Changes to Insurance in Super  

Background

In 2011, the Government issued a statement as part of the Stronger Super recommendations that demonstrated its concern regarding life insurance definitions within superannuation:

“…Currently, some members are being charged premiums for own occupation cover in TPD insurance policies and other types of insurance that may not be released to them when an insurance payment is made for them, because the circumstances do not meet a condition of release.

“The Government will end this practice. The Government believes it is in the best interests of members to align insurance definitions with the conditions of release so that insurance is consistent with the purpose of superannuation and that insurance monies are available to members at the time of their disability.

“The Government considers that this change needs to made as rapidly as possible and will consult with industry on an appropriate timeline for the phase‐out of existing policies that are not consistent with definitions of life, TPD and income protection insurance that will be incorporated in the legislation…”¹

New operating standards

On 1 March 2013, amendments to the SIS Regulations were made when the Superannuation Legislation Amendment Regulation 2013 (No 1) (SLI No 26 of 2013) was passed. The operating standard was changed so that trustees of a regulated superannuation fund (ATO regulated includes SMSFs, while APRA regulated includes industry funds, retail funds, and corporate funds) would be prohibited from providing members with insured benefits other than those that satisfy the conditions of release under Schedule 1 of the SIS Regulations for death (Item 102), terminal medical condition (Item 102A), permanent incapacity (Item 103) and temporary incapacity (Item 109). This operating standard has an implementation date of 1 July 2014.

Let’s examine each of these individually…

Death

Death is not specifically defined under the SIS Act or SIS Regulations. While this would normally not be an issue, circumstances where people become ‘clinically dead’ (ie: during surgery) but later recover could pose a problem for trustees. It may be prudent for both trustees and insurance companies to confirm that death benefits will only be paid/released upon declaration from a coroner, or where a Death Certificate is issued by a relevant registering authority where the death took place.

In most circumstances, the policy terms and conditions of the life insurance contract held by the trustee of the superannuation fund cover this potential gap in the SIS legislation. Life insurance companies will not normally release insurance benefits to the superannuation fund trustee until a death certificate from a coroner is received.

The new legislation has no significant impact on the release of death benefits from superannuation.

Terminal illness

There is no change to existing practices for these insurance benefits. For terminal illness, the trustee must ensure that:

…two registered medical practitioners have certified, jointly or separately, that the person suffers from an illness, or has incurred an injury, that is likely to result in the death of the person within a period (the certification period) that ends not more than 12 months after the date of the certification; and at least one of the registered medical practitioners is a specialist practicing in an area related to the illness or injury suffered by the person.’ (SIS Regulations 1994 – Reg 6.01A)

The new legislation has no significant impact on the release of terminal illness benefits from superannuation.

Total and Permanent Disablement (TPD)

Permanent incapacity, in relation to a member, means ill-health (whether physical or mental), where the trustee ‘…is reasonably satisfied that the member is unlikely, because of the ill-health, to engage in gainful employment for which the member is reasonably qualified by education, training or experience’ (SIS Regulations 1994).

‘Disability superannuation benefit is a superannuation benefit if:                     

1. The benefit is paid to an individual because he or she suffers from ill-health (whether physical or mental); and 
2. Two legally qualified medical practitioners have certified that, because of the ill-health, it is unlikely that the individual can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.’ (ITAA 1997)

The result in this more onerous definition is two-fold. ‘Own occupation’ TPD will be prohibited for any new insurance cover issued to a member within a superannuation fund after 1 July 2014. Secondly, any other ‘ancillary benefit’, such as loss of limbs or sight, loss of independent existence, inability to perform activities of daily work, or inability to perform activities of daily living, for any new insurance cover issued to a member after 1 July 2014 will need to meet the additional criteria that: ‘the member’s ill-health (whether physical or mental) makes it unlikely that the member will engage in gainful employment for which the member is reasonably qualified by education, training or experience’ (SIS Regs 1.03c).  Insurance that does not meet the second criteria will not align with a condition of release.

From 1 July 2014, only ‘any occupation’ TPD definitions will be permitted to be purchased within a superannuation fund. Again, this requirement is for any new TPD policy issued by a life insurance company to a superannuation fund after 1 July 2014. Existing policies that were in-force prior to this date may remain owned by a superannuation fund.

Advisers will have to be very careful when recommending TPD insurance inside superannuation after 1 July 2014. TPD policies inside super will not automatically provide ancillary benefits, as opposed to a typical any occupation TPD policy held outside superannuation. Many life insurance companies now provide a split TPD alternative, that permits ‘SIS-aligned’ TPD benefits inside superannuation to be linked to an own-occupation TPD benefit outside superannuation.

Temporary incapacity (income protection)

From 1 July 2014, temporary incapacity benefits paid from superannuation will have significant restrictions when compared to a similar income protection policy outside super.

In order to meet a temporary incapacity condition of release from a superannuation fund, the insurance policy definition must align with the condition of release. The SIS Regulations state (1.03c & 6.01):

‘A non-commutable income stream cashed from the regulated superannuation fund for: 

1. The purpose of continuing (in whole or part) the gain or reward which the member was receiving before the temporary incapacity; and
2. A period not exceeding the period of incapacity from employment of the kind engaged in immediately before the temporary incapacity.’

‘Temporary incapacity’, in relation to a member who has ceased to be gainfully employed (including a member who has ceased temporarily to receive any gain or reward under a continuing arrangement for the member to be gainfully employed), means ill-health (whether physical or mental) that caused the member to cease to be gainfully employed but does not constitute permanent incapacity.

‘Gainfully employed’ means employed or self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment.

The definition of temporary incapacity raises a number of issues regarding income protection policies owned by superannuation trustees.

There is no guidance in the legislation regarding the period a trustee may calculate the ‘gain or reward which the member was receiving before the temporary incapacity’ (Schedule 1 – Item 109 – Part (a)). The minimum life insurance industry standard is to calculate ‘pre-disability income’ over the previous 12 months, but the regulations are not clear on this matter.

A significant consideration for an adviser when recommending income protection (temporary incapacity) within superannuation, is what occurs if a member was between jobs when they suffered the temporary incapacity? In this circumstance, the ‘gain or reward which the member was receiving before the temporary incapacity’ is nil on the date of disablement, thus they are not entitled to a benefit (Schedule 1 – Item 109 – Part (a)).

Trustees will also need to take care that any income protection policies acquired after 1 July 2014 do not pay any lump sum benefits, such as genuine redundancy, crisis, specific injury or home care benefits.

Temporary incapacity benefits (income protection) have a number of provisions that must be complied with:

• The member must cease to receive any gain or reward. This means that an individual who is between jobs, either due to unemployment, retrenchment, redundancy, or is between contracts (ie: many people in the IT or mining industries), is not entitled to receive a temporary incapacity benefit from an SMSF (or any other super fund).
• As benefits can only be paid for the period of incapacity, certain ancillary benefits paid via superannuation may be prohibited. Critical illness or specified injury benefits that pay a predetermined monthly benefit (3x or 6x) when a person suffers an injury (broken bones) or illness (heart attack, cancer, stroke, etc) may be in excess of the period of incapacity (Schedule 1 – Item 109 – Part (b)). It is likely that ancillary benefits will be prohibited if there is any possibility that any member could return to work prior the period of incapacity that had been paid in advance.

Another concern has arisen regarding what occurs to an income protection benefit paid from superannuation when a member becomes permanently disabled (any occupation). The SIS legislation states that a temporary incapacity benefit must cease when a member becomes permanently incapacitated (any occupation). This does not automatically mean that the income protection benefit from superannuation must cease. Provided that the trust deed of the superannuation fund permits a permanent incapacity benefit to be paid as a pension (rather than a lump sum), then the client/member should not notice any difference in the level or frequency of the income protection benefits. The ability to pay a superannuation disability pension will provide additional reporting and compliance requirements for the trustees of the superannuation fund, including but not limited to, minimum payment standards and taxation of benefits.

Trauma

It has been argued in the past that a traumatic or critical illness event will normally result in either temporary incapacity or permanent incapacity. While this would normally be the case, because it cannot be guaranteed that in every situation a trauma payment would automatically meet a condition of release (under either temporary incapacity or permanent disablement), or that the full trauma payment would be released, these benefits will now be prohibited for any new policy from 1 July 2014.

It is important to note that trustees will generally be prohibited from acquiring these policies from 1 July 2014. Trustees of SMSFs will not be permitted to purchase these policies on behalf of members after 1 July 2014 as these policies do not strictly align with any of the four conditions of release.

Grandfathering

The SIS Regulations which enact the changes above will not apply to the continued provision of insured benefits to members who joined a fund before 1 July 2014 and were covered in respect of that insured benefit before 1 July 2014.

Therefore, where a trustee took out a trauma or own occupation TPD policy for a member prior to 1 July 2014, they can continue to maintain that policy after that date. In addition, the Government has also confirmed a trustee can vary their level of cover from 1 July 2014. For example, the cover could be increased or decreased, and associated premiums adjusted, after 1 July 2014.

If a client has an existing policy in super, then they have the right to retain any current terms, conditions and benefits. Both advisers and clients must understand that existing terms, conditions and benefits only determine that the insurance company has the obligation under the life insurance contract/policy/schedule to pay the benefits to the trustee of the superannuation fund. The trustee of the superannuation fund must still ensure that the member meets a condition of release prior to the release of any benefits. If the member does not meet a condition of release, then the insurance proceeds will get trapped inside the superannuation fund until the member meets a condition of release at a later date. Normally, these proceeds will get credited to the member’s account and will serve to increase the member’s superannuation balance. But, this will be of little comfort to the member if they were intending on using these benefits immediately to pay off debt, pay hospital bills, or pay for normal living expenses such as groceries or electricity.

Summary

Existing members of superannuation funds may retain existing insurance benefits. From 1 July 2014, any new members may only be provided with SIS Act compliant insurance benefits. New insurance arrangements inside super will become quite homogenous after 1 July 2014, and SMSF trustees may need to consider more generous terms and conditions outside super for their members (ie: trauma, own occupation TPD, and ancillary benefits for income protection).

Jeffrey Scott is the Executive Manager, InsuranceTech & Business Delivery at CommInsure.

Jeffrey has been in the insurance industry for 25 years and is a regular media commentator on the topics of insurance, superannuation and finance.

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1. Stronger Super Information Pack, 21 September 2011 – Link to article ↩