Rice Warner’s recently-released Underinsurance in Australia 2015 report highlights once again the critical and relentless gap between the level of insurance needed and the level of insurance cover in place.

Our latest research shows that the median level of life cover meets only 61% of basic needs, defined as the minimum required to pay all non-mortgage debt and sustain the current living standard until age 65 or until children reach age 21. Furthermore, median life cover is only 37% of the income replacement level, the level required to replace the expected net income of the insured and maintain current living standards until the insured would have reached age 65.

Further, median levels of total & permanent disability (TPD) cover and income-protection cover meet only 13% and 16% of their respective needs.

Young families

The underinsurance gap for parents with young children is much greater than suggested by the median levels of insurance cover.

A couple aged 30 with young children needs the equivalent of nine to 12 years of income for the higher-earning partner as protection to provide a basic level of life insurance protection for the family, as shown in the below table.

Yet this same family needs the equivalent of 17 to 21 years of income for the higher-earning partner to provide an income-replacement level of life insurance.

A positive development is that Rice Warner’s tracking of the life insurance gap over the past 10 years indicates a narrowing of the shortfall, particularly for low-income earners. This results from higher levels of default cover within superannuation, increased focus on insurance by financial advisers and superannuation fund trustees, and an active direct insurance market.

Wholesale insurance

Superannuation funds provide a significant proportion of the total sum insured and monthly benefits of Australia’s insurance coverage – a total of some 14.6 million life covers are held inside and outside superannuation.

Average insurance needs per partner, expressed as years of income*, families with children

*Higher Earner: multiple of own income; Lower Earner: multiple of family income

However, the median default cover of superannuation meets only about half of the basic death cover needs for households with no children and a much lower proportion for families with children (less than 25% for families with one child). Members’ insurance needs vary markedly depending upon the composition of their families.

The level of default life cover held by young single members is likely to be higher than their needs given that most have no children. In contrast, changing family formation patterns and higher debt levels at older ages means that default cover is often inadequate for older members.

It should be emphasised that default insurance cover through superannuation funds aims to provide for part of their members’ insurance needs.

Challenges for superannuation funds

Steps that superannuation funds can consider to improve the adequacy and appropriateness of their cover include:

• Differentiating members’ default cover by marital status and the number of independent children instead of merely age. This is challenging given the lack of detail about member family characteristics typically recorded on fund data bases.
• Tailoring default cover at younger ages to reduce the possibility of over-providing life cover given that younger members generally have more limited liabilities and responsibilities.
• Maintaining a balance between cover at older ages and the erosion of balances. Default cover tends to taper faster than their insurance needs because of the significant premium growth.
• Encouraging members to report life events ­and whether they have dependent children. This information would assist funds to better align default cover to needs.
• Reconsidering the fundamental redesign of their TPD and income-protection cover to provide a “disability package” that is closely aligned to needs.

These challenges have led to some superannuation fund trustees to review their default life and TPD cover to ensure better alignment to member needs. In particular, we have seen the increased use of lifecycle or age-based designs.

Superannuation funds have an obligation not to allow the costs of insurance to unreasonably erode members’ retirement incomes. This requires trustees to carefully take account of insurance costs when considering the degree to which members’ insurance needs are met.

Nevertheless, the persistent underinsurance of fund members presents continuing opportunities for technological innovation, enhanced member engagement, some creative thinking and further investment by funds.