SMSFs and insurance - what you need to know

SMSFs now have to consider the need to hold insurance cover for their members. Michael Hallinan outlines the practical implications of this change and the issues trustees must consider.

Trustees of self-managed super funds (SMSFs) will now have to consider the need to hold insurance cover for their members. This requirement arises from recent changes to the investment strategy operating standard.

The key word in relation to the change is “consider” and not “hold” insurance cover. Now that the change has been made, what are the practical implications of the change and what must trustees now do?

Some initial points need to be made. First, the change is directed at insurance cover which forms part of the benefit to be paid for a member; it is not directed at insurance cover the trustee may take out to address liquidity or liability issues (eg, liquidity issues arising from the fund having lump assets or liability issues arising under limited recourse borrowing arrangements).

Second, the change does not require SMSF trustees to implement insurance cover on each member.

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The final point is that the change does require the SMSF to document its consideration of the need for insurance cover.

The final point arises because the change has been made to the Superannuation Industry Supervision (SIS) Act operating standard, and the trustees must have a documentary trail to show that they have complied with the operating standard.

The technical details of the change are provided at the end of this article.

The four-step process for SMSF trustees

To comply with the insurance cover aspect of the operating standard and to demonstrate that they have complied with the insurance cover aspect of the standard, SMSF trustees could apply the following four-step process:

• Step 1: Survey the field
• Step 2: Consult with each member
• Step 3: Decide on the type and amount of cover
• Step 4: Implement the decision.

Survey the field

This step simply requires the trustees to obtain information as to each member’s current insurance arrangements – whether in the fund, in another fund or outside super.

It may be that a member has sufficient cover in another fund or it may be that the member has sufficient cover outside of super.

Unless the trustees obtain this information they are not in a position to consider whether the current cover is sufficient or insufficient.

Surveying the field may require the trustees to use a standard form to obtain and record the relevant information.

Ideally this form should be signed by the member to confirm the accuracy and completeness of the information provided.

Consult with each member

The member has a material interest in the type and level of cover. Premiums will be borne by the member and premiums for cover at advanced ages can be significant.

Additionally if the member is not convinced for the need of the cover, the member is in a position to frustrate the effecting of the cover by not co-operating with the insurer by competing the lifestyle and medical statements or undertake any required medical examinations.

Automatic acceptance limits are not likely to apply at the SMSF level and each member would have to be underwritten.

The member may have good and sound reasons for not wanting the cover – such as premium loading issues or coverage exclusions which may apply.  

The form used by the trustees as Step 1 should also permit the member to express their views as to the level and amount of cover they consider they need. In particular, if the member is of the view that no cover or only limited cover is required, the member should expressly record that view on the form.

Decision as to type and amount of cover

This step requires the trustees to consider and form a decision as to whether cover of a particular type is required and, if so, the amount of that cover. This decision should be made in respect of each member.

For some members the decision may be relatively straightforward – such as members in pension phase and who have attained age 65.

For these members, insurance cover is probably not commercially available, or, if available, the premiums would be too great.

The trustees would simply record a decision in the minutes to the effect “considered the need for insurance cover but given the member is in pension phase and of advanced age, commercial cover is not available or would be disproportionate to the benefit to be achieved and would be inconsistent with the income needs of the member”.

For other members a decision may have to be made as to whether they have (irrespective of source of cover) already sufficient cover and, if so, simply record that the member has sufficient cover.

This will require the trustees to form a view as to what is sufficient cover (both as to type and quantum of cover).

This may be a situation where the trustees could rely on practical rules of thumb such that the total death cover on a member should at least equal their total debts (ie mortgage plus personal & credit card debts) plus a multiple of their current net earnings.

TPD cover could be equal to the death cover. Salary continuance cover is usually limited to 75 per cent or a lesser percentage of the members’ net earnings.

Once the trustees have determined what the sufficient cover for a member is they will then have to determine the shortfall in that cover and whether the shortfall can be addressed by cover provided by the fund.

It may be that the member’s account balance or likely contribution inflow cannot support the premiums for this type and amount of risk cover. It may be the member has no interest in having additional cover.

Or it may be that shortfall cannot be met by insurance coverage due to underwriting issues.

The trustees would then have to record the outcome of their consideration such as “determined that the member already has sufficient cover provided outside of the fund” or “determined that sufficient death cover for the member is $500,000 and that the shortfall in cover is $300,000 and that the Trustee will apply for that amount of cover”.

Ideally the trustees should advise each member of their decision in relation to the member. This will preclude the member (or their estate) from subsequently claiming that the member thought the trustee was effecting cover and therefore the member did not attend to taking out cover.  

Implementation

If the trustees have determined that cover should be provided for a member, then they must apply for that cover and attend to the various underwriting enquiries.

It is important that the trustees correctly advise the member that they are seeking to obtain cover on the member – and not that cover has already been obtained.

Advising the member that cover has been obtained must only occur once the insurer has confirmed in writing that the risk has been accepted and the premium paid.

Further, trustees should also review their governing rules to ensure that the member’s benefit can be adjusted for the premiums and also if the insurer declines any claim under the coverage.

Final comments

Finally, the trustees will presumably have to undertake this process on annual basis and implement the process for each new member who is admitted to the fund.

The change has been effected by an amendment to SIS Reg 4.09(2) by inserting a further paragraph as follows “ (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”.

This change was made by Superannuation Industry (Supervision) Amendment Regulation 2012 (No 2) which applies from 7 August 2012.

Michael Hallinan is the special counsel at Townsends Business & Corporate Lawyers.