Making sense of the transitional rules for insurance
Changes to the rules around insurance and superannuation have restricted the type of insurance that can be held by an SMSF and the ability to self-insure via a reserve. How do the transitional provisions operate for these rules?
Insurance policy restrictions in an SMSF
From 1 July 2014, regulated superannuation funds have only been allowed to offer insurance cover where it is consistent with a superannuation condition of release.
SISR 4.07D (2) says: “A trustee of a regulated superannuation fund must not provide an insured benefit in relation to a member of the fund unless the insured event is consistent with a condition of release specified in item 102, 102A, 103 or 109 of schedule 1.”
Insurance cover consistent with a superannuation condition of release is restricted to cover for:
• terminal illness;
• ‘any occupation’ permanent incapacity; and
• temporary incapacity.
Prior to this, SMSFs were able to have insurance in the fund that may be unable to be released from the fund in the event of a claim including ‘own occupation’ total disability benefits (TDB) and trauma insurance.
Transitional provisions apply to members who joined the fund before 1 July 2014 and who were already covered by these types of insurance policies before 1 July 2014. (4.07D(3)).
For policies that commenced prior to 1 July 2014 that do not fall under the new restrictions, trustees will need to maintain records to show the insurance was in existence at 30 June 2014. Additionally, the transitional rules do allow for the fund to adjust the level of insurance held under an existing policy.
Self-insurance via a reserve
The new regulations also remove the ability for an SMSF to self-insure via a reserve.
Self-insurance was an option used by some funds where traditional life insurance policies weren’t available due to age or illness; however, with the new regulations this is no longer an option. SMSFs are now only able to provide insurance benefits to members by taking out an insurance policy.
If, on 1 July 2013, a regulated superannuation fund does not self-insure, in relation to a particular risk, a trustee of the fund may, on and after 1 July 2013, provide an insured benefit, in relation to that risk, to members of the fund only if the provision of the benefit is fully supported by an insurance policy provided by an insurer.
From those currently self-insuring these new rules won’t take effect until 1 July 2016.
Many fund members presently have cover in their SMSFs for various reasons which, seemingly, may not meet the new rules. For example:
• An individual over 55 holds trauma insurance in their SMSF. Generally in this instance, in the event of a trauma, the SMSF would receive the lump sum payment from the insurer. The member would then be eligible to access an income stream under the transition to retirement provisions.
• The fund has a limited recourse borrowing arrangement (LRBA) and is using the superannuation guarantee (SG) payments from the member, who is a surgeon, to repay the debt.
The fund takes out ‘own occupation’ disability insurance for a member so that in the event the member can no longer work as a surgeon the loan repayment obligations will still be met. In this instance the injury may not result in a condition or release being met but the purpose of the cover is not for the benefit of a member but to meet loan obligations.
While cover similar to those referred to in the examples above will be permitted to remain if held prior to 1 July 2014, under a specific exemption, the regulations remove the ability of funds to take out similar cover in future.
Investment strategy and insurance
The investment strategy requirements state trustees of a SMSF, are:
• required to conduct a review of the fund's investment strategy on a regular basis;
• required to consider insurance for fund members as part of the fund's investment strategy (Regulation 4.09 (2) (e).
Are there risks by not taking out Life and TPD Insurance?
With a fund’s investment strategy now requiring trustees to consider insurance, this raises the risk potential of liabilities against trustees in the event of the death or disablement of a member where a beneficiary may feel that the trustees did not adequately perform their duties in considering insurance.
Determining what insurance cover is adequate depends on the personal circumstances of a member and can include a range of concerns including debts, family planning requirements, lifestyle requirements, potential medical expenses, care and spouse employment considerations, to name a few. Not everyone is the same and it is likely that the requirements of each member will differ.
Additional consideration needs to be given for any other insurance policies the member may hold outside of the SMSF or in other superannuation funds as well as the costs of the premiums.
Therefore, accountants should be careful when printing out pre-filled investment strategies for clients to sign stating trustees have considered insurance, as they could find themselves in the firing line. Additionally, ensure all members sign the investment strategy showing they have agreed that the trustees have considered insurance.
Remember trustees have to regard what is in the best interest of the member and have to offer insurance options. Also, remember that accountants cannot advise whether a fund has adequate insurance for members without a licence.
Deanne Firth, director, Tactical Super