In a statement issued earlier this week, the ATO confirmed cross-insurance for any new insurance products is not permitted in light of regulations that came into effect on July 1 this year.
These types of arrangement are prohibited because the insured benefit will not be consistent with a condition of release in respect of the member receiving the benefit, the ATO said.
Speaking to SMSF Adviser, AMP SMSF’s Peter Burgess said this could increase the risk of limited recourse borrowing arrangements, given that cross-insurance is used as a risk mitigation strategy.
“It’s called cross-insurance because when one member dies or becomes TPD, for example, then the proceeds instead of being added to their account go to the other member,” Mr Burgess said. “If the proceeds are just added to the deceased member’s account then it doesn’t provide any liquidity benefits for the fund.
“But if the proceeds are added to the other member’s account, the surviving member, then the fund can use that money to retire debt. So these type of strategies are commonly used where there’s a limited recourse borrowing arrangement in place.”
In light of the statement from the ATO, SMSF practitioners should think about other ways in which their clients’ funds could service a debt in the event that one of the contributors to the fund dies, Mr Burgess said, given that this option no longer seems to be available.
Generally speaking, insurance inside super is now “far easier to understand”, CommInsure’s executive manager for insurance tech and business delivery, Jeffrey Scott, told SMSF Adviser.
“Whether it’s inside a self-managed super fund, an industry super fund, or a retail super fund, the definitions for any new policy from 1 July 2014 are going to be very consistent, very homogenous,” he said.
Hi Eri, The deceased member’s benefit, in the absence of any prescriptive deed requirement, never needs to be sold down. Consider an example where the only asset the deceased member has is a residential property. Upon death, rather than liquidation at a fire sale price, the remaining (alternative) trustee could simply elect to in-specie transfer the asset to the beneficiary. If firesale was a concern, the in-specie option would give the suriving beneficiary time to then liquidate at an appropriate time.
The comment by the ATO does not make sense “These types of arrangement are prohibited because the insured benefit will not be consistent with a condition of release in respect of the member receiving the benefit”. The cross-insured member is not making a withdrawal. The insurance benefit adds to the surviving members account. As investments are generally pooled in SMSFs, there is now cash to pay out the death members benefit. The insurance benefit is not paid out as this is the balance of the surviving member, only the death members balance is – which does not include the insurance benefit.
There is more to this than just LRBAs. I have seen and commented on many funds that have a significant holding in one asset, say business real property, with limited other assets. It has been an issue that if one member dies, the one asset must be sold quickly to pay the deceased members benefit, therefore at a fire sale price. The other member loses. This could have been countered by cross insurance, or insurance payable to the SMSF itself. Is this a bigger issue than first thought?
So what alternatives can you provide to protect liquidity in a SMSF where there is LRBA.