The rules around the investment strategy operating standard for SMSFs have been significantly amended. Lawyer Michael Hallinan explains some of the changes.

The investment strategy operating standard as it applies to self-managed superannuation funds (SMSFs) has been significantly amended.

Trustees of SMSFs must now regularly review the investment strategy – but also consider whether they should hold insurance cover in respect of the members of the fund.

This article will briefly consider what the amended operating standard means for trustees of SMSFs and how they are to comply with the amended operating standard.

The relevant sections of the amended operating standard are:

“(2) The Trustee of the entity must formulate, review regularly and give effect to an investment strategy that has regard to the whole of the circumstances of the entity including, but not limited to, the following:

(e) for a self managed superannuation fund – whether the trustees of the fund should hold a contract of insurance that provides insurance cover for one or more members of the fund.”

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Statutory Reference: SIS Regulation 4.09(2) as amended by Superannuation Industry (Supervision) Amendment Regulation 2012 (No 2). The changed text has been underlined.

The origin of this change can be traced to the Super System Review (popularly known as the Cooper Review), which noted with concern that many self-managed superannuation funds provided little or no insurance cover for their members when those members may require such cover.

In short, the review considered that there was a material issue of under-insurance in the SMSF sector. 

The need for this standard is clear, given the high level of under-insurance in the SMSF sector just as in the broader community.

Also, the popularity of SMSFs has meant that many super members have moved from funds which provided risk cover to SMSFs where generally there is little or no risk cover.

Three major points need to be made before considering the implications of the amended operating standard.

First, the relevant insurance cover is cover which forms part of a member’s benefit. Insurance cover which a trustee may effect to address liquidity and liability issues (such as cover the trustee may effect because the fund has entered into a limited recourse borrowing arrangement) is not relevant.

Second, the amended operating standard does not mandate that the trustee effect insurance cover on the members.  

The amended standard does require trustees to apply their minds to the issue of whether insurance cover should be effected and, if so, what type of cover and the amount of cover.

The final point is that the trustees need to be able to demonstrate to the auditor and to the Australian Taxation Office (ATO) that they have in fact complied with the amended operating standard. The best evidence of compliance with the amended operating standard will be minutes or resolutions of the trustees’ decision-making process.

This last point will be particularly relevant from 1 July 2013, when the new administrative penalty regime for trustees commences.

Regular review 

The amended operating standard requires that the trustee regularly review its consideration of the insurance cover for each member.

Presumably this means review on an annual basis.

Such an annual review could be included as part of the end-of-year activities for the fund.

However the trustees may need to review the need to provide insurance cover (or the level and type of cover) at other times.

For example, a review may be warranted upon the admission of a member to the fund, or upon the occurrence in relation to a member of a major life event such as birth of a child or transition to pension phase.

Particular issues for trustees

The amended operating standard will raise some interesting issues for trustees.

In particular, will trustees be liable to third parties for the decisions they make in relation to insurance covers for their members.

Also, are trustees in position to make an informed decision as to the type or level of cover which is require d for a particular member?

The third party liability issue will most likely arise where a member has died and their family members subsequently claim that the trustees should have effected cover or greater cover on the member.

Possibly the best response which trustees can take to mitigate such risk is to require the member to formally confirm the trustees’ decision and require the member to acknowledge that the member is able, if they so wish, to effect cover outside the fund.

The adequacy issue will most likely arise where the member has died or suffered total and permanent disablement and there are complaints that the level of cover was insufficient.

Similarly with the third party issue, the risks for trustees arising from the adequacy issue is to engage an insurance expert and to require the member to confirm the trustees’ decision, as well as requiring the member to acknowledge that the member is able, if they so wish, to effect cover outsider the fund.

Seven steps of the amended operating standard

While there may be many ways of complying with (and showing that trustees have complied with) the amended operating standard, our suggested approach involves seven steps.

1. Determine the investment/financial structure of the fund

The first step is simply to identify the relevant aspects of the fund such as the benefit phase of the funds (whether growth or pension); the size of member accounts and whether those accounts are likely to increase (due to contribution inflow and investment earnings) or decrease (due to benefit outflows) and the ages of the members.

2. Determine the type and amount of existing cover on the members

The second step is to determine whether the members have cover in other funds or outside super, and the amount of such cover.

Without this information trustees will not be in a position to make an informed decision as to whether cover should be provided

3. Determine the need for cover

The third step is to determine whether cover is needed. It may be that members already have sufficient cover in other funds or outside super.

Alternatively, it could be that while cover is needed, the cover is either unattainable (because of the particular member’s personal circumstances) or obtainable only at such a significant premium as to be unreasonable.

4. Determine the type and amount of insurance cover for each member

The amended standard does not require the trustees to provide the same type of cover and same amount of cover for each member. It may be that some members require death cover for a relatively small amount while others require much greater cover.  

5. Make a formal decision of the trustee

The decision of the trustees must be formally recorded as a minute or resolution.

The minute or resolution should include the particular decision in respect of each member and the basis for that decision.  

For example, the decision could be that member A has no cover provided in the fund as member A has sufficient cover outside of the fund.

Alternatively the decision could be that member A has indicated that they do not wish to have cover in the fund.

6. Implement the decision for cover

Implementation of the decision to effect cover may take some time (completion of application forms, personal statements, medical underwriting) and more administratively burdensome that first thought.  

7. Ensure there is an audit trail

The audit trail may require the trustees to keep advisers’ reports and recommendations relevant to the trustees’ consideration of the insurance requirements of the members, as well as fully document their assessment and decision.

Michael Hallinan is special counsel, superannuation at Townsends Business and Corporate Lawyers.