Industry versus retail superannuation: A tale of two policies

Col Fullagar takes a look at two income protection policies - one is offered by an industry superannuation fund, while the other comes from a retail fund. While the premiums may vary significantly, it is important to conduct a proper cost-benefit analysis, so that a client is better able to make an informed choice.

In seeking to make an income protection insurance recommendation to her client, an adviser was recently confronted with the following options. Should she:

• Recommend the client retain cover within an industry fund for which the premium was $400, or
• Recommend the client move to a retail product for which the premium was $1,200.

The problem of course centred on the cost-benefit analysis. What was driving such a dramatic premium difference, and was it possible the retail product was so much more appropriate that the difference could be justified?

Irrespective of the answer, the adviser needed to be able to provide a response for the client, so she arranged for an analysis to be undertaken.

To ensure apples were being compared it was confirmed that both contracts were for the same benefit amount, benefit and waiting period and both premium quotes were on a no-commission basis.

The analysis was undertaken at four different levels:

1. Premium

When making a premium comparison, it is often necessary to go further than comparing the current year’s premium. Future premiums may also reveal material differences:

• For stepped premiums, are both premiums stepped in the same way?
• For level premiums, how are indexation increases treated, at original rate or current rate?
• Is one set of premiums calculated in age bands such that large increases occur when a previous band ends and a new one starts?
• Is one set of premiums calculated on a flat basis ie the same for all ages, such that the younger lives are heavily subsidising the older lives?

This information alone may account for a large component of any premium difference.

2. Contractual

The first level was on a traditional basis: contractual differences were identified and an estimate was made of the approximate value of each of the featured differences. To ensure “reasonableness”, an actuary was asked to check and confirm. Set out below are the findings:

(i) Indemnity versus agreed value

The industry fund was insured through a group insurance contract. As a result, each year the client needed to advise their then current level of earnings, and cover for the coming year would be based on that figure.

Further, the policy stated “if actual earnings at time of claim are less than nominated earnings, the benefit will be based on actual earnings.”

In other words, cover was issued on an indemnity basis both from year to year and also within each year.

The retail product was agreed value.

The agreed value facility within a retail income protection insurance policy is worth around 15 per cent of premium.

(ii) Ancillary benefits

In addition to the core benefits of total and partial disability, the industry fund only included the following ancillary benefits:

• Death benefit, twice times the last monthly benefit paid;
• Rehabilitation expenses reimbursement – at the total discretion of the insurer, and
• Waiver of premium, only whilst on claim.

The inclusion of a full, comprehensive range of ancillary benefits within a retail income protection insurance policy is also worth around 15 per cent of premium.

(iii) Exclusions

The industry fund contained several exclusions that were not present in the retail product:

• Engaging in professional sporting activity;
• Flying except as paying passenger or as a passenger in a chartered plane for the purposes of carrying out the duties of the member’s occupation, and
• The member’s involvement in, or perpetration of, a criminal act, with discretion to reduce or refuse benefit payment if the member is imprisoned.

There was also a pre-existing conditions exclusion. The precise conditions of this were relatively complex.

However, in brief it excluded any claim that arose as a result of an injury where the injury originally occurred in the 12 months prior to cover starting and an illness that occurred in the six months prior to cover starting.

In the event of “war”, the insurer reserved the right to increase premiums or exclude benefit payments if the claim was caused directly or indirectly as a result of war.

“War” was defined as declared war, armed aggression by one or more countries resisted by any country, combination of countries or international organisations, participation in an action to defend a country or region from civil disturbance or insurrection, or in an effort to maintain peace.

Thus not only were significant additional exclusions introduced, but the presence of the war provision had the effect of adding a cancellable element to the industry fund product.

None of the above conditions were present in the retail policy.

The absence of the above exclusions with a retail income protection insurance policy is worth around 10 per cent of premium.

(iv) Offsets

Benefit offsets within the industry fund product included payments received from any of the following:

• Workers’ compensation;
• Social security or other statutory or government payment;
• Any payment in respect of loss of income (whether under legislation or otherwise);
• Statutory accident compensation and
• Other disability insurance except term and permanent disability (TPD).

There were no offsets in the retail product.

The absence of the above offsets with a retail income protection insurance policy is worth around 5 per cent of premium.

(v) Claims

There were several unique claim conditions within the industry fund.

One stated that the insurer could require the insured to be examined by a medical practitioner of the insurer’s choosing who “must confirm the condition.” This might be problematic if the nature of the condition was unknown: for example, a mental or nervous disorder for which the specific diagnosis was open to debate.

The insurer could require the insured to undergo rehabilitation. This provision appeared to contradict the definition of total disability to the extent that it purported to deem total disability if one duty could not be performed, the insured was following medical advice and was not working. 

If the insured refused or felt it inappropriate to undergo rehabilitation, it was contractually possible for benefits to be withheld.

Finally, if there was a dispute concerning claim admission, the policy indicated that the matter would be referred to the “claims review committee” and “the parties agree that any determination of the claims review committee is final and binding”.

This could be perceived as an attempt to negate any appeal to the Financial Ombudsman Service or the legal process. 

The absence of the above issues within a retail income protection insurance policy is worth around 2 per cent of premium, although the actual impact at the time of claim might be much greater.

(vi) Cover end date

Cover under the industry fund policy ended if:

• The member commenced active duty with the armed forces of any country;
• The member permanently retired from employment (clarification of when this assessment would be made, by whom and on what basis, was not provided);
• The member was on unpaid leave for longer than 12 months;
• The member worked overseas for longer than three months (notwithstanding the policy spruiked that it provided 24-hour, world-wide cover;
• The member ceased to be a member of the plan (it then became clear that the policy did not provide for a continuation option);
• The member, who is not an Australian resident, was no longer permanently in Australia or not eligible to work in Australia.

Again, the absence of the above cancellation provisions within a retail income protection insurance policy is worth around 2 per cent of premium.

(vii) Miscellaneous areas of difference

Not unexpectedly, there were also numerous subtle but potentially important areas of difference, for example:

• The waiting period requiring the insured to attend a doctor rather than simply stop work;
• Pre-disability earnings not being indexed whilst on claim;
• The absence of a guarantee of upgrade, and so on.

When the impact of the above contractual differences was taken into account, the premium comparison became somewhat different:

Retail product $1,200

Less reduction for:

• Indemnity (15 per cent)
• Ancillary benefit (15 per cent)
• Exclusions discount (10 per cent)
• Offsets (5 per cent)
• Claims (2 per cent)
• Cover end date (2 per cent)

Net premium = $700

While this brought the premiums much closer, there was still a considerable difference: $700 compared to $400.

3. Procedural

Having considered the contractual differences and the monetary value of these, the procedural differences were considered next.

The main area of difference was the administration efficiencies associated with group insurance:

• Group automatic acceptance avoids individual new business administration and underwriting costs; and
• The dynamics of group insurance drive lower lapse rates.

Irrespective of whether or not group cover is provided at an employer or a fund level, the above factors will deliver economies of scale that will be reflected in the premium.

The positive impact for the client of automatic acceptance levels would be the speeding up of cover commencement. Lower lapse rates, on the other hand, would have little or no procedural impact. However, they would impact on premium cost.

4. Representation

An important area of difference and thus a material matter in the product analysis was that of client representation.

Under group insurance arrangements, it is generally necessary for the client to deal with a middle-person: ie the trustee, employer or administrator.

While this may generate a cost reduction for the insurer, the arrangement may be to the detriment of the client, as many who have had to deal through a middle-person will attest.

If the client does not have a personal support base, they will be on their own when it comes to advice and assistance. Should they need either, it may well be necessary to pay a fee either to an accountant, a solicitor or a financial adviser. 

Depending on the amount of assistance required, it may well be that any premium difference would be very quickly negated if the contractual differences within the industry fund product manifested as a greater likelihood of misunderstandings and disputes, particularly at the time of claim.

The premium, contractual, procedural and representative differences between the two policies and the potential direct and indirect costs associated with them mean that a cost-benefit analysis is not necessarily straightforward.

For some clients, the cost will be more important than the benefits foregone, while for others it will not.

Naturally, the question of what is appropriate for a particular client is not for determination within this article. Rather the intent of the article has been to consider various ways in which differences may be presented to a particular client such that the client is better able to make an informed choice.

Depending on the circumstances, a simple premium or contractual comparison may suffice. Sometimes it may be necessary to go further and consider the monetary value of these differences. It may even be necessary to consider non-contractual factors such as the value-add of adviser involvement.

The challenge for the adviser is to know when one basis of analysis is appropriate over another and then to have the tools at their disposal such that they can assist the client to make the all-important informed choice.