SMSFs and the tightening rules on insurance and self-insurance

The regulatory controls on the manner in which self-managed super funds (SMSFs) approach risk insurance coverage for fund members are tightening in a number of respects.

Self-insurance

Firstly, the scope for self-insuring is diminishing.

So far as the current law is concerned, in its Interpretative Decision ID 2012/32 (issued on 4 May this year) the Australian Taxation Office (ATO) formed the view that allocating an amount from a fund's self-insurance reserve to pay disability benefits (or supplement a disabled member's accumulation account in lieu of work contributions) constituted a payment from a reserve for contribution cap purposes in the case in question.

The logic would appear to extend to typical self-insurance reserve strategies. If it does, then this could detract significantly from the appeal of these strategies.

So far as potential changes to the law are concerned, in September the Government tabled its third tranche of Stronger Super measures, the Superannuation Legislation Amendment (Further MySuper and Transparency Measures) Bill 2012, which provides the framework for regulations to be made which will effectively ban accumulation funds from using self-insurance reserves to pay death or disability benefits.

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This measure is expected to apply to SMSFs from 1 July 2013. 

Its impact, including any transitional rules, will not be entirely clear until regulations are released.

There is perhaps a question as to whether the ban would extend to anti-detriment death benefit reserves where these are built up over a number of years.

It is to be hoped that a common anti-detriment arrangement will be excluded because its purpose is distinguishable from self-insurance reserves and in many cases they are more in the nature of a suspense account than a reserve.

Insurance changes

Secondly, requirements for insuring via risk policies are becoming more prescriptive.

In August the Government made Superannuation Industry (Supervision) Amendment Regulation 2012 (No. 2), which contains various SMSF-related Stronger Super requirements which became law on 7 August.

One of these requirements is that SMSF trustees, in developing and reviewing the fund's investment strategy, must consider whether they should hold insurance cover for a fund member.

This requirement is an operating standard, rather than a covenant.

Whereas the ATO is unable to enforce compliance with covenants (which are deemed to be incorporated into the fund's governing rules) it can enforce compliance with operating standards.

So if an SMSF trustee breaches this requirement it will be punishable by a fine currently not exceeding $11,000 (although, as part of the Mid-Year Economic and Fiscal Outlook, there is a proposal to increase that to $17,000 in the future).

Having said that, trustees should not find it difficult to comply with the regulation.

It can be met by documenting decisions in the fund's investment strategy or minutes of trustee meetings that are held during an income year.

SMSF trustees are expected to be self-reliant in determining the type and level of insurance cover members might require, and whether that cover is held within or outside their SMSFs.

So far as potential changes to the law are concerned, once enacted the Stronger Super bill referred to earlier would also provide a framework for the Government to introduce a standard which would limit trustees to only taking out risk insurance policies that provide benefits in circumstances that satisfy the SIS conditions of release for death, terminal medical condition, permanent incapacity or temporary incapacity.

It is expected that such a standard will be made in the coming months and apply to SMSFs from 1 July 2013.

In many respects this development is consistent with recent moves by some insurance product providers to provide super risk policies which both align with the SIS cashing rules and sit alongside linked non-super policies which supplement the cover.

(For example, for total and permanent disablement cover, the super policy will insure for permanent incapacity and the linked non-super policy will cover the balance of disabilities falling within the "own occupation" definition).

These arrangements were also developed in part to produce optimal tax results for clients.

Details of the provisions supporting the proposed standard, including any transitional rules, are not yet available. 

Hopefully the provisions won't be drafted in such a manner that they prevent funds from taking out risk policies for purposes other than immediate payment of benefits, such as for the purpose of extinguishing fund debt on limited recourse borrowing arrangements.

This seems unlikely, but one to watch nevertheless.

David Shirlow is the executive director, Macquarie Adviser Services.