Life insurance adequacy
- On 08/02/2018
- insurance, underinsurance
Life insurance in Australia is sold through three different channels, all of which are under scrutiny. Direct sales fill some needs but they are often relatively poor value, as evidenced by the current ASIC investigation into this segment. Similarly, intermediated retail sales are comprehensive but profitability has been challenging for most life companies in recent years. The remaining segment, group insurance sold through superannuation makes up about 70% of all cover for Australians and has been the main factor over the last decade in reducing Australia’s underinsurance problem.
Recently, there has been considerable focus on the affordability of insurance in superannuation, and whether offering too much will draw away funds which could be used to ensure adequacy of retirement benefits. This is a balancing act and Trustees have a responsibility to consider the adequacy of insurance benefits.
Rice Warner recently released its Underinsurance in Australia 2017 report. A key highlight is that the underinsurance gap remains significant for Australia’s working age population, using updated Census data and adjusting for dependent adults such as students living at home, who have little need for life insurance.
The 2016 Census data has introduced a structural change to the distribution of family units and their income assumption in Australia, compared to our previous report. The most significant change is an increase in the number of individuals with no partner or children and very low income (annual earnings less than $399 per week). Median household income is $1,438 per week or approximately $75,000 per annum.
Other changes impacting the calculations include a reduction in the number of families and a decrease in family income for most families. Despite these changes, the underinsurance gap for the Australian working population is still substantial.
Insurance needs vary due to many factors such as income, age, family and working status and the number and age of any children. Rice Warner has reviewed needs for several cohorts of the population separately and combined. As expected, families without children have significantly lower need for insurance cover for death. Income Protection (IP) insurance requirements are usually around 85% of income, regardless of family status.
Table 1 demonstrates the amount required when a person with a family dies or becomes totally and permanently disabled. The need on death has been considered on two bases, basic life cover to meet minimum needs and life cover to replace future income. The table expresses the insurance needs as a multiple of years of family income.
Table 1. Average insurance needs for families with children expressed as a multiple of years of family income
The amount of insurance cover Australians hold varies considerably between individuals and can be significantly less than their insurance needs. It is estimated that 94% of working Australians have some level of life cover with an average cover amount of approximately $344,500, which is around four and a half times median household income.
The high proportion of insured members demonstrates the tremendous progress made by the life and superannuation insurance industries in meeting a growing proportion of basic life insurance needs, through developments such as compulsory default insurance cover within superannuation and the increased focus on risk insurance by financial advisers. It however should be noted that the average levels of cover can be misleading as they are skewed by a relatively small proportion of the population (typically those on relatively high incomes with active financial advisers) that have high levels of cover. For this reason, the median level of insurance cover is more appropriate when measuring the insurance cover held across Australia.
For those who have life cover, the median cover level is estimated to be approximately $143,500, which is only twice the median household income.
The proportion of the working population with TPD insurance is slightly less than life insurance at 81%, as some superannuation funds may only offer default life insurance cover to some of their members. The average and median cover amounts however are only $237,000 (or three times median household income) and $99,500 (less than one and a half times median household income) respectively.
The situation around Income Protection (IP) cover is the worst with only a third of the working population currently insured. The average cover amount is however reasonable at 75% of median household income. When measured on median level insured, this percentages decreases to only around 36%.
The results of significant underinsurance not only restrict the lifestyle the claimant and their dependants can enjoy after an unfortunate event, it also incurs substantial cost to government mainly in the form of social security benefits.
Rice Warner’s Underinsurance in Australia 2017 report estimates the insurance needs for a 30-year-old parents with children to be,
- 8 times family income for life insurance on income replaced basis,
- 4 times family income for TPD insurance, and
- 85% of family income for IP insurance.
Trustees have a challenging role in determining the default level of cover that it will provide to its members due to the differences in their members’ personal circumstances and insurance needs. However, by considering fund demographics and average needs for Australians at different ages and across family types, this can give a good indication of member need.
Most Trustees will be reviewing their fund’s insurance cover in the light of the Insurance in Superannuation Code of Practice which includes a limit on the premium deductions from member accounts (1% of estimated level of salary), as well as a requirement to automatically cancel insurance cover in some circumstances when no contributions have been received for 13 months.