Improve guidance and disclosure in general insurance
Improve guidance (including tools and calculators) and disclosure for general insurance, especially in relation to home insurance.
The general insurance industry should guide consumers as to the likely replacement value for home building and contents for the purpose of insurance. If significant progress is not made by industry within a short time frame, Government should consider introducing a regulatory requirement to provide this guidance at the point of renewal or on entering into a contract with a new insurer.
The general insurance industry should enhance existing tools and calculators for home insurance, including providing up-to-date information about building costs and building code changes.
The general insurance industry should complete its work on improving disclosure in insurance product disclosure documents, including consumer testing, and providing information at the appropriate point in the sales process.
- Reduce the incidence of inadvertent underinsurance by assisting consumers to make an informed decision about the sum insured.
- Increase the ability of consumers to make informed decisions when taking out insurance.
- Enhance consumer understanding of insurance policies, especially key features, caps and limits, and exclusions.
Problem the recommendation seeks to address
Many stakeholders are concerned about underinsurance flowing from natural disasters and high premiums, especially in disaster-prone areas. The cost of insurance can be high, especially for coverage in higher-risk areas such as flood plains and cyclone-prone areas, leading to non-insurance and underinsurance. The Inquiry believes this issue should be primarily handled by risk mitigation efforts rather than direct government intervention, which risks distorting price signals. (For more discussion on relevant issues, see Box 12: General insurance and natural disasters).
Studies after natural disasters reveal inadequate levels of insurance.63 After the Canberra bushfires in 2003, ASIC found affected consumers were underinsured by 27 per cent on average. Research undertaken by Legal Aid NSW in relation to the Blue Mountains bushfires of 2013 found, “of the 68 survey participants who were insured and had suffered a total loss of their home at the Blue Mountains, a total of 82 per cent experienced some level of underinsurance for their home building policy and/or home contents policy”.64
The current regulatory settings allow insurers to provide guidance on the replacement value of home building or contents without needing to comply with the personal advice rules.65 At present, this is not working and insurers are not typically providing guidance on replacement value. The Inquiry believes that commercial disincentives mean insurers are reluctant to provide this type of guidance. Although many insurers provide online calculators to estimate replacement value, insurers typically refrain from giving guidance on the replacement value either over the phone or on a renewal notice. A recent ASIC report identified that most insurers operate on a ‘no advice’ or factual information model.66
The draft Productivity Commission (PC) report on natural disaster funding arrangements commented on a number of important issues consumers face during natural disasters, including a lack of consumer understanding about risk and insurance leading to non-insurance and underinsurance.67 Underinsurance often occurs because most standard home building and contents insurance policies require the consumer to decide on the amount of insurance. One of the causes of underinsurance includes consumers setting their replacement value amounts too low, due to a lack of knowledge and the specialist skills required to more accurately estimate the cost of rebuilding a home and replacing home contents.68
The ASIC report found that “consumers frequently sought assistance from insurers about how best to decide a sum insured amount”. However, in many instances, sales staff advised they were not able to assist. Insurers have access to information that allows them to assess replacement value better than consumers. However, insurers typically do not give phone-based guidance or refer consumers to existing online tools and calculators, which would help with these replacement estimates.69 Renewal notices also typically do not include this information. The Inquiry believes that it is important for insurers to provide guidance on replacement value to consumers to lessen the risk of underinsurance.
Tools and calculators
Tools and calculators can be updated to help consumers estimate replacement costs more accurately. The Inquiry acknowledges that the insurance market has developed some tools to address ‘estimation risk’; for instance, providing ‘uplift’ factors to sums insured, indexation or inflation adjustments to sums insured, and technological tools designed to assist consumers. However, the Inquiry sees further scope to address this issue, including the industry improving tools and calculators by referencing up-to-date building costs and changes in building codes that may affect rebuild cost. The draft PC report discussed how information imbalances may increase underinsurance due to consumers being unable to access relevant information, such as changes to building codes that may increase the cost of building a home.70
Although general insurance has a specific product disclosure regime, the industry lacks standard practice in describing a policy’s key features and exclusions. The PC also commented on the difficulties consumers face in understanding the information they receive about their insurance policy.71
Survey results highlight that even when consumers take the time to read insurance documentation including the product disclosure statement, many misunderstand it, scan it briefly due to over-reliance on sales staff or fail to understand it due to its complexity.72 For example, as a consequence of recent natural disasters, it became clear many consumers did not understand whether they were covered for flood. A survey by the Caxton Legal Centre after the Queensland floods of 2011 found that of participating consumers:
- 51 per cent read the policy but misunderstood important exclusions or limitations.
- 12 per cent received the policy but never read it.
- 4 per cent tried to read the policy but gave up as they could not understand it.
The Inquiry believes that underinsurance would reduce if, as standard practice, insurers gave consumers relevant information, guidance and advice on home building and contents insurance. Some stakeholders argue that total replacement policies would be the best solution to the issue of underinsurance. However, this may increase risk for insurers, which may exacerbate affordability issues. The Inquiry considered whether introducing standardised or default insurance products would reduce the risk of consumers failing to understand policies’ key features and exclusions. On balance, the Inquiry considers the consequent reduction in competition and potential disincentive for innovation does not warrant this kind of response.
The Inquiry encourages insurers to provide consumers with enhanced guidance about likely replacement values, and to develop further and make consumers aware of tools that can help them to purchase adequate insurance cover. Industry should standardise the way replacement costs are estimated. To the extent this is limited by the existing regulatory regime, industry should work with Government to resolve. Such estimates should be given at the time of purchase, and changes to replacement costs should be communicated to consumers at each renewal.
Insurers providing consumers with enhanced guidance on replacement values would lessen the risk of underinsurance and increase confidence and trust in the sector. This may also reduce the need for governments to provide assistance after natural disasters. If, within the short term, industry has not made significant progress in providing this guidance to consumers, the Inquiry considers that Government should require industry to provide it.
The Inquiry believes the general insurance industry should complete its recent work on reducing complexity and facilitating consumer understanding of key features and exclusions, including relevant consumer testing. This work can be a useful supplement to the key facts sheet for home building insurance, which was introduced in November 2014.73 Insurers could also incorporate elements of the key facts sheet when giving information, guidance and advice over the phone and online.
The Inquiry believes that the recommendations build on existing industry work and practices, and should have lower implementation costs than compliance with a prescriptive regulatory regime.
Box 12: General insurance and natural disasters
Many stakeholders raised concerns in relation to general insurance. The Interim Report highlighted two issues on general insurance and natural disasters:
- The costs of insurance, especially for coverage in higher-risk areas, such as flood plains and cyclone-prone areas. It observed that increased use of risk-based pricing is likely to increase premiums in these areas.
- The incidence of underinsurance following a natural disaster, especially inadvertent underinsurance, where homeowners underestimate the cost of rebuilding.
Cost of insurance
High premiums can lead to calls for government intervention; for example, in relation to the cost of home and strata title insurance in North Queensland. The Australian Government Actuary, which has completed two reports on the issue, attributed recent price increases to historic underpricing of coverage, higher reinsurance costs and the cost of natural disasters. It also found that insurers were providing appropriate risk-based products and pricing.74
The Inquiry recognises a few areas where the absence of private sector providers creates a need for governments to provide insurance; for example, for terrorism insurance or cover for catastrophic personal injuries. However, in most cases, the Inquiry considers the main role of government is to support the market in working as effectively as possible rather than subsidising prices. The costs of natural disaster insurance can be reduced through improved data, further mitigation efforts — such as building flood levies, and in the case of states and territories, by reducing the tax burden on insurance contracts (see Appendix 2: Tax summary). The Inquiry notes Government has recently decided to provide a comparison website for home insurance in North Queensland and has clarified that unauthorised foreign insurers may provide some competition and offer lower prices in targeted areas prone to natural disaster.75
Insurance coverage and underinsurance
Price competition can also help to address underinsurance. For mass-marketed insurance products, governments can play a role in encouraging comparison websites. In Chapter 3: Innovation, the Inquiry recommends the PC review how data can be used more effectively to enhance consumer outcomes, better inform decision making, and facilitate greater efficiency and innovation in the financial system.
Statutory insurance is insurance that is mandatory; for example, compulsory third-party motor vehicle insurance, workers’ compensation insurance and professional indemnity insurance. While there are strong justifications for making some insurance cover mandatory (especially liability insurance) where the detriment is to third parties, governments imposing this requirement should take steps to encourage an adequate market (where they do not provide the cover themselves). Where governments provide insurance in competition with the private sector, this should be done on the basis of competitive neutrality.
63 Australian Securities and Investments Commission (ASIC) 2005, Report 54: Getting home insurance right, ASIC, Sydney; ASIC 2007, Report 89: Making home insurance better, ASIC, Sydney.
64 Legal Aid NSW 2014, Second round submission to the Financial System Inquiry, page 5.
65 Corporations Act 2001, s766B(6).
66 Australian Securities and Investments Commission (ASIC) 2014, Report 415: A review of the sale of home insurance, ASIC, Sydney, pages 9, 10, 47.
67 Productivity Commission 2014, Draft Report: Natural disaster funding arrangements, Volume 1, Commonwealth of Australia, Canberra, page 31.
68 Australian Securities and Investments Commission (ASIC) 2005, Report 54: Getting home insurance right, ASIC, Sydney, page 5.
69 Australian Securities and Investments Commission (ASIC) 2014, Report 415: A review of the sale of home insurance, ASIC, Sydney, page 10.
70 Productivity Commission 2014, Draft Report: Natural disaster funding arrangements, Volume 2, Commonwealth of Australia, Canberra, page 385.
71 Productivity Commission 2014, Draft Report: Natural disaster funding arrangements, Volume 2, Commonwealth of Australia, Canberra, page 385.
72 Caxton Legal Centre Inc 2011, Submission to the Standing Committee on Social Policy and Legal Affairs: Inquiry into the operation of the insurance industry during disaster events, page 16.
73 Insurance Contracts Regulations 1985, Part 4, Division 4.
74 Australian Government Actuary (AGA) 2014, Second report on investigation into strata title insurance price rises in North Queensland, Commonwealth of Australia, Canberra, pages 19–20; AGA 2012, Report on investigation into strata title insurance price rises in North Queensland, Commonwealth of Australia, Canberra, pages 7, 16–17.
75 Cormann, M (Minister for Finance and Acting Assistant Treasurer) 2014, Initiatives to help address insurance affordability in North Queensland, media release, 23 October, Canberra; Senate Economics Legislation Committee 2014, Hansard transcript, 31 October, Commonwealth of Australia, Canberra, pages 13–25.