The 867,000 members of self-managed superannuation funds (SMSFs) are a pretty independent lot. They’ve foregone the services of public-offer superannuation funds in preference for trusting their accountant or financial planner and backing their own abilities.
However, it seems many of them are foregoing insurance as well – especially those that have been advised by accountants – and in so doing may be putting their nest egg at risk.
Only about 13 per cent of SMSF members have life insurance through their funds.
There would be a few more with a policy outside super but it still amounts to an underinsurance problem, according to the chairman of the Australian SMSF Members Association (ASMA), Grant Abbott.
It’s a problem he believes could blow up in a lot of accountants’ faces.
There are two events that will make SMSF under-insurance incendiary, Abbott says.
One is historical: the 2007 law that allowed SMSFs to borrow to buy property, which many more will now do following recent clarifications to the rules around repairing and renovating the investment properties.
The other event will happen later this year when trustees by law will have to consider insurance as part of their SMSF investment strategies.
There has been “improper consideration of insurance” by many SMSFs to date, Abbott says, mostly in funds advised by accountants. This is because accountants have been subject to an “exemption” from holding an Australian Financial Services licence, which has allowed them to set up an SMSF but not talk about any of the financial products – including insurance – contained within it.
“If it’s a financial planner that’s established the SMSF, they’ll leave a bit of money in the trustees’ previous retail or industry funds to keep their group life insurance policies going, whereas an accountant hasn’t been able to do that,” Abbott says.
The government now wants to let accountants talk about insurance and investments, so long as they don’t mention specific products but it’s too late to prevent “a lot of legal actions coming down the track”, Abbott says.
“You’ve seen this big upsurge in borrowing to buy properties in SMSFs and the banks have assessed those loans based on the principal contributors to the fund. If one of them passes away, or has a total permanent disability [TPD] or trauma event and can’t contribute, the fund’s in danger of going into negative cash flow if there’s no insurance there.”
Once that happens, risk-averse banks will liquidate the properties in question, and trustees will be “looking for scapegoats and they won’t be looking at themselves”. Accountants can guard against clients suing them by preparing a “one pager” that sets out all the downsides of not having insurance, Abbott says, and sending the clients to a trusted insurance broker.
The banks also need to step up, he believes.
“It’s crazy that banks lending to SMSFs say you have to have general insurance over the property but then they don’t make any demands around what life or TPD insurance the trustees have.”
The government can also play its part in the looming under-insurance crisis, Abbott insists, by allowing premium payments for insurance inside super to not count towards concessional contributions caps.
The maximum amount that can be contributed to super at the bargain 15 per cent tax rate is now $25,000 for most people, down from the $100,000 cap under the previous government.
Abbott says his entire cap was eaten up by insurance premiums last financial year. The holder of a $5 million life and TPD insurance policy, Abbott admits he’s probably in the rare category of the over-insured but he says the principle stands – insurance within super is a contributor to sustainable retirement and should be encouraged by allowing premiums to attract a tax deduction (which insurance outside super doesn’t) without eroding contribution caps.
The founder of insurance broker Self Super Insurance, John Kelly, says underinsurance extends beyond life and TPD and into the general insurance that SMSF trustees take out on their properties.
The cap limits and a tight rental market force trustees to settle for basic cover that’s riddled with exclusions, Kelly says. “Trustees get tripped up on damage, for instance,” he says. “The investment house burns down and they find they’re only covered if the tenant started it, not if there was faulty wiring in the roof.”
Insurance policies are complex legal documents and trustees need expert advice before signing them, he says.