Addressing strategies for insurance in SMSFs

There is a tremendous shift in the focus of individuals to take control of their own retirement funding.

Currently in Australia, there are more than 528,000 SMSFs, with more than one million members.

Over the past 12 months there has been an increase of 26,000 new funds and 50,000 new members. In 2010, less than 13 per cent of existing SMSFs had any life insurance.

Trustees of SMSFs must consider an investment strategy that addresses insurance for each member of the fund.

This does not make insurance mandatory, but it forces the trustee to review the insurance requirements on a regular basis (i.e. annually) for each member. This requirement was enacted on 7 August 2012.

Since then, ASIC has proposed disclosure requirements for SMSFs regarding life, TPD, and income protection insurance. Therefore, when implementing or reviewing the fund’s investment strategy, a trustee will need to consider a range of issues when determining each member’s insurance needs and whether they should hold a death or disability policy for them. These issues include:

• The members’ age, health, assets, liabilities, income level and whether they have any dependants
• Whether the member has any existing insurance cover held inside the SMSF, in another super fund, or outside super and the level and type of those insurances
• Whether the member, and/or their dependants, would be able to maintain their current quality of life in the event of the member’s death or in the event that the member was unable to work due to their temporary or permanent invalidity.

The trustees should document their decision in the fund’s investment strategy or alternatively in the minutes of a trustee meeting.

It is important to note that this new rule only requires trustees to consider the need to hold insurances for the member. It does not require a trustee of an SMSF to provide a minimum or default level of insurance for each member.

On 1 March 2013, amendments to the Superannuation Industry Supervision (SIS) Regulations were made and were implemented from 1 July 2014.

The operating standard was changed so that trustees of a regulated superannuation fund (including SMSFs) would be prohibited from providing members with insured benefits other than those that satisfy the conditions of release under Schedule 1 of the SIS Regulations for death, a terminal medical condition, permanent incapacity and temporary incapacity.

Let’s examine how these changes may affect insurance inside SMSFs.

Death

While death is not defined in either the SIS Act or SIS Regulations, a member (or more likely their beneficiary) will only be able to receive their benefits from the trustee of a superannuation fund once a death certificate is produced from a coroner (or registered authority).

Terminal illness

Two registered medical practitioners have certified, jointly or separately, that the person suffers from an illness, or has incurred an injury, that is likely to result in the death of the person within 12 months.

This does not create any change to existing definitions used by trustees, or in the policy definitions used across
the insurance industry.

Permanent incapacity (TPD)

“Own occupation” TPD will no longer be permitted for any new members who join an SMSF from 1 July 2014.

In order to meet the permanent incapacity condition of release, “ancillary benefits” such as loss of limbs, loss of sight, or loss of independent existence, will need to meet the second hurdle of also being “… unlikely that the member will engage in gainful employment for which the member is reasonably qualified by education, training or experience,” thereby making these “ancillary benefits” redundant within superannuation.

Temporary incapacity (income protection)

If the member is not in “gainful employment” on the date of disablement, then they are not entitled to a “temporary incapacity” benefit from superannuation (this will likely affect individuals who are between contracts of employment or who are unemployed at date of disablement).

Second, if a member is not earning any income from their employer (or any other gain or reward), then they are not entitled to a “temporary incapacity” benefit from superannuation (this will likely affect individuals who are on any unpaid leave from work, such as sabbatical or long-service or maternity leave).

Third, certain ancillary benefits will be prohibited – critical illness or specified injury benefits that pay a predetermined monthly benefit (3x or 6x) when a person suffers an injury (broken bones) or illness (heart attack, cancer, stroke, etc.) that may be in excess of the period of incapacity.

While temporary incapacity benefits are important, there are significant limitations when compared to a typical income protection policy outside of an SMSF.

Trauma insurance

Trauma insurance is prohibited for any new member of an SMSF after 1 July 2014.

Cross insurance

Life insurance is commonly used by SMSFs to fund limited recourse borrowing arrangements (LRBAs) in the event of death or permanent incapacity.

The ATO stated that the proceeds of an insurance policy must be released to the member who is the insured under the policy.

This means that cross-insurance arrangements where the proceeds of an insurance policy are paid to someone other than the insured under the policy are not permitted from 1 July 2014 under SIS Regulation 4.07D.

Grandfathering

Any existing insurance arrangements in an SMSF for existing members that was in place prior to 1 July 2014 will be “grandfathered” and are permitted.

Members of SMSFs will need to be careful to ensure that they do not lapse their policies within SMSFs, as the member runs the risk of any reinstated policy losing the grandfathered benefits.

Conclusion

Accountants, auditors and financial advisers who assist SMSF trustees need to consider, and document annually, an investment strategy that includes life insurance for the SMSF members.

With the legislative amendments that commenced on 1 July 2014, more restrictions are now in place with regards to how life insurance can be structured inside an SMSF.

Jeffrey Scott is executive manager of retail advice at CommInsure

ATO – Self-managed super fund statistical report – March 2014

2. Super System Review – 30 June 2010.
3. Australian Securities and Investments Commission – Consultation Paper 216 – Advice on self-managed superannuation funds:
specific disclosure requirements and SMSF costs (September 2013)