Hidden sting of life insurance costs in industry funds

Research firm Rice Warner believes Australians are underinsured on life insurance by $1.811 trillion.

Underinsurance is a significant problem in Australia. Research firm Rice Warner believes Australians are underinsured on life insurance by $1.811 trillion.

To help address this issue, basic life insurance is built into most industry super fund products as a default benefit when a new member joins. There is usually also an option to apply for a higher level of cover if desired.

Sydney Financial Planner Christopher Bates notes that “life insurance premiums charged by industry super funds are low when we are young and more expensive as we get older, reflective of the fact that we are higher risk for claiming sickness, disability and death benefits with age”.

Although automatic basic insurance coverage is an excellent feature of industry super funds, Bates notes that “industry super funds only offer life insurances on what’s called a stepped premium basis”.

Retail super fund counterparts also offer linked life insurances on a stepped premium basis but in addition “they can offer life insurance on a level premium basis”, Bate states.

The concept of level premium insurance is that you choose to lock-in your insurance premium at the age of application. The cost does not increase each year with age as it would under a stepped premium model. Level insurance premiums are initially set higher than stepped premiums but over time, work out to be more cost effective given the flat cost of level premiums opposed to the rising cost of stepped premiums.

For a 25-year-old electrician, insuring $1 million of life and disability cover with one of Australia’s largest industry super fund would cost $1596 per year. Compare this to one of Australia’s largest retail super and insurance companies on level premium. The cost comes in at $2078 for an equivalent policy, $482 more expensive than the industry fund offer. Fast forward 10 years to age 35 and the industry super fund insurance is still cheaper by $232 per year.

The problem is that from age 40, the industry super fund insurance cost has risen to the point where it is more expensive than the retail super fund insurance cost that was locked away under level premium arrangements at age 25. By age 50, the industry super fund insurance cost for the electrician is over $5000 per year while the retail super fund cover is still $2078 per year.

Accountant Nathan Vant locked in level insurance premiums when he was in his early 30s. “To me, it was a simple decision to go level premium. I will require this policy for the next 20 to 30 years so it makes sense to lock the premium away.” Vant explains.

“If I chose a stepped policy, I probably would have either reduced or cancelled it when the premiums got too high, though it would have been at that point when I would have needed the insurance the most”.

Although industry super funds may provide competitive investment returns and low fees, it is important to be aware of the increasing cost of their insurance and the lack of the level premium feature that retail super funds can offer.

James Gerrard is a director of independently owned financial planning firm FinancialAdvisor.com.au