Super reform dangers

PORTFOLIO POINT: The proposed ban on risk insurance commissions in super might be ditched. But it’s not that simple for SMSFs and it shouldn’t stop trustees in any case. Here’s what you need to know.

Assistant Treasurer Bill Shorten dropped a bombshell in financial planning circles in April when he updated the government’s plans for financial advice reform.

In the general media, it was overshadowed by the softening of approach over “opt-in” rules (from one year to two), but the previously unannounced plan for a blanket ban on insurance commissions inside super was, to many, a double shock because of the obvious conflicts of interest it would introduce to the process of financial advice, particularly in regards to superannuation.

The idea came from Jeremy Cooper’s Super System Review (which I still think is flawed at its heart. Click here to read that column), but appeared at first glance to have been ignored by the government.

The concept got a second bite at the cherry when Shorten updated the government’s Future of Financial Advice plans and announced the intention to outlaw the charging of insurance commissions in super.

The “conflict of interest” in the proposal arises because an adviser has, to a great degree, a “choice” as to whether to recommend that certain types of insurance be taken inside or outside super.

Either way can be justified (if a little less easily “sold”) to clients.

The types of insurance to consider

For a rundown on the four different types of insurance (life, total and permanent disability, trauma and income protection), click here to read my column from last year, which gives an explanation of the types of insurance to consider inside and outside your super fund.

Inside or outside?

The major pro’s of insurance inside super: premiums are deductible to the super fund; it aids personal cash flow; and with life insurance being left to financial dependants, there aren’t likely to be tax consequences (although there are potential tax consequences with total and permanent disability insurance).

The significant pro’s of insurance outside super: does not eat into your retirement savings; no SIS Act or tax issues with receiving TPD benefits; and no issue with leaving payments to non-dependants.

That is, an adviser can use strong, persuasive arguments either way.

One of the problems with Shorten’s super/insurance commission-banning model is that a portion of the financial advice industry, insurance-only “advisers”, are not allowed to advise on insurance inside most super because they are not qualified/licensed to.

If they can’t advise you to hold insurance inside your super fund, and therefore consider your whole position, are they really able to give you the best advice?

Given that Shorten’s recommendation was to ban insurance commissions inside super, but not outside, this could influence the recommendation on where to hold your insurance.

And it’s a big potential conflict of interest for advisers.

Advisers can’t work for free. Under the proposed model, in the event that it was recommended that the best place to hold the insurance was inside superannuation, they would need to charge some sort of fee-for-service to implement the insurance.

You’ll have to take my word for it, but this would end up costing the client more. At an experienced guess, the breakeven point of paying a higher upfront administration/implementation charge for insurance, with a reduced cost of insurance because commissions had been eliminated, would probably be somewhere between three and seven years (possibly longer), depending on the level of cover sought, with a potentially painful upfront fee.

There are two major problems with Shorten’s commission-banning model that is still on the table.

First, a conflict arises because it is so “easy” to justify the recommendation to hold the insurance outside super, as opposed to inside. And, if a commission is easier to get the client to pay or for the adviser to accept, then justifying the holding of the insurance outside super is easy enough, even if cash flow might make it harder for the client to pay.

Second, it rewards that section of the financial advice industry that does not take your full position into account, either because they haven’t got the educational qualifications or they are not licensed to do so.

As insurance-only advisers are not allowed to recommend insurance inside super, their business model would not change. Advisers who can recommend super and non-super insurance, would have to change their way of doing business, or succumb to the potential conflict of interest in recommending insurance outside super.

But the main question remains. Why introduce a system that would create a conflict?

Change in the wings?

The idea seems to have been primarily driven by Cooper’s mandate to increase the level of super savings, which, in a perfect world, would happen if commissions weren’t paid on insurance inside super.

But in the past few weeks, Shorten has indicated that the government is considering a change of heart, following lobbying from the industry. He has stated that he is coming around to understanding the value of advised insurance inside super.

Underinsurance is a huge problem in Australia. And this plan would have only worsened that situation.

What can SMSFs do?

The fact is that if no-commission insurance is the best way to go for you, then SMSFs have the power to request of a financial adviser that no commissions are paid on their life insurance now.

You can see an experienced risk insurance adviser and request a “fee for service” for insurance advice and implementation. But it will most likely be more expensive up front.

Historically, under the commission model, the whole of the first year’s premium is paid to the adviser. That is to cover the cost of the client interviews, the statement of advice, insurance applications, following up with underwriters, the client, doctors and accountants, shopping around with other insurers, etc. (Some advisers accept hybrid and level commissions, which is a slightly different situation).

If you take the commissions out of insurance, premiums will fall about 20–25%. But the time required for implementation would have to be paid for upfront.

Managed fund super

It is possible to try to do a similar sort of thing with non-SMSF super funds. With industry, government and some corporate funds, there is no commission paid anyway. So you will probably need to pay a financial adviser a fee-for-service in any case (or do it yourself).

However, most retail funds will have commissions inbuilt. They can usually, but not always, be turned off through a financial adviser. Again, the work involved in implementing insurance can be considerable, so be prepared for a fee.

Commissions versus non-commissions

Don’t be surprised if the government backs down on this plan.

But if you are dead against commissions, even for insurance, then don’t let this dissuade you from finding an adviser who will work with you on this as a solution.

SMSFs that breach concessional contribution caps for the first time will have 28 days to accept a refund of the excess – minus tax – or instead be penalised under the current rules, a consultation paper released today suggests. DIY super funds will be among the beneficiaries of superannuation minister Bill Shorten’s proposal to refund excess contributions that are under $10,000. The paper also recommends that only the excess sum is taxed instead of the whole year’s total contributions and that it isn’t counted towards non-concessional cap, unlike under the current policy. SMSF members will have to be proactive if they are to adjust to a new ATO clarification on stepchildren and death benefits. The tax office says children are not eligible to receive death benefits from a step-parent’s superannuation if their natural parent has already died, meaning any funds intended for them would have to be included in the step-parent’s will. SMSF members must either withdraw the money prior to death, or they could specify for their fund to pay an income stream to the remaining spouse and pay the rest out to the children. A claim that forcing SMSFs to have investment properties valued once a year could cost up to $10,000 has been rubbished by a DIY super industry group. Small Independent Superannuation Funds Association (SISFA) managing director Darren Kingdon said that while property valuations were essential within SMSFs, it was highly questionable that the fees would be that high for most funds. The $10,000 sum was suggested by the SMSF Professionals Association of Australia (SPAA), but chairman Sharyn Long said the cost was estimated over a three-year period, not annually, and was directed at funds owning large amounts of property. Superannuation minister Bill Shorten reiterated his view that compulsory superannuation contributions must rise from 9% to 12%, in a speech celebrating 20 years of government guaranteed super on Tuesday. He told an Association of Superannuation Funds of Australia dinner that guaranteed super of 9% was a “mature idea” but the industry still had the capacity to grow, to ensure capital adequacy in retirement. Shorten said once the 12% target was achieved governments should then stop “tinkering with the tax treatment of superannuation”. SMSF software provider BGL says it can “revolutionise” data processing for DIY funds. In the wake of Super Stream’s efforts to streamline the backend information processing systems, BGL said it had created a software system that would build in feeds from brokers, share registries and domestic banks. SMSF administrators would be able to see all feeds on the one screen instead of logging into multiple accounts. Managing director Ron Lesh said the package would reconcile all of the year’s financial transactions and also process the tax components automatically.

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 advised to consult your financial adviser.

Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.