The establishment of the compulsory Superannuation Guarantee was in recognition of the unaffordable nature of the pension system, given the demographic shift that the baby boomers would create in coming decades. It forms a major pillar in Australia’s retirement savings framework whereby retirement income is funded by:
- the safety net of the pension system
- superannuation savings including voluntary and compulsory contributions
- personal savings.
After only 20 years, Australia has created a savings pool that is the envy of the world.
Interestingly, there is nothing in the above which addresses insurance needs, yet life and TPD (total and permanent disability) insurance are playing an ever-increasing role in superannuation. There is little written about why insurance was included in the superannuation architecture, but one can envisage the logic went something like this:
- superannuation is a compulsory system and every working Australian should have at least one account
- there is an underinsurance problem in Australia
- we can solve the underinsurance problem if we default insurance in super
- if we try hard enough, we can make a link between life and TPD insurance and retirement income.
Insurance seems to be increasingly important in superannuation, whether it be the large increase in premiums in the last couple of years, or the entire section dedicated to insurance in the Super System Review recommendations (otherwise known as the Cooper Review). ASIC lists insurance as one of six key considerations in picking a super fund, while the acknowledgement of consideration of insurance is mandatory in accepting a super rollover form. For SMSF trustees, it is now mandatory to consider insurance as part of the SMSF’s investment strategy. Insurance is well and truly imbedded into the superannuation system.
Yet the question that does not seem to be asked is, “does insurance belong in super?”
The main objective of the super system is to alleviate the pressure on the age pension system. This gives us the ‘sole purpose test’ which ensures a super fund is maintained to provide benefits to its members upon their retirement (benefits can be released prior to retirement age, but these are only under special circumstances).
Contrary to the sole purpose test, life and TPD insurance provides protection primarily for the current day, whether for a member’s family in the event of death or the member themselves in the event of a permanent disability. The Cooper Review’s justification for this was that:
“Superannuation funds are generally structured towards financing a period of retirement after a long engagement in the workforce. Fortunately, that is the experience of most members. However, for a significant number of members each year, total and permanent disability (TPD) or premature death mean that they or their dependants need to call on their superannuation savings much earlier and for a longer period than they would have expected. Insurance plays a crucial role in allowing those needs to be met.”
This explanation is not a very convincing link but given the noble purpose outlined, it should not be an issue provided that it does not impact the functioning of the superannuation market.
And this is where things get interesting. Superannuation provides for a retirement outcome. The decision on which superannuation fund is the right fund for an individual is in itself a difficult one, considering fees, service quality, investment options, performance and trust in the institution. Insurance on the other hand provides protection for the current day. In selecting an insurance provider, an individual would consider the level of cover, premiums, service quality, policy exclusions and trust in the institution.
The problem with defaulting insurance in super is that it distorts the decision-making process.
For example, an individual may want to change super funds because they are not happy with the features and service levels of the incumbent fund; however their insurance offering is excellent. What decision does the individual make? Do they compromise their retirement outcome due to their present day insurance needs?
Conversely, a member’s superannuation fund may experience a large increase in insurance premiums. Does the member change super funds as a result, even if they are happy with all other aspects of their fund?
Both scenarios create difficult decisions for members and more importantly distract from what a superannuation decision should be based on, engaging with members on their desired retirement outcome.
From a super fund’s perspective, there is the time, effort and cost invested in managing insurance within the fund, whether negotiating a policy’s premium rates, managing data to support the group underwriting process or managing the claims process. All this distracts from the sole purpose of maintaining a superannuation fund for the purpose of providing benefits to its members upon their retirement.
In trying to solve an under-insurance issue, we have added cost and complexity to superannuation for both product providers and members. The further question is, does the social benefit outweigh the additional cost and complexity?
Christopher Sozou is Head of Wealth at Virgin Money.