Peter Hogan outlines the key issues trustees should consider when addressing insurance in a fund's investment strategy.
Concerned by the finding that less than 13 per cent of self-managed superannuation funds (SMSFs) held life insurance for their members, the Government amended SIS Regulation 4.09 effective in the 2012/13 and subsequent financial years.
This amendment requires SMSF trustees to consider holding insurance for fund members when formulating, regularly reviewing and giving effect to an investment strategy for the fund.
The key word here is 'consider', as it's not actually compulsory for trustees to take out insurance in the fund. But there are very good reasons why this should be given some serious thought if insurance is required.
The premiums are deducted from the member's super account, not their bank account. This makes insurance in super affordable for people who don't have sufficient cashflow to pay the premiums outside super.
Plus, if the members make contributions to cover the cost of insurance, they can benefit from some tax concessions generally not available when buying insurances themselves.
For example, if they are eligible to salary sacrifice, they may be able to buy certain insurances in super with pre-tax dollars.
Also, some members may be eligible to claim their super contributions as a tax deduction regardless of whether they are used to purchase investments or insurance.
What needs to be done?
There is no prescribed template for any aspect of the investment strategy, and there is limited guidance in the legislation. This essentially means that how the trustees choose to address this new requirement is entirely up to them.
But given the importance of holding sufficient insurance and the potential impact of not having enough, we suggest that trustees follow five key steps.
These steps look at the issues relating specifically to the need to include insurance in the investment strategy, and they ignore the other investment strategy requirements in the SIS Act and Regulations.
1. Consider the circumstances of all fund members
This includes their debts, age, health, retirement objectives, assets held within and outside super and the needs of their beneficiaries.
Also, if the fund has used a Limited Recourse Borrowing Arrangement (LRBA) to buy an asset, consideration should be given to how the fund would service (or pay out) the debt and pay a benefit if a member dies or becomes permanently incapacitated.
2. Determine the member's insurance needs
This involves determining the types and amounts of insurance cover each member needs and deciding whether that cover should be held within or outside super.
3. Identify insurances already held
This involves looking at the covers the members already have in place within and outside super.
4. Identify whether any changes are necessary
This is where the insurance needed is compared with the insurance already held to determine whether any changes need to be made.
5. Document the SMSF insurances required
This is where the trustees determine whether any cover should be retained, increased or taken out in the SMSF and the reasons for these decisions, which should then be documented in the investment strategy.
There are many valid reasons and circumstances where no insurance will be required in the SMSF. For example, some members will be uninsurable or the premiums are too high, due to age or health.
Some members may genuinely not need any cover (or already have enough) due to low debt levels and sufficiently high assets within and outside super.
Some members may need additional insurance but don't want to take it out in super. This could occur, for example, if a member is already using up their concessional contribution cap for investment purposes and doesn't want insurance premiums eroding their concessionally taxed retirement savings.
If no changes to insurances in the SMSF are required, we don't believe it's sufficient to simply state that the current arrangements have been reviewed and are appropriate for the members.
The trustees should document the reason(s) why the decisions were made. This will provide evidence the new requirement has been addressed.
We also believe that any decision to take out new insurance or change the level of cover in the fund should be documented in the investment strategy before the cover is arranged or amended.
What types of insurances should be considered?
Trustees should consider whether fund members need additional life, total and permanent disability (TPD) and income protection (or salary continuance) insurance.
It's also important to be aware that from 1 July 2014, it will no longer be possible to take out new policies in super that don't align with the conditions of release in superannuation law.
This includes TPD policies that pay a benefit if the member is unable to work again in their own occupation, and insurance that pays a benefit if the member suffers a critical illness specified in the policy.
Trustees may therefore want to consider these types of insurance before this window of opportunity closes and address them in the investment strategy.
Governing rules of the fund
The governing rules of the SMSF must allow the trustees to hold insurance for fund members and should specify the types of insurances that can be held.
The governing rules may therefore need to be amended to cater for the new requirements, especially if own-occupation TPD or trauma insurance is warranted.
LRBAs used to purchase business property
If insurance is taken out by a fund that has used an LRBA, it would be important to document the purpose for which the insurance is taken out, and how the insurance proceeds are to be used if a claim is paid.
Peter Hogan is senior technical manager at MLC Technical Services.
