The financial regulator is worried some insurers may stop selling income protection insurance direct to consumers after the industry lost $2.5 billion on the product over five years.
The Australian Prudential Regulation Authority has told life insurers they must fix issues with individual disability income insurance (DII) to improve the product's sustainability.
APRA executive board member Geoff Summerhayes said most life companies have long been aware of the issues, but their efforts to address them have so far been inadequate.
"In a highly competitive environment, life companies have focused on attracting policyholders through pricing and product features that are not sustainable," he said in a statement on Thursday.
"The result has been ongoing losses and a failure to deliver a satisfactory customer experience.
"Unless these adverse trends are reversed, there is a risk some life companies will ultimately exit the market for DII, worsening consumer outcomes through reduced competition, accessibility and affordability."
DII or income protection insurance provides replacement income to policyholders when they are unable to work due to illness or injury.
APRA's concerns centre on DII sold to individuals, rather than the income protection policies provided through superannuation.
APRA said the life insurance industry has collectively lost $2.5 billion through the product offering over the past five years, with no signs of improvement.
