Can we improve the delivery of group income-protection insurance?

Superannuation funds face the risk of providing a second-class product in their efforts to offer income-protection insurance for as many members as possible.

Rice Warner* believes that critical tests of whether a fund’s insurance is efficient is whether the cover is “adequate” and provided at a “reasonable” cost. A number of funds may fall short of these tests in regards to their income-protection insurance.

The levels of cover are generally short-term (benefit periods of 2 years) and the sums insured don’t provide full replacement of income. Yet, without the cover offered through their super funds, many Australians would have no cover at all and they would suffer financially if they became disabled.

There are clear social and financial benefits from superannuation funds providing group life insurance to a large proportion of the community at a competitive price that generally cannot be matched by retail cover. Superannuation funds provide insurance cover for more than 13.5 million individuals– making a significant contribution to the reduction in our persistent underinsurance gap.

The median income-protection cover in Australia meets only 16% of income-protection needs – and 41% of needs for those with cover. Just 40% of working Australians have any income-protection insurance.

By contrast, the median level of life cover meets about 61% of the basic needs for average households (or 37% of the amount required for dependants to maintain living standards).

The approximate average income-protection needs for young families with parents aged 30 is approximately $5000 a month.

Unfortunately, the compelling case for superannuation funds to provide group life insurance is more challenging for group income-protection cover.

The reality is that income-protection insurance is difficult to offer efficiently within superannuation for such reasons as the:

• High cost of providing an adequate level of cover: Superannuation funds have to try to find the balance between offering an acceptable degree of cover without diminishing retirement benefits.
• High net worth Australians can afford to buy this insurance outside superannuation, particularly as the premiums are tax-deductible.
• Benefits from income-protection cover only apply to members still working as a means to replace income. This means that members who are temporarily off work through unemployment or maternity leave are paying for the minimum cover – unless they have opted-out – without a potential benefit.
• Usual limit of income-protection benefits to 75% of salary (plus SG contributions) means that members who have cover elsewhere (e.g. with another fund, an employer-owned policy or an industry-based arrangement), and/or receive Workers’ Compensation benefits may have paid for cover yet may be ineligible to receive all the benefits.
• Limit of income-protection benefit payouts by most funds to two years even though income replacement should ideally flow through to retirement – particularly given the role of superannuation in providing for retirement.

Further, superannuation funds have little knowledge of their members’ current and changing personal circumstances such as their family makeup, number and age of dependants, debts including mortgages, and total superannuation and non-superannuation savings.

Such details are necessary when determining how much income-protection cover is needed. A fundamental error that members can make with income-protection insurance, as with life insurance, is to assume that the standard default cover is adequate – usually it is not.

So, what can funds do?

Funds need to be smarter about segmenting members and tailoring the cover to different groups. One useful industry trend is to handle double-cover by extending the waiting period when a claimant has income protection cover under another arrangement to so that benefits commence when payments cease under the other policy rather than offsetting the other benefit. This means that members in 2 arrangements providing 2-year income protection cover could receive 4 years of benefits.

We believe funds can place more of an emphasis on educating and advising members, including through fund advisory groups, about how much income-protection cover is needed for their circumstances.

Second, advise members, again through fund advisory groups, about the most cost-effective way to obtain that cover.

The funds’ current education programs, including their online superannuation calculators, can go some of the way to encouraging members to think how much income-protection insurance is necessary. However, calculators are, of course, only a starting point.

By encouraging members to obtain advice about their income-protection needs is likely to have the additional benefit of more members seeking holistic advice regarding their overall circumstances. Such advice would hopefully extend far beyond insurance issues to setting long-term goals, saving for retirement, setting asset allocation and diversification for portfolios, retirement-income planning and estate planning.

Insurance cover as a percentage of need

Source: Underinsurance in Australia 2015 report, published by Rice Warner, August 2016.

*Rice Warner submission to the Productivity Commission’s draft report, How to Assess the Competitiveness and Efficiency of the Superannuation System.