Super Watch Default Insurance Design

Transcription

1 Super Watch Default Insurance Design September 2016 Willis Towers Watson has expanded its 2014 analysis of MySuper default insurance arrangements to 54 of the largest public offer superannuation funds in Australia. Senior consultant PHIL PATTERSON comments on the updated analysis, looks at how the market has changed and highlights some of the significant cross-subsidies that remain prevalent in insurance design. The pressure is growing on trustees from a wide number of industry participants and media relating to insurance design within super. Consumer group Choice has flagged concerns about insurance premiums inappropriately eroding member account balances, and the Productivity Commission has raised questions about whether insurance within superannuation is delivering efficient benefits. APRA deputy chairman Helen Rowell, at the Financial Services Council s annual leaders summit in July, was quoted in the press as saying: We ve seen some reluctance across the industry to really tackle some of the hard issues about the design elements of what good insurance looks like going forward. Our analysis shows that somewhat surprisingly even in the face of this pressure and a continued increase in insurance premiums, there have been relatively few examples of significant change in default insurance design. At an industry level, not a lot has really changed. Significant cross-subsidies between members continue to persist in insurance design, particularly with the young subsidising the old. Salary Continuance Insurance (SCI) provides some of the worst examples. In this SuperWatch, we illustrate the size of these cross-subsidies. The role of default insurance We have previously questioned whether the role of default insurance should be to fully insure members to an adequate level or whether it should be set as a base level safety net from which a member can build higher levels of cover to meet their own personal needs at a cost they are prepared to pay. What balance does the trustee set between the competing goals of providing (and charging for) adequate insurance, and the main goal of superannuation being saving for retirement? Recent media coverage as well as the comments from Choice and the Productivity Commission have touched on this issue, with the discussion shifting significantly toward affordability and the minimising of account balance erosion, and away from insurance adequacy and solving the underinsurance problem that many Australians are facing. APRA deputy chairman Helen Rowell at the Financial Services Council s annual leaders summit has been quoted as saying there is a real tension between the sometimes competing obligations of super fund trustees to provide appropriate levels of default insurance coverage without eroding members balances, and I think there is some rethinking needed by the industry on the issue of insurance and what is needed at a default level. The government intends to enshrine in legislation the objective of superannuation as to provide income in retirement to substitute or supplement the Age Pension. This provides some perspective on the place of default insurance design within superannuation. Is the role of default insurance to fully insure members to an adequate level or should it be set as an affordable base level safety net? While default insurance continues to provide very valuable and efficient protection for millions of Australians who might not otherwise have any life or disability insurance, we must be mindful in our default insurance designs that retirement incomes are the main aim of superannuation, not insurance.

2 Figure 1: SCI benefits offered What default Insurance is being offered MySuper products are required to include default death and total and permanent disablement (TPD) cover, set at a level appropriate to the needs of the membership. Salary Continuance Insurance (SCI) is not compulsory, but currently forms part of the default insurance design for 50% of funds a small change from the 49% observed in There has been consistent market commentary about the merits of SCI, and the logic of benefits extending beyond the two year payment period, in combination with a lower TPD benefit, to reduce the moral hazard attached to a large lump sum benefit and better enable rehabilitation. However, the prevalence of SCI shown in figure 1 shows proportions in 2016 that are almost exactly the same as in our 2014 analysis. Similarly, only 20% of the products analysed in 2016 included a default level of TPD that was different from the death benefit. Of these 20% the majority limited the difference to young members only. Again, this result is almost identical to our 2014 findings. The research continues to show a very wide range of insurance designs on offer in the market encompassing all of the following fundamental design aspects: Unitised scales of reducing cover for a fixed premium per week (76% of funds) continue to dominate designs compared to 24% of funds offering premium rates stepped by age. How insurance costs are differentiated amongst members remains a crucial design question, and is a balance between simplicity of design and equity between members. The membership profile of the fund clearly influences this decision. The more homogenous the membership, the less need to vary insurance costs by gender or by occupation. 61% of funds now differentiate insurance costs by occupation, which is an increase from 49% in our 2014 analysis, possibly a reflection of more funds attempting to expand out from narrow industry defined membership into the broader public offer space. The proportion of funds differentiating insurance costs by gender actually fell from 16% in 2014 to 13% in 2016, although this was due to the expansion of our 2016 analysis to 54 funds and not a reflection of changing designs. Overall, the overwhelming finding is that there has been relatively little change to default insurance designs since The recent comments from APRA, Choice and the Productivity Commission indicate the impetus for serious change is increasing, but there remains a lot of work to do. No SCI 50% 2 year SCI 41% Figure 2: Death & TPD - fixed cost per unit or costs stepped by age Stepped 24% 5 year+ SCI 9% Fixed 76% Figure 3: Different insurance costs by occupation No 39% Yes 61% Figure 4: Different insurance costs for males & females No 87% Yes 13% 2 Super Watch Default Insurance Design

3 What are the current default insurance costs? Just as the research shows a wide variety in the level and type of default insurance, so too is there a wide range in the cost to members of default insurance in the MySuper products researched. This range has widened since our 2014 analysis. The 2016 analysis shows that the high end of insurance costs has continued to increase, but the lower end is largely unchanged. Not surprisingly, the funds offering default SCI as well as Death and TPD cover tend to have higher costs and the funds that have moved to stepped insurance costs by age tend to have the highest costs at the older ages. Figure 5 illustrates the total default insurance costs contained in publicly available PDS documents available in June 2016, then breaks up the 54 funds analysed into 10% bands, excluding the outliers of the 10% of funds with the highest costs and the 10% of funds with the lowest costs. The median default insurance costs are represented by the upper boundary of the 40% to 50% band, being $240 p.a. at age 25, $260 p.a. at age 35, $324 p.a. at age 45, and $395 p.a. at age 55. For those funds who were included in both our 2014 and 2016 analysis, the average default annual insurance cost has increased, although it is interesting to see in figure 6 that the increases have been higher at older ages than at younger ages, perhaps reflecting some unwinding of the cross-subsidies by age that are common in default insurance designs. Figure 6: Increases in average default insurance costs Age Age 25 last +10% Age 35 last +16% % increase Age 45 last +20% Age 55 last +25% Figure 5: Range of total default annual insurance costs $1,000 80% - 90% $800 70% - 80% 60% - 70% $600 $400 50% - 60% 40% - 50% 30% - 40% 20% - 30% 10% - 20% $200 Median $0 Age 25 last Age 35 last Age 45 last Age 55 last 3 Super Watch Default Insurance Design

4 Is default insurance inappropriately eroding balances? MySuper products are supposed to be targeted toward disengaged default members who may be unaware of their super at all, let alone the detail (including the cost) of their insurance. What then, is an appropriate cost to deduct from a member who may never want or need insurance cover? By definition, disengaged members have entirely unknown insurance needs (from a trustee perspective) so a trustee should consider the risk of over-insurance for a young single member, with no dependants, as well as the need for more adequate cover for a middle aged, mortgage holder with a family, when designing their fund s default insurance arrangements. The research shows a median default insurance cost for a 35 year old is around $260 p.a. To put that cost into perspective, the annual 9.5% SG contribution for an employee on $60,000 annual income is $5,700 before 15% contributions tax and APRA quotes the 30 June 2015 average balance in MySuper accounts at $28,401*. Thus, the median insurance cost represents 4.6% of annual SG contributions, or 0.9% p.a. of an average MySuper account balance. Are these costs at a level that inappropriately erodes the retirement income of members? The answer is probably no at these levels of contributions and account balance. However, the real issue is members with below average balances, multiple accounts or reduced contributions due to part-time or casual work for whom high insurance costs can significantly erode their account balance and ultimate retirement income. The real affordability issue is members with below average balances, multiple accounts or reduced contributions due to part-time or casual work for whom high insurance costs can significantly erode their account balance and ultimate retirement income. * Source:APRA Superannuation Annual Bulletin June 2015 (revised 23 August 2016) 4 Super Watch Default Insurance Design

5 Age cross-subsidies in default insurance One of the most significant design areas many funds are yet to address is the cross-subsidies by age inherent in their default insurance designs. Most commonly it is younger members who are cross-subsidising older members, contributing to the erosion of young members balances. The traditional dollar per week scales for death and TPD involve a fixed premium per unit of cover in return for a decreasing amount of insurance by age. While these scales can be outdated compared to current claims trends, at least there is significant recognition of higher insurance costs at older ages. The most glaring age cross-subsidies however are in default SCI designs. Of the 27 funds in our analysis who offer default SCI, 10 of those (or 18% of all the funds analysed) offer a fixed SCI benefit by age and a fixed SCI insurance cost by age (i.e. a 25 year old member gets the same cover at the same cost as a 55 year old member). The extent of cross-subsidies this potentially creates depends on the age distribution of the fund, but for a hypothetical fund with an age distribution similar to the distribution of the Australian working population, providing a two year SCI benefit with a 90 day waiting period, figure 7 illustrates the cross-subsidies involved. It compares indicative insurance costs, stepped by age (shown as the True Age Cost ), with the SCI fixed premium rate that would apply for the hypothetical fund to recover all of its insurance costs. In this example, members in their 20s are paying over 300% of the true cost, falling steadily to 100% at around age 47, but continuing to fall to below 50% over age 54. Not only is this design unfair to younger members, it leaves the fund very vulnerable to changes in age distribution. A one year increase in the overall average age for such a fund can lead to a 10% premium increase, even if claims experience has been in line with expectations. One of the areas of focus of the current Productivity Commission investigation into superannuation is whether insurance value is provided in superannuation compared to the cost of an equivalent retail product. The sort of cross-subsidies illustrated below cannot be sustainable, as members become more engaged and start to question the value of their default insurance. Older members engaged with their insurance may seek out funds with cheap crosssubsidised insurance, in much the same way that some members with medical issues have sought out funds with high levels of Automatic Acceptance. In this example, members in their 20s are paying over 300% of the true cost, falling steadily to 100% at around age 47, but continuing to fall to below 50% over age 54. Figure 7: Indicative SCI fixed Premium as % of True Age Cost 400% 300% 200% 100% 0% Age True Age Cost Fixed Premium (as % of True Age Cost) 5 Super Watch Default Insurance Design

6 Tackling good insurance design Despite a growing discussion, there has been surprisingly little default insurance design change over the period 2014 to There have been a few notable exceptions where funds have worked hard to re-shape their insurance to their membership, but these funds are a small minority. Perhaps this is because significant change, particularly to address major cross-subsidies by age, involve significant impacts on some members in favour of, or to the detriment of others. Further information Phil Patterson Senior consultant, Benefits, Australia phil.patterson@willistowerswatson.com Or your Towers Watson consultant: Melbourne Sydney Another issue may be that by the time a fund s insurance contract comes up for review it is too late to adequately address a significant change in design. A well-considered re-design process should include an analysis of membership and insurance costs to identify potential changes and impacts, before the insurers are engaged to provide quotations, so it is actually mid-cycle that trustees should consider whether design changes are appropriate, and in what area. It may have been easy for trustees to take the conservative approach and maintain the status quo on insurance design, however it is those funds with the courage of conviction to examine their insurance design properly, who may better serve their overall membership into the future. About Willis Towers Watson Willis Towers Watson (NASDAQ: WLTW ) is a leading global advisory, broking and solutions company that helps clients around the world turn risk into a path for growth. With roots dating to 1828, Willis Towers Watson has 39,000 employees in more than 120 territories. We design and deliver solutions that manage risk, optimise benefits, cultivate talent, and expand the power of capital to protect and strengthen institutions and individuals. Our unique perspective allows us to see the critical intersections between talent, assets and ideas the dynamic formula that drives business performance. Together, we unlock potential. Learn more at willistowerswatson.com. Copyright 2016 Willis Towers Watson. All rights reserved. WTW-AP-16-PUB-4790 willistowerswatson.com