Property, LRBAs & Cross-Insurance in an SMSF: Yes, No, Maybe?
In an SMSF, much like anywhere else in life, insurance is a matter for consideration and often necessity. Trustees of Self-managed Super Funds are required by the ATO to consider whether to hold insurance cover for each member of an SMSF.
Recent changes to the Superannuation Industry (Supervision) Regulations 1994 (Cth) (‘SISR’) which came into effect on 1 July 2014 introduced a regulation, namely 4.07D(2), This has caused some confusion and generated much discussion as to whether cross-insurance policies are still feasible in an SMSF.
We have put together this technical piece to clarify further the changes – both existing and proposed.
Before we go into detail….
What is cross-insurance and why is it relevant?
Cross-insurance allows insurance over a members life with the premiums deducted from another member’s account. This allows a payment to be made directly to the premium-paying member in the event of death.
The purpose of cross insurance is to enable the deceased members benefits to be paid out without having to sell illiquid assets, such as property. If the life insurance is held directly by the member, it will need to be paid out as part of their benefits also. This still requires the sale of the assets you are trying to protect. Cross insurance works so that the surviving member receives the insurance proceeds, and is then able to pay out the other members benefits from these, allowing them to continue holding the property. In effect their balance increases from the proceeds as they have been paying the premiums.
In any SMSF, and in particular those with LRBAs (Limited Recourse Borrowing Arrangements), the fund’s assets are generally all tied up in investments. Property, of course, is the most common situation for cross-insurance to be of benefit.
Cross-insurance is by no means a total solution for these situations. However, in the case of a couple or funds where there are two members who are also estate beneficiaries, this can be a blessing. A welcome reduction of pressure during a time where SMSF Administration may be the last thing on someone’s mind.
When the new regulations were introduced on 1 July 2014, although stated otherwise, Reg. 4.07D(2) contained the following statement, which caused many to question whether a cross-insured scenario was still ‘technically’ ok;
“A trustee of a regulated superannuation fund must not provide an insured benefit in relation to a member of the fund unless the insured event is consistent with a condition of release specified in item 102, 102A, 103 or 109 of Schedule 1.”
Without following into the same legal & financial discussions we have seen of late, it’s safe to say that many have been seeking ‘yes’ or ‘no’ clarification on the matter. With compliance and potentially future assets at stake it is easy to understand why.
The ATO’s Response
During November, the ATO provided their own clarification on the matter, giving the following view;
“Can an SMSF take out insurance on a cross-insurance basis?
Regulations that came into operation on 1 July 2014 do not permit cross-insurance on any new insurance products. These types of insurance arrangements are not permitted because the insured benefit will not be consistent with a condition of release in respect of the member receiving the benefit.”
Whilst it can be argued that the ATO is merely giving their interpretation on the regulation, we feel it is only a matter of time before the issue is officially clarified and brought into regulation.
If you have commenced an existing cross-insurance policy prior 1 July 2014, you may continue your policy as it will be grandfathered so long as premiums are met and the policy remains current. If you have begun a cross-insurance policy on or after 1 July 2014, we recommend seeking advice upon continuation or cessation of said policy.
For those interested in the idea of cross-insurance, or wishing to better understand how to limit risk and exposure for a fund during insured events, please feel free to contact iSUPER® for more information on (02) 9377 0766.