the market and, in turn, how life insurers respond to competitive market pressures.

APRA will continue to monitor progress and, where appropriate, work with the industry on ensuring IDII moves to a sustainable state. APRA’s expectation is that the industry delivers and maintains IDII products that meet the needs of consumers, provide policyholders with stable and affordable premiums, and are financially viable over the long term. APRA also expects that life insurers extend their learnings from IDII to other parts of the portfolio to ensure similar risks are proactively managed.

 

Sustainability of life insurance in superannuation

Insurance offerings available through superannuation also face sustainability challenges. In March 2021, APRA sent an industry letter to RSE licensees and group life insurance CEOs regarding concerns it had as to the sustainability of life insurance in superannuation generally, and specially developments in relation to premium volatility, availability and provision of data, and tender practices. APRA’s view was that these developments, if unaddressed, were likely to result in poor member outcomes, and adversely impact the availability and sustainability of life insurance offered through superannuation.

 

Increased use of offshore reinsurers by life insurers

In April, APRA released a package for consultation designed to address concerns about the increased use of offshore reinsurance by life insurers. These concerns are particularly heightened in relation to the group risk market, which plays an important role in Australia’s superannuation system. The proposed updates to Prudential Standard LPS 117 Capital Adequacy: Asset Concentration Risk Charge (LPS 117) will impose an aggregate limit on the exposure of life insurers to offshore reinsurers which are not regulated by APRA. Offshore reinsurers that enter the domestic market and become an APRA-registered entity will not be subject to the aggregate limit. Additional enhancements are also proposed to the standard. The review of LPS 117 is due to be completed in the first quarter of 2022. 

 

Capital resilience and stress testing

Stress testing is used by APRA and its regulated entities to provide forward-looking assessments of entities’ resilience to severe but plausible downturns, and complements APRA’s risk-based supervision approach by enhancing capital management practices.

With the onset of the pandemic, APRA conducted a series of stress testing activities on life insurers and published the results in August 2021: Stress testing insurers during COVID-19: results and key learnings. The results demonstrated that insurers were well-positioned to withstand a severe economic downturn, while still meeting their commitments to policyholders. They demonstrated capital resilience at an industry level and also provided insights into how insurers use stress testing to inform their capital and risk management frameworks, as well as wider business decision-making.

 

Capital framework

APRA continued its work on integrating the Australian Accounting Standards Board’s new standard on insurance contracts, AASB 17, into the capital and reporting framework for general, life, and private health insurance industries. The proposed changes aim to ensure the continued resilience of the prudential standards for insurers while minimising the regulatory impact. After seeking industry feedback on proposals published in November last year, in December 2021, APRA released a number of draft prudential and reporting standards for industry consultation aimed at integrating AASB 17 into the insurance capital and reporting frameworks.  APRA expects to release final standards in Q3 2022.

Private health insurance

Introduction

COVID-19 has significantly impacted the short-term financial position and outlook for private health insurers, due to factors such as delays in premium increases, pauses on elective surgery and a recent pick-up in membership amongst younger age groups. Despite the positive short-term profit impacts, there remains considerable uncertainty over the longer-term outcomes.

APRA also remains concerned about the longer-term sustainability challenges facing the private health insurance (PHI) industry due to longer-term declining membership trends, an ageing membership base and worsening product affordability.

The industry landscape

During the year to June 2021, the number of private health insurers remained unchanged at 35 (Figure 5a). Since then, a merger between two funds in the September quarter of 2021 took the total number of private health insurers to 34. Notwithstanding some market share changes at an institution level, market concentration overall remained relatively stable with the largest five insurers holding 73 per cent of industry assets, and the largest 10 insurers holding 87 per cent (Figure 5b).

Industry profitability bounced back in 2021 after an 11-year low in the previous year, supported by both higher insurance margins and investment income (Figure 5c). Gross margins on health insurance business grew strongly to 14.5 per cent (Figure 5d), reflecting an increase in premium income in line with a solid growth in membership in the year to June 2021. Meanwhile the management expenses ratio increased slightly to 9.4 per cent in the year ending June 2021 (2020: 9.2 per cent). Net margins improved to 5.0 per cent after a 16-year low in the previous year (2020: 2.7 per cent). Investment income also increased during the year to June 2021, largely reflecting a recovery in equity earnings.

Private health insurance participation increased for the first time in six years with hospital treatment membership rising by 245,189 persons in the year to June 2021 to 11.4 million persons (Figure 5e). As a result, the proportion of the population covered by private health insurance (hospital treatment) rose, for the first time in many years, by 0.9 percentage points over the 12 months to June 2021 to 44.5 per cent.

The industry’s Prudential Coverage Ratio remained stable at 1.6 times APRA’s regulatory requirements (Figure 5f).

Key issues and initiatives

Accessibility, affordability and sustainability

Although the private health insurance industry has been resilient throughout the COVID-19 pandemic and membership growth has been trending up in the short term, APRA’s long-standing prudential concerns remain due to twin challenges of affordability and adverse selection. At the heart of the challenge is rising health system costs that are exceeding premium increases, which are in turn going up faster than household incomes.

Therefore, APRA continued its heightened supervisory focus on the sustainability of the industry, and ensuring that private health insurers have in place robust and feasible strategies to address affordability risks and meet their commitments to policyholders. 

• live the APRA values and behaviours;
• listen to our people;
• create a safe environment;
• drive inclusion in all that we do; and
• commit to targets and measures of success.

APRA’s I&D networks – each sponsored by one or two Executive Directors – have been instrumental in bringing to life APRA’s vision for an inclusive workplace across the areas of Aboriginal and Torres Strait Islanders, Accessibility, GenDelta, Gender, GenX+, LGBTIQ+ and Multicultural. The networks hosted talks, panel discussions, awareness-raising sessions and cultural events – all designed to raise awareness and showcase why an inclusive and diverse workplace is in everybody’s interests.

I&D highlights in 2021 included:

• SBS Core Inclusion program launched enterprise-wide.
• APRA’s new gender affirmation guidelines launched on the Transgender Day of Visibility.
• RISE - the accessibility network - consulted on the accessibility requirements for APRA’s re-designed offices.
• To celebrate NAIDOC Week 2021, APRA’s Reconciliation Action Plan working group acquired the organisation’s first piece of indigenous artwork. The artwork is from the Warlukurlangu Artists Aboriginal Corporation in central Australia
• The generational and multicultural networks hosted APRA’s inaugural I&D-themed Virtual Amazing Race.

APRA continued to benchmark its progress on inclusion and diversity against leading industry practices through participation in Pride in Diversity’s Australian Workplace Equality Index, Workplace Gender Equality Agency reporting, and its Innovate Reconciliation Action Plan.

2025 APRA-wide I&D Goals

1. Goals will be measured over the 4-year strategy period.
2. Target areas and goals are as measured in the APRA I&D Survey, and APRA’s demographic profile. Goals to be achieved with no material differences across demographic groups.
3. 40/40/20 refers to 40% Female, 40% Male, and 20% non-binary/male/female/choose not to disclose.  

Supporting health and wellbeing

2021 was a demanding year for APRA employees as they faced a heavy workload, revised priorities and a disrupted environment. APRA supported employee wellbeing by offering a wide range of resources and services. For example, a series of webinars, virtual workshops and coaching sessions provided tools for employees to manage their career, wellbeing and family priorities. APRA’s Employee Assistance Program, delivered by the Centre for Corporate Health, offered employees and their families confidential support and counselling services. Additionally, an app-based tool for building resilience was launched to employees.

Regular pulse surveys, which gauged employee sentiment in the areas of support, work arrangements and wellbeing, were conducted throughout the year. The feedback provided useful insights used to drive improvements across these areas.

APRA’s Wellbeing Ambassadors program offered further assistance through peer support and the opportunity for individual employees to confidentially raise concerns about their own or their colleagues’ health and wellbeing. Comprising trained APRA employees, the program welcomed seven new ambassadors in 2021.

Keeping APRA offices COVID-safe was an important focus, particularly as preparations were made for Melbourne and Sydney employees to return to the workplace post-lockdown. APRA has adopted all Safe Work Australia guidelines and established COVID-safe workplaces in all of its offices.

Ways of working at APRA

From the outset of the pandemic, APRA employees adapted well to remote and flexible working practices, including the introduction of collaboration tools such as MS Teams for virtual workshops and meetings. This tool provided the organisation with the agility to remain fully operational during periods of lockdown and other disruptions. More importantly, it also paved the way for ongoing hybrid working at APRA.

By early 2021, hybrid working – in which employees were given the flexibility to combine office attendance with remote working –had become the ‘new norm’ at APRA. Based on the guiding principles of trust and empowerment, hybrid working enabled teams to meet, collaborate and stay connected across organisational boundaries regardless of individuals’ work locations. At the same time, face-to-face meetings remained an important aspect of APRA’s engagement with employees and the entities it regulates – where COVID restrictions allowed.

While state and regional lockdowns kept employees at home for much of the second half of the year, efforts continued to update APRA’s offices to reflect changing modern workplace requirements and to facilitate hybrid working.

In recognition of technology’s role as an enabler for hybrid working, a project was established to address limitations to existing technology and provide a more streamlined and integrated online experience for employees. In 2021, the Enable Modern Collaboration project began the integration of office applications, and delivered a redesigned and upgraded intranet to act as the central virtual hub for all news and information at APRA. Collaboration technology infrastructure is also being developed to support future enhancements to APRA’s archiving and secure document management system.

A bookable desk system was introduced in the Sydney, Melbourne and Brisbane offices to provide greater flexibility in seating arrangements and a more efficient use of office space.

Surface Hubs – large interactive touchscreens – were installed in communal areas and meeting rooms across APRA’s offices. The touchscreens have provided an improved meeting and collaboration experience for all meeting participants, whether they are in an APRA office or joining remotely. 

Two floors of APRA’s Sydney office were reconfigured to include contemporary collaborative spaces and more diverse working arrangements that are tailored to individual and team needs.

The organisation is continuing to look at ways to enhance the work environment across all of its offices to support ongoing productivity and efficiency.

Renewing the APRA Enterprise Agreement

In October 2021, APRA and employee representatives began the bargaining process to renew APRA’s 2018 Enterprise Agreement.

A key element of the proposed 2022 agreement is the phase-out of annual performance bonuses (in accordance with new guidelines announced by the Australian Public Service Commission in August 2021) through a one-off transition payment. The proposed 2022 agreement also includes funding for an annual remuneration increase linked to the private sector Wage Price Index and further improvements to working arrangements in areas such as parental leave and compassionate leave.

During the six-week bargaining period, several employee information sessions were held, led by employee bargaining representatives and management representatives, to keep employees informed of progress and proposed changes to the agreement.

In December 2021, after a final period of consultation, APRA employees voted strongly in favour of the proposed 2022 APRA Enterprise Agreement. The 2022 Enterprise Agreement will take effect early in 2022, subject to final approval from the Fair Work Commission.

In tandem with the Enterprise Agreement renewal process, APRA has initiated a refresh and simplification of the frameworks and systems that underpin career advancement, performance review and remuneration, to provide greater clarity for employees. The intention is to empower employees to build fulfilling careers at APRA in which they can perform at their best and contribute to APRA’s success.