There are important differences between taking out life insurance through super and taking out life insurance outside super.
Most super funds offer default insurance cover, meaning you are automatically insured unless you opt out. Default cover generally includes term life and TPD. Some super funds include income protection (known as salary continuance in super) in their default insurance, while others may require opting in and paying an additional premium.
There are some things to be aware of when choosing insurance through super or choosing it outside of super.
Default insurance in super is a group policy which means it is typically not underwritten
Let’s separate it into the following:
| Inside Super | Outside Super | ||
|---|---|---|---|
| Group Insurance | Inside Super Group Insurance |
Outside Super Group Insurance |
|
| Individually Underwritten | Inside Super Individually Underwritten |
Outside Super Individually Underwritten |
- The orange box is default insurance through super.
- The green and blue boxes are individual insurance, typically done through an adviser.
Underwriting
Underwriting means assessing your insurability. It is the process of taking down your lifestyle and medical history and ensuring everyone pays their fair share into the pool of funds for paying out claims. The underwriter may increase the premium for those at a higher risk or add in exclusions. Not all insurance is underwritten, particularly in the case of group insurance policies (which we will get to shortly). The benefit of underwritten insurance is that it gives you the certainty that you will be covered for anything that isn’t excluded in your policy.
Underwritten policies ensure two critical things:
- The terms of the insurance contract cannot be changed to your detriment without your express consent. Also, with individually underwritten insurance policies, your contract is ‘guaranteed renewable’, which means that as long as you keep paying your premiums, you’ll continue being insured under the same terms.
- The insurance company cannot make further discretionary judgements at claim time (aside from confirming what they already know) because they already agreed to it.
Group policies
Group insurance (as opposed to individual insurance) is insurance that covers many people in the same contract. It is typically offered by organisations, such as super funds (the orange in the above diagram) or employers (the purple in the above diagram), who have a contract with an insurance company where they can offer wholesale insurance to the group (e.g., super fund members).
As mentioned above, with individually underwritten insurance, the insurer can not change their terms. However, they can still increase the cost of insurance. Even for level insurance, where they can not increase the cost based on your age, they can increase the cost across the board if they deem it necessary.
In contrast, the way group policies through super funds works is that every three years, the super fund puts out a tender where insurance companies apply to be their insurer. This way, if an insurer increases their cost out of line with the industry, the super fund can choose a new low-cost insurer. It is a way for insurers and super fund trustees to keep a lid on insurance costs.
However, as a result, group policies, unlike individually underwritten insurance, can have their definitions changed, making it harder, in some cases, for claims to be made. This lack of certainty can be detrimental to those insured under the group policy.
Also, if the insurance company doesn’t assess your health when the premium is taken out, they will do the investigations at claim time to see if they can limit or exclude cover. This will be at a time when your health is likely to have declined due to aging. Since the purpose of insurance is to be there when you desperately need it, you have to think carefully about whether it is worth the risk of not having underwritten insurance.
TPD insurance through super has has historically been the type of insurance that people have the most trouble successfully claiming, and this is due to default policies in super being group policies, which are not individually underwritten. However, ASIC has been on their back in recent years, and it seems to be improving, but there are still fundamental differences.
Here are some examples of why TPD in super has been the most difficult to claim successfully.
The general definition for a TPD insurance claim is:
“you will be declared totally and permanently disabled if you are unlikely to work again in any occupation to which you are reasonably suited by previous education, training or experience.”
The definition by Australian Super’s TPD at the time of writing this is:
“you will be declared totally and permanently disabled if you are unlikely to work again in any occupation to which you are reasonably suited by previous education, training or experience, or may become suited to with further education, training or experience“.
In other words, if you can be retrained or reskilled to do literally any other occupation, you are not considered TPD and you are ineligible to be paid out. There is also no time restraint given, so even if it takes you 5 years to be retrained or reskilled, you are not eligible for a claim.
Another example is ART’s TPD saying they can reassess you each year for 5 years, effectively meaning the same thing.
Another example is ESS Super’s TPD definition saying that even if you work for no reward, you don’t meet the definition for a claim. So if you do volunteer work to maintain ties to your community, you are not eligible to claim.
Even if your super’s default group policy definitions are not as bad as these, as super funds open up the insurance offered to tender every 3 years to reduces the cost, the terms are subject to change at any time without your consent required.
Important points regarding underwriting and group policies
Individually underwritten insurance policies can be paid through super, but they are not the default insurance offered by your super fund. They are insurance policies you take out privately, but they are paid from your super. So you can have individually underwritten insurance that comes with the tax benefits of being paid through your super. An adviser is often the best person to help with this.
Also worth noting is that just because insurance is outside super doesn’t necessarily mean it is underwritten. Not only for group policies offered through an employer, but direct insurance (e.g., from an ad and not through a financial adviser) often will not be underwritten. The take-home point is that you likely want your insurance underwritten. However, if you are uninsurable due to having pre-existing conditions, insurance through a group policy, where there is often no underwriting, is usually better than no insurance.
The final point relating to underwriting is that you have what is known as a ‘duty of disclose’ to tell them all relevant information about your health that they ask about so that they can adequately assess your risk. You want to be open with this information because if you don’t disclose information and they find it out later when you make a claim, you may have your claim denied due to breaching your duty of disclosure obligation. By providing your full information, you will know that anything not in the list of exclusions can be counted on when you need it.
Insurance through super is more restrictive for some types of insurance
Besides the issues around group insurance, there are a some restrictions on the types of insurance that can be taken out through super.
Firstly, for Total and Permanent Disability (TPD) insurance, in super, own occupation TPD insurance is not available, only any occupation TPD insurance is available. Own occupation TPD insurance is where you are unable to perform the primary duties of your current occupation. It is more difficult to make a successful claim under any occupation TPD insurance because you must prove that you are unable to perform the substantial duties of any occupation, not just your own job.
Secondly, trauma insurance is unavailable through super.
Thirdly, super fund policies can cease offering you income protection cover if you are unemployed or taking unpaid leave for an extended period.
The first two restrictions are legislative. For money to be released from super, it must meet what is called a condition of release, and the law restricts what types of insurance you can purchase in super to ensure benefits can be released from your super when they are paid out by the insurance company into your super.
Many mainstream insurers allow for a mix of super and non-super funded individually underwritten policies, which can help with cash flow constraints without these restrictions that apply to super-held policies. A professional is best placed to help with that.
Other downsides of insurance in super
Other downsides of insurance in super include:
- For life insurance in super, if you die and any of the proceeds of that insurance is passed to someone who is not a financial dependant, they may lose up to 17% of the proceeds to tax. Specifically, financially independent children over 18 fall into the category of not being considered a financial dependant under tax law, and therefore the proceeds will be taxable.
- For a recipient of a TPD insurance claim from super who is under 60, the proceeds may be taxable, which is not the case with a TPD claim from insurance held outside super.
- For income protection insurance, if paid personally, you can claim a tax deduction on the premium, which reduces the cost of premiums by your marginal tax rate, which reduces the cost by approximately half for those on the highest marginal tax rate and a third for those on the 32% marginal tax rate (including the 2% Medicare levy).
- If your income is high enough such that your employer’s compulsory contributions are already maxing out your concessional cap, you can’t effectively pay through additional concessional contributions for a tax deduction, and you may want to avoid paying from super so that the money in your super can remain there to grow in a low-tax environment.
- For TPD insurance, as mentioned above, you can’t access own-occupation in super, but you can get a split policy where most of it is paid through super, with a smaller amount outside super to access the own-occupation definition. But see the above point about whether you want that part of it paid through super if you are already maxing out your concessional contributions.
Benefits of group insurance through super
While there are disadvantages to default group policies offered through super, there are some benefits. The main ones are:
- Having begun working in financial advice, I’ve seen for myself that individually underwritten insurance without commissions is cheaper than group insurance through industry super funds, but with advisors who take commissions (which is almost all advisers), group insurance is often cheaper because it is a group policy and does not come with ongoing commissions that inflate premiums by up to 30%. Also, with individually underwritten insurance, while it is guaranteed renewable and the terms can not change without your consent, you are locked into that insurer as you age, and you become less insurable due to increasing medical issues. Group policies don’t suffer from this, and super funds use that to negotiate lower prices as they put their insurance out to tender every three years to get the lowest price.
- If you are older or have some medical issues and are unable to get life insurance outside super, you may still be able to get insurance in super due to the lack of underwriting upon first joining many super funds. This ‘automatic acceptance’ is usually only available when you first join a fund and are still working. The default cover amount may not be adequate, and increasing the cover generally requires filling out a health questionnaire (i.e., underwriting), but in case you are unable to get underwritten insurance, the automatic acceptance of default cover is likely a lot better than being uninsured. This is by far the biggest benefit of group insurance through super.
- It is more tax-effective for life and TPD insurance. You still pay for it (from your super, which is your money), so it isn’t free, but it is paid for with pre-tax dollars. However, you can still get the tax benefit from individually underwritten insurance through super.
- It doesn’t impact your cash flow (but depletes your super, so not such a great upside unless you are really strapped for cash).
Benefits of individually underwritten insurance through super
A situation where paying your individually underwritten insurance through super is beneficial is if you are not maxing out your concessional contributions. Paying life and part of your TPD insurance through super allows you to claim a tax deduction on a concessional contribution used to pay the premium in super, making it far more tax-effective. You can pay the remaining part of TPD insurance personally to gain the own-occupation definition.
Super insurance auto-cancellation for balances below $6,000 or 16 months of no contributions
Two things to be aware of with insurance through your super fund is that from 1 April 2020, super funds are now required to cancel insurance on inactive super accounts that have not received contributions for at least 16 months and accounts with balances below $6,000. You will need to contact them directly to instruct them to continue with your coverage if you require it.