Insuring for some super rule changes

Insurance is not usually top of mind when you set up a SMSF.

But, as of two years ago, SMSF trustees must consider insurance needs for each of their members.

It does not mean trustees must take out insurance for members. However, the fund’s “investment strategy” must cover off on the deliberations for those needs. I covered off on that requirement in this column (see Beating the Superman syndrome).

Tomorrow (July 1, 2014), more new rules come into force for insurance inside superannuation. And SMSF trustees need to be aware these new rules, if for no other reason than changing insurances after today could mean a forced reduction in the quality of cover you can take out for yourselves as members.

Superannuation funds, including SMSFs, will not be able to offer insurances that won’t pay claims in line with the Superannuation Industry Supervision Regulations (SISR).

That means that insurance offered inside superannuation must meet the conditions to be paid out of super under the “condition of release” rules.

Life insurance

There are no great changes to life (death) insurance cover. You’re either alive, or you’re dead. Qualification for a payout here doesn’t change much and no insurers have signalled any major changes to their policies as a result. However, some of the smaller ancillary benefits offered by insurers will have to be dropped.

Total and permanent disability (TPD) insurance

The issue with TPD has always been that insurance companies have been able to offer claim conditions based on market pressures. As a result, insurance companies have competed to offer more generous policies regarding payouts.

Super funds will no longer be able to offer the higher standard of “own” occupation. All TPD insurance contracts will need to be “any” occupation policies.

This has occasionally (in less than 5% of cases) led to situations where an insurer has paid out a claim to a super fund, but the super fund has then been unable, according to the SISA, to make the payout to the member.

For example, a member has taken out a $2 million TPD insurance policy, with an “own” occupation definition. The member’s current occupation is as a brain surgeon, but prior to that, they had worked as a general practitioner.

The member suffers an injury that means he cannot work as a brain surgeon. However, the accident was such that he could continue to work as a GP (“any occupation for which the member was reasonably qualified by education, training or experience”).

The insurer would pay out to the super fund the $2 million. However, under the SISA, the member could still work as a GP. As a result, the payout would have to remain in superannuation until another condition of release (see The great super release) was met.

TPD contracts offered inside super will now have to meet the definitions of “permanent incapacity”, as defined by the SISA, so that if a TPD contract is paid out, it will also qualify to be paid out of the super fund to the member under a condition of release.

If you have an existing TPD contract with, for example, an “own” occupation condition, at some stage you might need to weigh up whether you keep the contract, with the possibility of having a payout by the insurer, that might have to stay in the fund (for potentially decades), until another condition of release is met.

Terminal illness

Terminal illness is where two qualified practitioners (one needs to be a specialist in regards to the condition) have said that the condition suffered by the member means the member is unlikely to live for 12 months.

Insurance policies and super funds have roughly been meeting this condition, so no major changes are expected from insurers here.

Trauma insurance

Another immediate change is that trauma insurance (also known as critical illness insurance) can no longer be taken inside super.

Trauma insurance is generally designed to cover major illnesses, such as heart attack, cancer and stroke.

This has always been a concern to the industry – and one that I’ve not recommended be taken out inside super – as there is no direct correlation between suffering one of these events and being able to meet a condition of release to have the money paid out of the fund.

Income protection

This is another area where competition has meant that policies inside super have often been more generous than could actually be paid out to the member under SISA restrictions.

Income protection policies are more complex (and are generally best taken outside super in most cases), but the benefits payable under a super policy have been reduced, due to the fact that the policies will need to be able to be paid out under the “temporary incapacity” definitions in the SIS Regulations.

Grandfathering and taking out new insurance

Insurance arrangements that are in place as at today (June 30, 2014) will be grandfathered.

If you are looking to update your insurances inside a SMSF or with an APRA regulated fund, you will need to pay attention to the cover that you already have in place. Do you want to give up the conditions that you have associated with your existing policy, for a policy of lower value?

The answer might be yes, but don’t cancel the existing insurance before considering the quality of what you’ve got and comparing it with the new policy.

New insurance arrangements

In preparation for these changes, insurers have been innovating.

This includes policies where the own and occupations for TPD are split on the same policy, allowing the “any” occupation portion of a policy to be held in a super fund, with the “own” portion held and paid for outside super.

For example, a $1.5 million policy is held, where the premium is, say, $1,500. About one-third of the cost of the policy would be paid for by the member outside of super ($500), while two-thirds is paid inside super ($1,000). This will differ between the insurers who offer these policies.

If a claim is made, the insurer will first test the claim against the own occupation rating. If it passes there, the payment is made outside of super and no “conditions of release” need to be met. If it does not qualify for a payment based on own, but does on “any”, then the payment will be made into the super fund, where it will need to meet a condition of release to be paid out to the member.

A similar situation has developed with income protection policies, where the ancillary benefits are held and paid for outside super.

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking. E: bruce@castellanfinancial.com.au

• SMSF members are getting younger, according to the latest trends in SMSFs report from CoreData. The report says the age distribution of members has changed from 36.6% being between 34 and 54 last year to 62.1% now. Of the roughly one million SMSF members, those aged between 25 and 34 make up 11.1%, compared to only 4% a year ago.
• The amount of SMSF funds in pension phase reached $294 billion in December last year, more than half of the $543 billion of SMSFs in total, according to Sydney-based research group DEXX & R. The research group said the total holdings from SMSFs should climb to $922 billion by 2023.
• The federal government should consider scrapping the yearly limit on superannuation contributions, according to Deloitte. “There is limited and inadequate scope to top up super in the years approaching retirement to finance a comfortable lifestyle,” said superannuation partner Russell Mason at the firm’s media launch of its Adequacy and the Australian Superannuation System report.