Is the insurance component you pay for in your superannuation fund actually junk?

Liberal Senator Andrew Bragg has branded the insurance offered inside super funds as junk but for most it’s not that cut and dry.

When people most need life insurance is generally when they are least able to afford the premiums.

In a recent summit on superannuation, Coalition Senator Andrew Bragg made comments about life insurances in super.

In particular he felt that the insurance members automatically get when they join a super fund, known as group insurance, is “junk insurance”.

This raises the question of whether life insurance should be paid by super funds at all. If the sole purpose of superannuation is to provide a benefit at retirement, some may argue that costs should be minimised and life insurance premiums prohibited from being paid from super.

According to Senator Bragg: “For a lot of people, insurance in super is junk insurance, and I think the trustees in many cases have conducted themselves appallingly.”

In terms of what constitutes a “junk” insurance policy, Bragg puts a life insurance policy in that category if it is “paid at a rate which is so low, relative to what that person might be expecting and particularly if their premiums are particularly high”.

Industry statistics show that the average time it takes to process a life insurance policy held in super can vary depending on the type of cover.

For life insurance, the average time to process and pay out a claim is 1.1 months. For income protection insurance it is 2 months while for total and permanent disability insurance the average processing period is 5.6 months.

Another gripe that Senator Bragg has put forward is the way that life insurance policies in super come into existence in the first place.

“Group insurance has a privileged position in the superannuation system as an ‘opt out’ mandated product, and the industry recognises there is work to do by trustees and life insurers to ensure members consistently receive value for money,” Bragg said during a recent radio interview.

Noting that a superannuation fund balance can be eroded by life insurance premiums, there are some safeguards in place. The government introduced legislation five years ago to force super funds to cancel life insurance policies if the member had not made a contribution for 16 months.

In addition, many super funds have put in place additional controls to protect small super balances.

Senator Andrew Bragg has rubbished the value of insurance policies contained and paid for within superannuation accounts. Picture: Flavio Brancaleone

Australian Super, which is Australia’s largest super fund with more than three million members, does not provide automatic insurance cover for members under the age of 25. In its product disclosure statement it notes the reason is to “help reduce the chance of your super balance being eroded by insurance costs while you’re starting out in the workforce, working part time or studying for example”.

The argument for life insurance components in super is that people are generally underinsured. Although the average life expectancy is 81 for men and 85 for women, some people will die much earlier.

For the average Australian in their 30s or 40s with a spouse, children and a mortgage, life insurance premiums generally rank low when it comes to priorities on the monthly household budget.

But in reality, if one spouse gets sick or dies, the financial consequences can be devastating and this is where the true value of life insurance comes in. The catch is that the time when people most need life insurance is generally when they are least able to afford the premiums.

As such, superannuation is a helpful mechanism to bridge the gap.

A strategy worth considering is to use superannuation to pay for life insurance in your younger years, and when you are over the hump with the mortgage paid off and kids out of the nest, you make extra super contributions to replace the life insurance premiums paid via super in the earlier years.

If you operate a self managed super fund then it is a mandatory requirement to consider the life insurance needs of each member as part of the investment strategy document.

But in many cases the SMSF may be unable to obtain a life insurance policy at a reasonable cost due to a member’s pre-existing health condition. In these circumstances, the member may be able to set up or retain an external retail or industry super account which has an automatic insurance cover attached. The SMSF can then be satisfied that the insurance need has been met via an externally held insurance policy.

It is important to read the fine print since most super funds will have an exclusion period of up to two years on pre-existing conditions while some put a blanket ban on claims from pre-existing conditions.

In addition, if you are not actively contributing to the super fund, your cover may get cancelled or be ineligible for a claim. And finally, you need to keep an eye on the fees as fixed-dollar costs can deplete the super account and result in the linked insurance being cancelled.

While Senator Bragg has a valid point regarding whether life insurance policies have a place in super, the benefit of being able to fund a life insurance policy, as opposed to going without, is compelling.

That said, communication could be improved to ensure that people know what automatic insurance premiums are set up and paid from their super account – and when it comes to claim time, it also appears that more work can also be done to reduce the processing period.

James Gerrard is principal and director of Sydney financial planning firm www.financialadvisor.com.au