The Cooper review found only 13 per cent of SMSFs held any form of life insurance and, in response, the government introduced regulation 4.09(2)(e) of the Superannuation Industry (Supervision) (SIS) Act 1994, which commenced at the start of the 2013 financial year.
The regulation requires trustees to consider life insurance for SMSF members, to ensure insurance is considered as a risk management tool, takes into account the members’ circumstances and is documented as part of a well-planned investment strategy. Financial planners also have a statutory obligation to document financial product advice under the corporations legislation.
At first, the wording in SIS regulation 4.09 seems innocuous and fairly tame, though when read in conjunction with the covenants built into the SIS Act, there is a sting in the tail. This can impact on SMSF trustees as well as their accountants and advisers who fail to properly document the insurance requirement.
Regulations 4.09 (2) (c) and (d) also cross over with the need to consider insurance because they encompass an SMSF’s liquidity, cash flow and ability to discharge existing and prospective liabilities. All of these components can have a negative impact when an insurable event occurs, such as the unexpected death or disability of a fund member or members.
The key points in the regulations below have been highlighted and will be explained further in the article. These could have important implications where it is not possible to substantiate that trustees have taken the requirements of the covenant into consideration. This is over and above the supervisory role of the ATO and other regulators.
Regulation 4.09 (2) states: “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:
(c) The liquidity of the entity’s investments having regard to its expected cash-flow requirements.
(d) The ability of the entity to discharge its existing and prospective liabilities.
(e) Whether the trustees of the fund should hold a contract of insurance that provides insurance cover for one or more members of the fund.”
The words and phrases italicised above show SMSF trustees are responsible for formulating an effective investment strategy, taking into account the whole of the circumstances of the fund and its members.
Many articles have been written with the stern message that trustees can be fined up to $17,000 by the ATO for breaches of the investment strategy regulations (including not properly considering insurance). While trustees need to keep this in mind, a more significant risk to SMSF trustees and their accountants/advisers comes from growing litigation for loss or damages in the areas of insurance, retail/industry superannuation and now SMSFs, as this is a growing area for litigation lawyers, particularly where the death or disability of the SMSF member(s) involves blended families, other family law situations or financial loss.
When looking at the insurance covenants in the SIS Act, as a summary, it is a trustee’s duty to formulate, review regularly and give effect to an insurance strategy on behalf of the beneficiaries (members) of the fund, which includes:
• the type of insurance to be offered or acquired,
• the levels of insurance cover to be offered or acquired,
• the basis for the decision to offer or acquire insurance,
• the costs to all beneficiaries of offering or acquiring insurances,
• offering or acquiring insurance if the cost does not inappropriately erode the retirement income of beneficiaries, and
• doing everything that is reasonable to pursue an insurance claim.
How do SMSF trustees and their accountants/advisers ensure proper compliance and protection from litigation instigated by members, beneficiaries or other parties?
1. Section 55(5) of the SIS Act provides a defence for trustees against actions for loss or damages in relation to an investment for the fund, including insurance. The defence is that the investment has been made in accordance with the covenants in section 52B and SIS Regulation 4.09, including insurance.
2. For trustees to defend an action for loss or damages relating to holding inappropriate insurance or no insurance cover for members, they should demonstrate they have made the investment in accordance with an investment strategy that complies with the covenants. For purposes of due diligence, trustees should have on file a document as well as a process clearly showing insurance strategies and solutions have been considered to take into account the financial risks associated with an unexpected death or disability of fund members.
3. In addition, the SMSF trustees, accountants, advisers and other professionals who provide advice and facilitate compliance for their SMSF clients should have on file evidence that they have a process in place to consider the relevant insurance of fund members and the annual review. This will assist in providing protection from litigation by trustees, members and beneficiaries for loss and damages relating to SMSF clients holding inappropriate insurances or no insurances.
The escalation of litigation in the courts in relation to binding death benefit nominations and other matters relating to SMSFs means it is only a matter of time before we see challenges to the decisions of trustees for fund investments and whether appropriate insurance cover has been made as required by the SIS covenants.