Insurance in super – challenges remain

The Stronger Super reforms aim to raise the role and importance of insurance in superannuation and to improve the retirement outcomes for beneficiaries. However, challenges remain. This article explores some of the implications of Stronger Super for insurance benefits.

The Stronger Super reforms aim to raise the role and importance of insurance in superannuation and to improve the retirement outcomes for beneficiaries. The legislative reforms introduce new rules about the types of insurance that can be offered through super. Other substantial reforms include the new prudential requirements for trustees to implement an insurance management framework, insurance strategy and well documented processes for the selection and engagement of insurers. This article explores some of the Stronger Super implications for insurance.

Insurance in MySuper

A key feature of Stronger Super is to provide minimum levels of commission-free death cover and total and permanent disability (TPD) insurance on an opt-out basis for members with MySuper products. MySuper is designed to provide a low cost, value for money option for those members who take no active interest in their super and remain in the default investment option in their fund. Those superannuation products that are not MySuper are commonly referred to as “choice funds.” The question is whether the proposed Superannuation Legislation Amendment (Further MySuper and Transparency Measures) Bill 2012 (referred to as Tranche 3) will achieve all of these objectives.

In our view, some clarification and refinement is required before Tranche 3 is finalised and passed into law.

Opting out of insurance in MySuper

Tranche 3 sets out the requirements for the default or minimum insurance option to be available in MySuper. In essence, super funds will need to offer both life (ie, death cover) and TPD insurance on an opt-out basis to members.

There may be circumstances where a fund cannot obtain this type of insurance on an opt-out basis, (to be prescribed in regulations) in which case the fund must provide compulsory insurance in MySuper. For example, a fund may be unable to secure insurance on an opt-out basis at a reasonable cost. Insurers are likely to be concerned about anti-selective behaviour for those funds with a relatively small membership base and may not be prepared to offer insurance on an opt-out basis or if offered, for a significantly higher premium than would otherwise be the case.

The way the opt-out provisions in Tranche 3 are framed suggests that a member could elect to opt-out of either or both of life and TPD insurance cover.

In the market today, most life insurers do not offer stand-alone TPD cover. The standard is to offer death cover, or death and TPD cover. We understand that premium rates would vary significantly if insurers were required to offer opt-out insurance on this basis. It is not clear if this is an oversight on the part of the parliamentary drafters but we expect that trustees may have difficulty in negotiating separate premium rates for these covers that appropriately relate to the individual risk of members who elect to opt-out of either cover. Submissions on this point in Tranche 3 have been made to Treasury and we hope that this will be rectified.

Limiting the types of insurance through super - unintended consequences

Tranche 3 anticipates that operating standards will be made to stipulate the types of insurance that can be offered through super. In the case of MySuper, insurance will be limited to death and TPD cover generally. It is anticipated that income protection or salary continuance cover may be available on an opt-in basis only in MySuper.

Implications for existing insurance falling outside of the operating standards

APRA has foreshadowed in the draft Prudential Standard SPS 250 Insurance in Superannuation that trustees who have been offering insurance benefits other than those that will be permitted will need to prepare a phase-out plan for the non-permitted insurance products and agree a process and timetable with APRA. With the start date of 1 July 2013 for the new legislation being some way off, APRA is expecting that insurers will be able to meet the new prudential requirements from that date or have agreed transition plans with APRA to ensure they reach compliance soon after.

This suggests that APRA is not in favour of allowing the grandfathering of existing insurance arrangements when the Stronger Super reforms take effect. This raises some interesting questions. What will happen to those members who have “non-permitted” insurance. Will they lose those entitlements and how will they be transitioned? What happens, for example, in circumstances where a member would not be accepted by another insurer on similar terms by reason of their age or deteriorating health?

Defining what TPD means

One of the objectives of the Stronger Super reforms is to align the circumstances in which an insurer will pay a claim with the conditions of release of benefits by a trustee in a super fund. This is because there are instances where  members do not receive the benefits of insurance cover that they have paid for because there is a misalignment between insurance definitions for incapacity and the conditions of release that a trustee is required to apply. The response to this situation has been to impose new operating standards to be implemented under the SIS Regulations, that will limit trustees to only taking out insurance that satisfies the conditions of release for death, terminal medical conditions and permanent and temporary incapacity as defined in the SIS Regulations.

While it is important that members do have the benefit of what they pay for, the approach taken to address this issue is likely to have a number of unintended consequences. It will standardise the definitions, particularly for TPD covers across all MySuper products. Consequently, insurers that have offered tailored TPD definitions according to occupational groups in the past may not be able to do so in the future.

Other options to achieve the same outcome

In our view, a better approach would be to redefine the condition of release and permanent incapacity as satisfaction of the relevant definition in an insurance policy. Alternatively, another way to address this would be to clarify that trustees are not required to offer a single prescribed definition of TPD that is equal to the SIS definition of permanent incapacity. Rather, it will be sufficient if the definitions used in the insurance policy meet the principle of being at least as restrictive as the SIS definition. This approach would be consistent with the interpretative guidance given by the Australian Taxation Office in its draft tax ruling TR 2011/D6 in respect of the deductibility of premium for TPD cover.

The alignment of definitions such as “TPD” with “permanent incapacity” under the SIS Regulations will potentially mean the availability of TPD benefits will be more limited. The sole purpose test could continue to restrict trustees from negotiating insurance which does not meet policy objectives (such as trauma insurance) but would not inhibit development of definitions which could apply to categories of members such as those who may be unemployed for a period, those undertaking home duties or own occupation definitions. It seems perverse that Tranche 3 may in fact result in a narrowing of the availability of benefits for members in this manner.

The challenges of implementing the Stronger Super reforms

There is no doubt that the Stronger Super reforms are significant and wide reaching. As highlighted, we think there are a number of significant challenges in the area of insurance in super yet to be overcome in these final stages of fine tuning the reforms.

It will be vital that government and APRA take account of the implications of transitioning as proposed. Transition timetables need to be aligned given the scale of the reforms. Trustees should be given appropriate time to prepare a suitable insurance strategy and to negotiate new policies with insurers in accordance with that strategy. Each fund will have insurance arrangements in force and it is potentially disadvantageous for them to be required to renegotiate those policies in haste. We also wonder whether it would it also not be better to allow existing members the opportunity to have their insurance grandfathered.