There has been many adverse media stories in recent years over life insurance, with accusations of people paying twice for policies they don’t need and their benefits being eroded.
Today’s release of a KPMG report on the costs and benefits of default group insurance in superannuation – prepared for the Insurance in Superannuation Working Group (ISWG), an umbrella group of all Australia’s superannuation bodies, and Industry Super Australia – should inform debate on this important public policy issue.
KPMG adopted an evidence-based approach to the issue, using publicly-available industry-level data from the ATO, APRA and major superannuation funds. We analysed the benefit design of default superannuation funds and a 2 percent sample tax file containing 258,744 records. The same methodology and modelling was used to assess the impact on retirement benefits of the current system continuing, compared to potential changes to the system.
So what is our conclusion of our analysis? Overall, the news is good. Default group insurance in super system produces substantial benefits both for members and Australia as a whole.
But the downside is that some groups – low income earners, female workers and young people – are adversely impacted to a significant degree by retirement benefits erosion and we believe specific measures are needed to help those people.
The current system has the great advantage of ensuring greater insurance coverage for a larger part of the population – and this helps to reduce Australia’s long-standing underinsurance issue.
Many more people are covered, and to a much greater degree, than if they relied on government support. Death benefits also allow the surviving spouse, often female, to carry on working rather than having to leave the workforce and look after children. This is an important societal and economic benefit.
The overall reduction to retirement benefits for members is moderate – on average, 6.2 percent of the superannuation guarantee contribution, and less than 1 percent of salary. But the data confirms that a relatively small proportion of members are disproportionately affected.
Our report finds that income level is the key factor to benefit erosion, more so than age or gender. For example, the impact on the retirement benefits for females aged 35-39 earning between $18,000 – $37,000 is 14 perent but may be higher for those earning less than $18,000.
This is clearly an issue that needs to be addressed. But the answer is not necessarily to remove default cover for young people – we do not believe this will have the intended effect when examined over a person’s working lifetime. Further, any removal of cover can be expected to cause premiums to rise for the rest of a fund’s members.
We are also not convinced that an opt-in regime would necessarily solve the key problems, and could well remove or detract from the main benefits of the current system.
So what do policymakers need to do? Here are three issues to consider:
Firstly, insurance should vary according to the individual’s needs for protection, depending on age, income, dependents etc. The use of lifecycle or needs-based default cover can significantly mitigate the impact on retirement benefits.
Second, as salary is an important driver of benefit erosion, consideration should be given to a premium cap based on the Superannuation Guarantee Contribution, which is in turn linked to salary.
Thirdly, introducing appropriate cessation rules can make a significant difference to segments of the population like casual workers and people, largely women, who have broken work patterns.
But it is worth recapping on the many additional benefits of the current system:
- 80 percent of group insurance premiums are paid back to members in claims, with 12% spent on expenses and commissions. By comparison, 50 percent of individual insurance premiums are paid back as benefits and 40 percent are spent on expenses and commissions.
- There is lower cost and minimal need for underwriting in comparison to individual insurance held outside super.
- In some instances default insurance in super improves access to insurance for people in high-risk occupations.
- The income protection benefits offered under default insurance disqualify recipients from claiming a full Disability Support Pension, representing a significant saving to the public purse.
- Income Protection benefits save the government between $3-$4.2 billion over ten years in terms of claims on the Disability Support Pension.
- Tax on insurance payments benefit the public purse by $2.9 billion over 10 years, outweighing the costs of tax concessions provided to group insurance in superannuation.
Our analysis suggests that making targeted rather than wholesale changes may be more effective in solving the issues that concern the community. The government might also consider, on the grounds of rationale and costs, whether the components of disablement cover are all essential. Is it cost-effective to provide both a lump sum and income replacement on disablement – and are Death, TPD and IP (income protection) cover all necessary for default group insurance cover or could TPD and IP be interchangeable?.
The ISWG is comprised of Australia’s superannuation bodies – ASFA, AIST, FSC, IFF and ISA – and to co-incide with KPMG’s report, has released a Code of Practice to be applied to superannuation funds. The Code is the superannuation industry’s commitment to high standards when providing insurance to members of superannuation funds.
We would be supportive of a code that would look to address issues around erosion of retirement benefits and cross subsidisation that impacts females and low income earners the most.
Is important to bear in mind that for the majority of Australians, government benefits are not an adequate substitute for insurance. The amount available to members who become disabled or for the families of those who die, are not sufficient to sustain their existing lifestyles. The evidence suggests that without default group insurance, many would simply lack any cover.
Taking out insurance communally rather than individually is more cost-effective, and if the rough edges of the current system are smoothed – by the suggestions we make in our report – we believe this would be the best outcome for Australia.