The impacts and unintended consequences of the proposed Federal Budget changes

The 2018/2019 Federal Budget proposed a significant change to default group insurance that will impact superannuation funds and insurers.

The proposal was that insurance within superannuation should move from a default framework to be offered on an opt-in basis.

This will be for:
• members with low balances of less than $6,000,
• members under the age of 25 years,
• and members whose accounts have not received a contribution in 13 months and are inactive.

This proposal extends significantly beyond what was prescribed in the Insurance in Superannuation Voluntary Code of Practice, which was released with the intention for funds to be compliant no later than 30 June 2021.

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The changes are proposed to take effect on 1 July 2019, with affected superannuation members having a period of 14 months to decide whether they will opt-in to their existing cover or allow it to be switched off.

What are the impacts of the proposed changes?

The proposed changes are not mutually exclusive. Therefore, many superannuation fund members may meet more than one of the requirements for default insurance to be removed. The key impacts for default insurance arrangements in superannuation are summarised below:

Insurance coverage impact

The first impact of moving from a default framework to an opt-in model for the three cohorts of members is the significant reduction in the overall insurance coverage inside superannuation.

The impact for each fund will vary significantly due to differences in insurance cover design, member demographic, account balance profile and proportion of inactive members.

Insurance premium impact

As a consequence of the reduction in insurance coverage, overall group insurance premiums collected can be expected to significantly decrease.

This reduction in cover and insurance premiums collected can be expected to have further consequences for the insurers and the remaining members of superannuation funds.

Firstly, many superannuation funds’ insurance premiums currently involve a level of cross subsidy between younger and older members of the fund. This is noted in section 5.1 of the KPMG 2017 report. Removing default cover for under 25 year olds means one can expect fewer younger members with insurance. To the extent that there is a cross subsidy in the insurance premium rates, removing default cover for younger members means the premium rates need to rise to compensate for what is effectively an increase in average age and risk within the overall insurance pool.

For example, if a single premium rate applies to all ages, the impact would be significant. If the premium rates are more reflective of the underlying risk based on age (i.e. increase with age), the impact would be reduced. 

In addition, removing default insurance cover from inactive accounts or accounts with less than $6,000 may further expose cross subsidies between different cohorts of members. Impact by fund will vary significantly but funds with a high proportion of inactive or low account balance members could expect a significant change in member demographic and overall claims experience, potentially leading to further material premium rate increases.

Secondly, when default cover is removed, impacted members will have a 14-month period to retain their existing levels of cover. This transition arrangement, and other opt-in arrangements for new members, may drive greater anti-selection, which will have an impact on the level of claims, hence the level of premium rates, as less healthy members elect to have the cover, while healthier members opt out, until later.

This anti-selection is commonly observed when cover is voluntary rather than default. When cover is optional and not default, the intention is that members who have a need for insurance such as those with a mortgage or dependents would opt in, while those with no need for insurance, would opt out. However, from a risk pooling perspective, members with higher risk, either through their occupation, activities or their health status (e.g. smokers, or members with family history of illness, or who can’t get insurance elsewhere) can also automatically qualify for insurance at standard rates.

A parallel of this phenomenon is found in optional private health insurance where healthy lives stay out of the risk pool until they need to cover, making the pool unsustainable in the long run.

A third reason for higher premium comes from the fact that insurers will be faced with a significant reduction in revenue while fixed expenses remain unchanged, further adding upward pressure on insurance premium rates.

The overall impact will differ significantly between superannuation funds depending on different member demographics, fund size and premium rate structures. For example, if the fund membership comprises many casual members with small account balances or younger members, they will be more greatly impacted.

APRA statistics show that although the average superannuation fund has about 15 per cent of members under 25 years of age, some funds may have as high as 35 per cent of members under this age. The impact on premium rates for these funds can be expected to be much higher than the average.

Similarly, some funds can have as many as 60 per cent of members with inactive accounts, making this a major issue for these funds, compared to an average inactive member ratio of approximately 32 per cent.

Impact on individual members

Overall, our modelling suggests that the impact of the Budget proposals could result in a 26 per cent increase on default insurance premiums within superannuation for the remaining members, allowing for the factors discussed above.

Retirement outcomes

If insurance premium rates are not increased as a result of the Budget proposals, then the retirement outcomes for members can be expected to improve.

On average, the erosion of projected retirement benefits due to default insurance premiums would reduce from 6.2 per cent to 5.8 per cent of the average final retirement balance. However, we note that this would vary significantly at the individual member level, depending on factors including account balance, number of accounts, age and salary.

However, if premium rates increased by 26 per cent as envisaged above, the level of erosion on average increases, from an estimated 6.2 per cent to 7.3 per cent, which is a significant increase for superannuation fund members as a whole. But here, the average does not tell the whole story given the impact may vary greatly depending on individual member circumstances.

Members who are likely to be better off are those who are currently paying premiums for multiple levels of default insurance cover, as they hold more than one superannuation account. Generally, members have one active superannuation account meaning the insurance cover will be switched off for any other account they hold, resulting in a reduction of the erosion impact on retirement benefits for those members. Members who hold one active superannuation account with a single level of default insurance cover would experience a higher level of erosion of retirement benefits if premium rates increases occur.

Members who need cover but fail to opt in are likely to be those that are worse off, as they may be unaware that cover has been removed unless communication is appropriately effective and simple to understand to combat the well-known apathy issue. Importantly, some of these members may not be financially sophisticated enough to understand they need the cover in order to opt into it.

Based on the above scenarios, if premiums increase by 26 per cent as noted above, it is expected to result in a higher level of erosion of retirement benefits for all segments. The most significant impacts are for females and low income earners.

For members under the age of 25, our modelling incorporates the removal of default insurance based on the Budget proposals. On the basis that default insurance is switched on once the member reaches the age of 25, there is the potential for members to end up paying more for cover over the longer term if insurers pass on premium rate increases. The above scenarios show for members under the age of 25, retirement benefits are on average eroded by a further 1.1 percent if premium rates increase by 26 per cent.

An important take out of this analysis is that all superannuation funds will need to consider reviewing the level of default insurance provided and/or the overall product design to manage any potential premium increases from further eroding retirement benefits.

Cost and timing of implementation

The Insurance in Superannuation Voluntary Code of Practice allowed participating superannuation funds until 30 June 2021 to be compliant. The new Budget proposals state that the effective date will be 1 July 2019. This is a significantly shorter timeframe to implement material changes.

KPMG expects superannuation funds to have to invest significant effort and money to undertake a variety of activities to implement the Budget proposals by 1 July 2019. This may include renegotiation of group insurance contracts, development of member communication plans and material upgrades to administration systems and/or processes.

Given the number of regulatory and legislative changes impacting superannuation, a 1 July 2019 implementation date for the Federal Budget measures will prove to be challenging for most superannuation funds.

In summary

The proposed changes will have material impact (both intended and unintended) for both superannuation funds and insurers.

The impact will vary significantly by superannuation fund with a multitude of factors determining the overall change. From a retirement outcome perspective, the final impact is subject to the future adjustment to insurance premiums based on the proposed changes. However, we remain concerned that these changes may have significant unintended consequences to member retirement account balances.

In addition, material resourcing will be required to perform impact assessments, product re-designs and to implement the changes from an administrative perspective by both superannuation funds and insurers. In short, this will all create challenges for the overall industry, and now is the time to think and plan ahead.