Insurance costs the ‘sleeper’ in choice of fund
The question of super fund costs has become a major issue; especially since the advent of choice of fund. With up to half a million more members due to become eligible for choice from this July, the issue of costs is again likely to command a high profile.
To date, the focus has been almost exclusively on management costs – that is, the administration and investment fees that members pay either directly or indirectly from their accounts. Yet there is another whole area of costs that is just as significant but receives little public attention. That is insurance.
The variation between funds in the cost of insurance is at least as great as the variation in management costs. For some people it is much greater. So, for members to make an informed choice they need to look at both fees and insurance costs and weigh up the overall value offered by any fund they are considering.
SUPER’S ROLE IN COMBATING UNDERINSURANCE
Before we look at insurance costs in detail, it is worth noting the significance of insurance provided through workplace super. It is generally recognised that Australia has an underinsurance problem when it comes to death and disability. Left to their own devices, many workers would probably leave their families with less than adequate protection.
Insurance through super doesn’t solve the problem, but it certainly helps. Most workers now receive some death and disability cover automatically, paid for out of the compulsory contributions made by their employers. This is generally tax-effective, because the premiums are deductible to the employer. It is also convenient, because members don’t have to make a conscious decision to insure themselves and the premiums don’t come directly out of their pockets.
While the amount of standard cover that most funds provide is generally low, it is better than nothing. Importantly, it also provides a foundation for funds to talk to their members and educate them about assessing their insurance needs properly. As those education initiatives take effect, and with funds generally improving their insurance offerings, we would expect to see the amount of cover provided through super to increase . And that will increase the importance of insurance costs in the overall decision on which fund to choose.
THE TOTAL COST PACKAGE – FEES PLUS INSURANCE
Table 1 below illustrates the fees and insurance costs for different types of fund for two 40 year old non smokers – one a white collar female and the other a blue collar male. We have based the costs on the standard account balance of $50,000 and a representative death + TPD insurancebenefit of $300,000.
The first point to note is that, in general, members of public sector and industry funds pay lower total costs (fees plus insurance) than members of master trusts. For those public sector and industry funds, insurance counts for roughly half (+ or – 10%) of their total costs.
Master trusts typically charge higher fees so, for their members, insurance premiums are a smaller proportion of their total costs. In dollar terms, however, the white collar female pays roughly the same premiums, on average, as she would in a public offer or industry fund, while the blue collar male pays more.
Table 1 also shows the ranges for both fees and insurance, and readers may be surprised to see that the highest insurance premium exceeds the lowest by a factor of between 4.5 times (i.e. 873/187) and 6 times (1,143/191). If we were to consider older members (ages 55-60), the highest insurance premium would exceed the lowest by a factor of up to 30 times. That is, a particular member may be paying an insurance premium 30 times greater than what they would pay in another fund.
|TABLE 1: ANNUAL COSTS ($) FOR $50,000 ACCOUNT BALANCE AND $300,000 DEATH + TPD COVER (NON SMOKER RATES)|
|Fund Type||Fees||Insurance||Insurance as %|
|Median||Range||Median||Range||of Total Cost|
|FEMALE WHITE COLLAR AGED 40|
|Public Sector Fund||286||192 – 750||375||195 – 873||57%|
|Industry Fund||436||285 – 575||330||191 – 499||43%|
|Corporate Master Trust (small company)||823||547 – 1,497||330||228 – 445||29%|
|Personal Master Trust||1,051||500 – 1,609||315||187 – 486||23%|
|Overall||833||192 – 1,609||330||187 - 873||28%|
|MALE BLUE COLLAR AGED 40|
|Public Sector Fund||286||192 – 750||456||195 – 873||61%|
|Industry Fund||436||285 – 575||409||191 – 1,137||48%|
|Corporate Master Trust (small company)||823||547 – 1,497||676||529 – 1,143||45%|
|Personal Master Trust||1,051||500 – 1,609||573||403 – 820||35%|
|Overall||833||192 – 1,609||565||191 – 1,143||40%|
|Number of funds included: Public Sector Funds (6), Industry Funds (18), Corporate Master Trusts (23), Personal Master Trusts (36) = Total funds (83)|
The insurance premiums do not vary only between fund categories, but vary widely within fund categories. Within industry funds alone, the highest premium for a 40 year-old blue collar male exceeds the lowest by a factor of 6 times (1,137/191).
The differences in insurance costs charged by various funds are huge, and they highlight the need to compare insurance costs between individual funds, not just between categories of fund.
WHAT MAKES (OR COULD MAKE) A DIFFERENCE?
Management fees pay no regard to age, sex or occupation type, but that is certainly not the case with insurance premiums. These factors, together with smoking status,can potentially have a major impact on the premiums charged.
The word ‘potentially’ is a key one. The fact is that some funds take all these factors into account, while others take some but not all into account. There are even funds which, in some respects at least, largely ignore these factors when setting their insurance charges.
The reality is that insurance is more expensive to providefor:
- Older people compared with younger;
- Males compared with females;
- Blue collar occupations compared with white collar;and
- Smokers compared with non-smokers.
So, to the extent that funds ignore these factors, they distort the true costs and introduce an element of cross subsidy between their members. At the extreme, several industry funds charge the same premium for income protection cover for a 20 year old, white collar, nonsmoking female as for a 55 year old, blue collar, male smoker.
Generally speaking, master trusts are more likely to charge premiums related to the real cost of cover, while public sector and industry funds are more likely to include an element of cross-subsidy. Many industry funds, for example, still base their death and TPD benefits and/or premiums on age alone. This situation is gradually changing, but it does exist now and it is an important element to bear in mind for anyone looking to choose a fund.
For example, an older male, blue collar smoker would almost certainly pay much lower premiums in a public sector or industry fund than in a master trust. Indeed, in the case of a personal master trust, he may not be able to obtain the cover he wants at all. Conversely, a young healthy female professional may get a better deal in a master trust (or a predominantly white-collar industry fund) where she is not helping to subsidise the cost of other members.
That is an over-simplification, of course, and there are many other factors to take into account, but it is an indication of how insurance is something of a ‘sleeper’ in the whole choice of fund debate.
Table 2 below illustrates the impact of age and smoking status on premiums for personal master trusts members. It shows that if our 40 year old male were to have a smoking habit he should expect his insurance premiums to nearly double. And, smoker or not, if he were aged 50 rather than 40 his premiums would be roughly three times as much.
|TABLE 2: ANNUAL COSTS ($) FOR $300,000 DEATH + TPD COVER IN A PERSONAL MASTER TRUST|
|Member Details||Age 40||Age 50|
|MALE BLUE COLLAR|
|Non smoker||573||403 – 820||1,766||1,180 – 2,504|
|Smoker||1,031||515 – 1,811||3,357||1,572 – 5,765|
‘MAKE IT EASY FOR ME’
Costs aside, members will be attracted to funds that make it easy for them to obtain the type and level of cover they are looking for. Providing health evidence, with the rigmarole of personal statements and medical examinations, is a major turn-off for people looking for higher amounts of cover.
Funds that offer generous levels of automatic acceptance (cover that does not require any health evidence) will tend to be favoured. As a rule, corporate master trusts score well here. A typical automatic acceptance limit would be $250,000 for a small employer fund with about 20 members, and over $600,000 for a larger employer fund with 200+ members.
Industry funds also provide some level of automatic acceptance, but this is generally restricted to a maximum of about $100,000, which may be insufficient for most members. Some industry funds have recognised this weakness and are negotiating higher levels with their insurers as part of an overall review of their insurance offering.
Most retail master trusts do not provide any automatic cover, because personal members who might suffer froma known condition represent a risk of selection against the fund. This is why anyone considering leaving a group arrangement in favour of a personal fund needs to be sure that, if they wish to replicate the cover they have enjoyed, they can do so and at an acceptable cost.
COMPETITION CONTINUES TO CHANGE THE LANDSCAPE
Choice has caused all super funds to self-examine from a competitive viewpoint, and insurance has now made its way to the top of the ‘must do’ pile. Many major funds have either completed insurance reviews or are in the process of doing so. As a result, we are seeing a trend towards lower premiums and higher or more flexible cover.
Insurance costs and benefits are becoming a critical point of differentiation. Funds that provide poor value will struggle to attract or retain members who are becoming increasingly savvy about what to compare and how to do it. Just as there are tools available for members to compare fees, tools are now available to help them compare insurance costs. Chant West launched its PersonalSuper Insurance Calculator in the April edition of its research.
As always, increased competition and better informed consumers will drive out inefficiencies and purge some ofthe more blatant overpricing in the market. This can only be a good thing because, of course, every dollar that is not deducted in premiums is a dollar invested towards the member’s long-term financial wellbeing.
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