Important changes to cross-insurance in an SMSF
What do the changes to the rules on what types of insurance super funds can hold ultimately mean for strategies such as cross-insurance?
The rules on what types of insurance super funds could take out changed from 1 July 2014. One strategy put at risk by the new rules was “cross-insurance” – a common approach in funds with limited recourse borrowing arrangements where:
- the fund has more than one member
- it also has a loan
- if Member A dies, the trustees don’t want Member B to be forced to sell the asset (either to pay out a death benefit or because they can no longer support the loan)
- the trustee therefore took out insurance on Member A’s life (and vice versa) with the intention of using any proceeds to effectively pay out the loan or the death benefit or both, rather than adding it to Member A’s balance and paying it to his/ her beneficiaries as part of a death benefit.
It is this last step – not paying the proceeds to Member A’s beneficiaries but rather keeping it in the fund for the long-term benefit of Member B that raised questions.
The new rules on insurance specifically highlight that new insurance policies (ie. those taken out after 1 July 2014) cannot provide for insurance “in relation to a member of the fund unless the insured event is consistent with a condition of release” (SIS Regulation 4.07D). It is easy to see how this provision rules out trauma insurance. Trauma policies pay out on an event such as a heart attack, stroke or other significant illness. While these may well be life-changing events, they are not necessarily covered under the usual superannuation conditions of release – permanent disability or temporary disability.
Cross-insurance was less clear. The cross-insurance arrangement above does describe insurance that is consistent with a condition of release (death), it’s just that on Member A’s death, the proceeds are not used to actually pay out a benefit in relation to Member A.
We have long been advocates of cross-insurance and like many others we have been keen for the ATO to express a view on this issue.
Now they have – the ATO considers cross-insurance inconsistent with, and therefore prohibited by, the post 1 July 2014 rules.
What we probably didn’t expect was that their view on this very important matter affecting many funds with limited recourse borrowing arrangements would be expressed via three lines added to some web content.
Note that this doesn’t mean that policies before 1 July 2014 need to be unwound – they are grandfathered. However, it will be a critical issue for any fund with a large indivisible asset (eg. a property) that effectively covers more than one member’s entitlements. It will be particularly relevant for new limited recourse borrowing arrangements as the premature death of one member may seriously hamper the ability of the remaining member to continue to service the loan.
Meg Heffron is head of customer at Heffron SMSF Solutions.