TPD insurance: Cracking the code

Jeffrey Scott explains transitional relief for superannuation funds and the deductibility of disability benefit premiums.

On 13 October, 2009, the then Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen, announced an amendment to the tax law to provide transitional relief to complying superannuation funds for the deduction of insurance premiums for disability superannuation benefits. But what does this mean in the real world?

Until 30 June, 2011, any total and permanent disability (TPD) insurance premium paid by the trustee of a super fund to an insurance provider will receive a full tax deduction.

From 1 July, 2011, in order to receive a tax deduction the insured risks must meet the strict superannuation disability benefit definition, below:

“A benefit that is paid to a person because he or she suffers from ill-health (whether physical or mental), and two legally qualified medical practitioners have certified that, because of the ill-health, it is unlikely that the person can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.”

There has been significant discussion within the insurance industry as to whether or not ‘loss of limbs and sight’, ‘activities of daily living’ (ADL), and ‘own occupation’ benefits will continue to be entitled to a tax deduction after 1 July, 2011.

• The ‘own occupation’ definition of TPD states: “The person is incapacitated to such an extent that it is unlikely that he or she will be able to engage in his or her own occupation ever again.”
• The ‘loss of limbs and sight’ definition of TPD states: “The person has sustained, as a direct result of injury or sickness: the complete and irrecoverable loss of use of both hands; or the complete and irrecoverable loss of use of both feet; or the complete and irrecoverable loss of use of one hand and one foot; or blindness in both eyes, whether aided or unaided; or the complete and irrecoverable loss of use of one hand and blindness in one eye, whether aided or unaided; or the complete and irrecoverable loss of use of one foot and blindness in one eye, whether aided or unaided.”
• The ADL definition of TPD states: “There is a permanent and irreversible inability to perform without the assistance of another person any two activities of daily living (dressing, toileting, feeding, maintaining continence, and mobilising) or all of the defined home duties (cleaning, preparing meals, purchasing food, washing and ironing).”

Where these additional benefits exist, the trustee will require an actuarial certificate each year to show what amount of the disability premiums is deductible.

In most superannuation funds, this will only affect professionals who have ‘own occupation’ TPD. Most members who have an ‘any occupation’ definition of TPD will be unaffected. Each superannuation fund will need to determine if the ‘loss of limbs and sight’ benefit, along with the ADL benefit, produces any additional risk to the any occupation TPD pricing. If so, then apportionment of premiums will need to occur from 1 July, 2011. If no there is no additional risk, then full deductibility will continue to occur.

Case study

Let’s look at an example. A member of a superannuation fund (an accountant) pays $1,350 for his ‘own occupation’ TPD policy. The equivalent cover for any occupation TPD cover would cost $1,000.

Until 30 June, 2011, the fund can claim the full own occupation TPD premium of $1,350 as a tax deduction. This equates to a tax savings of $202.50 (15 per cent of $1,350). From 1 July, 2011, the fund will only be able to claim the equivalent value of an any occupation TPD premium, or $1,000, as a tax deduction. This will reduce the tax savings within the fund to $150 (15 per cent of $1,000). Since the premium is not fully tax deductible, the fund’s tax liability will increase by $52.50. The combination of this increased taxation liability and the added fund cost of engaging an actuary will result in higher effective insurance costs.

What it means

What does this mean to pricing and product design after 1 July, 2011?

One of three things will occur:

• Nothing changes. If a trustee only provides the ‘any occupation’ definition of TPD to its members, and the actuaries have determined that there is no additional risk in providing ‘loss of limbs and sight’ or ‘loss of independent existence’ benefits, then full deductibility of premiums will continue. However, fund expenses may increase to reflect the cost of the actuarial certificate.
• In the case of ‘own occupation’ TPD benefits within superannuation, the increased administration costs and reduction in tax deductibility to the trustee of the superannuation fund could be passed along to the members — with a negative flow-on impact to accumulating member benefits.
• Where the actuaries have determined that there is an additional risk in providing ‘loss of limbs and sight’ or ‘loss of independent existence’ benefits, then one of two options may occur. TPD benefits and features within superannuation could get stripped back to reflect the strict ‘superannuation disability definition’ under the Superannuation Industry (Supervision) Act 1993 (SIS Act). This could result in premiums remaining stable or possibly reducing, since fewer benefits are being provided. Alternatively, the increased administration costs and reduction in tax deductibility to the trustee of the superannuation fund could be passed along to the members — with a negative flow-on impact to accumulating member benefits.

Bowen believed that the transitional relief provided the superannuation industry with enough lead time to make the necessary administrative changes.

Over the next few months, trustees of superannuation funds need to review TPD benefits. It may be necessary to modify benefit systems, or reduce investment returns as a consequence of the more stringent rules that commence on 1 July, 2011.

Jeffrey Scott is the executive manager for business growth services at CommInsure.