Managing the insurance pricing impact of Budget changes

Super Outcomes

August 27, 2018
| Australia

By Phil Patterson

All insurance practitioners in the superannuation industry need to be preparing for changes to default insurance. What was flagged in this year’s Budget and encapsulated in the Treasury Laws Amendment (Protecting Your Superannuation Package) Bill 2018, is yet to be passed, but the Senate Economics Legislation Committee did not recommend any revisions despite numerous submissions about the short timeframe and potential unintended consequences. Government is forcing funds down the path of removing valuable insurance coverage from some members who may need it and imposing increased costs on fund members who remain insured.

The draft measures involve automatically cancelling existing insurance cover (subject to affected members explicitly opting in) in any one of the following circumstances:

  • Aged under 25, or
  • Account balance under $6,000, or
  • Inactive accounts (where no contributions or Rollovers have been received for a period of 13 months).

We understand that as a transitional measure those members currently aged under 25 and with an account balance over $6,000, will not automatically have insurance cancelled. Going forward, no new members under age 25 will be entitled to automatic insurance cover regardless of their account balance, and will be required to actively opt-in to receive cover.

What will be the impact on individual funds?

The impact on each individual fund will depend on that fund’s membership in the three groupings of affected members. Where there is a material change in insured membership, most insurance policies will include the right for the insurer to re-price the insurance.

The Australian Government Actuary’s advice to Treasury dated 1 May 2018 (AGA Report) provides an estimate that up to 51% of superannuation accounts with insurance across the industry may be affected, comprising:

  • 14% affected by the under age 25 requirement
  • A further 22% of accounts affected by the $6,000 balance requirement, and
  • A further 15% of accounts affected by the 13 month inactive requirement.

These estimates are, however, broad averages, so Willis Towers Watson has analysed the published 30 June 2017 APRA data for funds to estimate the proportion of members affected for each measure. In our analysis, we examined 159 funds (excluding ERFs) for which complete data was available.

While the APRA data is not a perfect match to the Budget legislation groupings, with the segregation between insured and non-insured members not being clear, the following chart gives some insights by estimating what proportion of each fund’s membership may be affected by each of the Budget measures, and showing how many funds fall into each percentage band.

Estimation of what proportion of each fund’s membership may be affected by each of the Budget measures, and showing how many funds fall into each percentage band.

The chart shows that for the under age 25 requirement:

  • 83 of the 159 funds are estimated to have less than 5% of their members affected
  • five funds have 20% to 30% of their membership aged under 25 and
  • only four funds are estimated to have more than 30% of their members affected.

The latter nine funds do, however, include some funds with very large memberships. Thus the under age 25 requirement is likely to have a large impact on a small number of funds, but a minimal impact on the majority of funds.

In contrast, the opt-in requirement for account balances under $6,000 shows a significant impact on a large number of funds:

  • 76 funds are estimated to have over 20% of their membership in this category, and
  • 32 funds are in the 10% to 20% range.

Each fund clearly needs to examine its own data on these membership cohorts, and to what extent their members fall into multiple affected groups, particularly separating members who are under age 25 with an account balance less than $6,000, from under 25s who do have $6,000 and are therefore potentially exempt from the requirements. Only by understanding this data can funds make the decisions that will be required and plan for discussions with their insurer and administrator.

What is the likely impact on pricing?

There has been considerable discussion about the potential impact on insurance premiums arising from the Budget legislation. TAL, AIA and Metlife, in their testimony to the Senate Economics Legislation committee, suggested increases in the 10% to 25% range.  The AGA Report, however, suggests a 7% to 10% increase for the members who remain insured over age 25 after the application of the opt-in rules. All of these estimates are based on key assumptions about many factors including the take-up rate for members who do opt-in, and a judgement on whether these members opting in represent a higher risk group than other members. The end results for different funds are likely to vary widely.

In preparing for pricing discussions with insurers, it is important for funds to understand the drivers behind potential premium increases, so that they can be effectively managed where possible by sensible insurance design. Some of the key drivers include:

Fixed Costs If total premium volumes fall significantly then marginal costs of insurance activities such as claims assessment will fall too, however fixed costs for both funds and insurers will be spread over a narrower premium base forcing a higher proportion of premiums being spent on expenses. The AGA report, however, estimates average fixed costs to be only 7% of premium, so increases in this area are likely to be relatively minor.

To the extent that a fund’s current insurance design includes significant cross subsidies where the younger members subsidise the older, then removing the under age 25 cohort from the insured pool will increase premiums for older members. This impact will be very fund specific, and directly related to the proportion of under age 25 members and the level of cross subsidisation they are providing. This element appears not to have been estimated in the AGA report, which perhaps contributes to the lower estimates compared to the comments by AIA, TAL and Metlife to the Senate committee. Funds are already starting to examine and unwind any historical cross-subsidies as part of the ISWG affordability measures, and funds that have already addressed cross-subsidies should not expect premium increases to arise from this issue.

It is not intuitively obviously that members with low account balances would be subsidising those with higher balances, as premium rates do not typically vary by account balance size. Premium increases from this source (which is the measure that affects the greatest number of funds) should therefore only be accepted when based on hard evidence.

Are opt-in members higher risk? Beyond the relatively obvious cross subsidies by age, logic would suggest that within the opt-in group there will be some members who know themselves to be higher risk, and therefore value the insurance more highly than other members because of their increased likelihood of claiming. Inclusion of these opt-in members in the insurance pool is likely to increase the average cost for the insurance pool, and the proportion of members who are likely to opt-in becomes an important factor.

The overall pricing effect will be a complicated outworking of all of these factors overlaid on the membership demographics of each individual fund, and is likely to be highly variable from fund to fund.

Funds with small proportions of affected members, combined with robust insurance designs that do not contain significant cross-subsidies, may have an argument for little if any premium increase. Indeed the insurance policy re-rating clause may not be triggered at all. Often policy documents have clauses that require a 25% change in insured membership before immediate re-rating is required. Other funds with high proportions of affected members and significant inherent cross-subsidies may have to deal with the potential for higher increases.

Overall, while the media attention is naturally drawn to high potential premium increases, we would not expect that many funds should have to contemplate premium increases of 20% or more.

What can funds do to manage premium increases?

While funds cannot control the final requirements of the Budget legislation, there is work that can be done to plan and mitigate the potential effects.

Fund executives and insurance managers should be examining their membership data to determine how many members are potentially affected and who they are, and opening discussions with their insurer and administrator if they have not already commenced. In addition however, there are a number insurance benefit design questions and issues that can be tackled in advance of final Budget legislation.

Identifying and reducing cross subsidies in the insurance design that make the fund more vulnerable to the Budget legislation is one key area, and indeed these changes provide the impetus to address design issues that may have been previously put on the back burner.

A further important consideration is to what extent health evidence and perhaps pre-existing condition clauses can and should be used to manage the potential higher risk posed by members opting in. It is unreasonable and unfair to apply underwriting processes to existing members who are being asked to opt-in to keep cover that they previously have had, however such processes could be considered for new members, or members becoming inactive in the future.

At one extreme, if members opting in are required to undergo full or partial underwriting, then the additional risk and cost that is potentially borne by all insured members can be mitigated. At the other extreme, making it easy for members to opt back in under Automatic Acceptance may encourage a higher take-up rate, broadens the base of insured members, and is consistent with some of the great strengths of simple and accessible group insurance for as many members as possible within the fund. The government appears to be forcing funds in to a difficult choice, to balance their best interests duties to both members opting in and members who might bear increased costs.

Willis Towers Watson has been assisting a number of funds in diverse areas of membership analytics, design alternatives, cross-subsidy analysis, predictive premium modelling and Insurance Code gap analysis to help fund executives determine their insurance design positioning, which will ultimately lead into their articulated Insurance Outcomes.

For further information, please contact Phil Patterson.

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