Defining underinsurance

Underinsurance is defined as the gap between the amount of life insurance needed by an individual or family and the amount of life insurance held.   Since 2005, Rice Warner has been carrying out research to quantify the underinsurance gap in Australia and we have recently released our Underinsurance in Australia 2020 report.

The life insurance industry has seen numerous changes over the last 18 months, from the Insurance in Super Voluntary Code of Practice, Life Insurance Framework reforms, Protecting Your Super (PYS)/ Putting Members’ Interests First (PMIF) legislation and the impacts of the COVID-19 pandemic.

All these changes have had an impact on the level of underinsurance in Australia. In particular, the implementation of PYS/ PMIF legislation has played a key role in attempting to remove duplicate accounts and unnecessary insurance through the ceasing of default insurance cover for young members, inactive accounts and low balance accounts.  The impact of this has allowed us greater clarity than ever before around how many Australians are insured and the amount of insurance held compared to their needs.

Cover is changing over time

Graph 1 shows the change in sums insured by market segment since 30 June 2018, based on APRA’s Life insurance claims and disputes statistics data at 30 June 2020 (released 20 October 2020) for death and TPD. It shows that the total sum insured across all distribution channels has decreased by 17% and 19% for death and TPD cover respectively since June 2018. This is a significant reduction and is driven mostly by the drop in Group insurance inside superannuation, being 27% for death and 29% for TPD cover.

Graph 1.            Death and TPD sum insured by market segment from June 2018 to June 2020

What cover do people need?

Inevitably, there will be different views as to the level of life insurance protection that working Australians require.  Our research is underpinned by methodologies that base needs around required objectives. For example, we allow for specific objectives such as insurance to cover housing costs, repayment of debts, funeral costs and the needs of a partner or dependent children. To consider varying affordability, we have developed three levels of cover which are aimed to meet a partial, basic and income replacement level of insurance requirement. These levels also consider insurance needs based on family structures, age of parents, number of children, income bands and work status.

Table 1 shows the average basic level of death and TPD insurance needs per insured, for young parents both aged 30 and older parents both aged 50. Insurance needs reduce for the older parents, reflecting a shorter period until retirement, lower expected debt, higher superannuation savings and increasingly less dependants.

Table 1. Average insurance need per parent
There had been a significant increase in the amount of insurance cover provided to the community though superannuation funds over the last ten years and the underinsurance gap had been significantly reducing as a result. However, in light of the current insurance landscape, and the greater clarity that PYS and PMIF has introduced, our research shows that the underinsurance gap has widened since our last research in 2017. Our research also shows:

Underinsurance is a direct cost for the Government in terms of additional social security and other related payments, particularly for Australians on modest incomes. We have estimated the current total cost to the Government in social security payments of death and TPD underinsurance across Australia to be well over $600 million per annum. This is based on the income replacement level of death and TPD needs.  Group insurance in superannuation still dominates the type of life insurance held by Australians, and the vast majority of this is default cover.  Without it, the potential additional cost to the Government would be significant.

Superannuation

Striking the balance between adequacy and affordability of default cover within superannuation has always been a challenge for Trustees as insurance requirements vary significantly depending on member demographics and characteristics, including income and family composition. It is particularly difficult at the current time as the market is experiencing significant premium increases.

The default cover of typical superannuation funds does not meet the full insurance needs of many families as the median cover is significantly less than the income replacement level required for death cover and TPD cover. The median default cover of superannuation funds meets approximately 65% to 70% of basic level death cover needs for average households, but a much lower proportion for families with children.

Retail

Retail advised insurance new business volumes sales have been reducing, due to a similar reduction in active insurance advisers. The aggregate sum insured held via this distribution channel has been decreasing since the end of 2018. Although we will see product innovation as insurers respond to APRA’s intervention on Retail Income Protection products, it will be challenging to completely reverse this trend.

Conclusion

The impact of recent superannuation legislation has allowed the true extent of the underinsurance gap to be more clearly revealed, and the life insurance industry needs to raise awareness of this position.

Underinsurance highlights the need to heighten targeted engagement and awareness of the underinsurance issue at an individual level.   The availability of Insurance Needs calculators for use by individuals to assess their unique circumstances has allowed individuals to better understand and tailor their insurance arrangements. Targeted marketing and improving the ease of accessing insurance via all distribution channels is also important.