How to Navigate a Changing World of Insurance Products

Parts one and two in this three-part feature from BT look at effective ownership structures for life insurance and structuring income protection cover for the self-employed. Part three reviews some of the strategies advisers might consider following the disappearance of agreed value IP cover…

 

Holding Cover Within a Super Master Trust Versus a Platform Super Fund

The cost effectiveness of different ownership structures for life insurance can sometimes lead to a complex web of scenarios involving insurance and superannuation, but there’s always a solution…

 

It’s well-known that holding insurance cover inside a risk-only superannuation fund (I.e. master trust) may give a client the advantage of an upfront 15 per cent tax rebate, if annual premiums are funded via partial rollover.

However, what may not be as well-known is that an equivalent 15 per cent concession generally applies if the insurance were instead held within a platform super fund, or a self-managed super fund. The net cost of the cover under both structures may therefore be the same.

Knowing exactly how the costs of the two structures compare could save the adviser and client from having to create a new super account.
Example of how a concession applies on cover via platform super:

Note: refer to the diagram below, which shows how the various tax rebate / concession plus any discounts apply across different life insurance ownership structures.

Let’s look at an example where an adviser has structured a client’s life and TPD cover via their existing platform super. From a fund accounting perspective, the annual premium the trustee pays gives rise to a corresponding tax deduction, which the trustee can use to offset the tax it has to pay on assessable fund income received. In recognition of the fund’s lower tax liability, the trustee generally passes on a tax ‘credit’ into the client’s super account.

So the net cost of the cover is likely to end up being 85 per cent of the ‘headline’ premium (total premium less 15 per cent tax credit), which is identical to the cost if cover is held in a risk-only super fund and funded via partial rollover.

Some insurers offer an additional 10 per cent discount if cover is funded from a qualifying platform, further reducing the cost and impact on the client’s retirement savings. Further discounts may apply.

An important point to consider is any timing differences; that is, how quickly does the trustee pass back the tax-credit following payment of the premium? Additionally, in some instances the tax-credit may be ‘socialised’ with other members of the fund, potentially diluting the credit in the pass-back process.

Cost effectiveness is a crucial consideration when providing advice on ownership structures for life insurance. BT encourages advisers to contact their BDM to find out more about how a tax rebate, concession or discount may apply.

 

Structuring Income Protection Cover for Self-employed Clients

The removal of new agreed value income protection contracts from 31 March 2020¹ leaves indemnity policies as the sole contract type available in the market. But does this change the way we think about structuring IP cover? This article from BT teases out some of the advice implications stemming from the removal of agreed value IP…

 

You’ve probably already considered which cohort of clients is likely to be affected by the removal of agreed value IP. Intuitively, it will be those with fluctuating levels of income, such as self-employed individuals and contractors; and given the current uncertainty in the job market and challenging business environment, it’s indeed important to weigh up the impacts of different IP strategies for such clients. What is your starting point when considering where to house IP cover after 31 March 2020? Inside or outside of the super environment, or a combination of the two?

While there is no right or wrong answer, the default position may be to house the IP cover within super, especially now that agreed value IP is no longer an option. Doing so obviously brings superannuation law conditions of release considerations into play.

For self-employed or contractor clients, it means that if at the time the disablement occurs, the contractor wasn’t engaged in paid work, or if the self-employed client’s enterprise has since come to an end, the temporary incapacity condition of release won’t be satisfied. This is because ‘temporary incapacity’ requires that the client ceases work due to illness or injury. If they have ceased work prior to becoming disabled, this condition cannot be satisfied. Claim proceeds will not be payable, as under the Stronger Super measures in place since 1 July 2014, and cover can only be offered by the super trustee, where one of four conditions of release can be met – one of these being temporary incapacity.

To combat this risk, one option is to ‘link’ IP benefits under two policies held inside and outside of superannuation. In doing so, the majority of the premium is funded from retirement savings and the non-super policy provides a second line of defence, in the event that the temporary incapacity condition of release isn’t satisfied.

While the prospect of holding most of the IP cover inside super resonates with many clients, as part of the decision-making process advisers should consider the impact of the premiums on the underlying retirement savings, particularly when advising self-employed clients. Some key points to note are listed below.

  • Capital gains tax (CGT) and contributions – The current tax law allows eligible small business owners to contribute part or all of the proceeds stemming from the sale of qualifying business assets into super, in accordance with the CGT contribution cap (as a result of qualifying for CGT relief). This may make up for the erosion of retirement savings from premiums during the accumulation years. However, it’s important to note these concessions / contribution caps have been the subject of recent reviews and may well be less accommodative in the future.
  • Regulations on paying premiums out of super – Regulatory scrutiny over the impact of insurance cover on the retirement income of super members has intensified, and in particular whether retirement savings are inappropriately being eroded by premiums.
  • The effect of compounding – If IP is self-owned, more capital remains compounding inside super and a greater proportion of contributions actually augment retirement savings, rather than merely replenishing accounts that have been eroded by premiums. Over time that could make a meaningful difference for self-employed clients who are otherwise coming off lower superannuation capital bases, especially if lump sum cover is housed within the account and contribution caps remain persistently low.

If IP is self-owned, the life-insured is generally entitled to a personal tax deduction for part or all of IP premiums paid. For example, if a $3,000 premium payable on an IP policy was directly debited from the client’s bank account during the financial year, the ensuing $3,000 tax deduction that the client can claim in their tax return reduces their overall income tax liability, meaning the actual cost of the cover is only $1,830 or $1,590, for a client in the second highest and highest tax bracket respectively. While a tax deduction claimed by the super trustee may be passed on to members, this is not guaranteed, and may only apply to a certain cohort.

Clients who are self-employed possibly stand to lose the most from the removal of agreed value IP. For these clients, self-owned IP is clean, simple and free from the superannuation law overlay. Further, unlike Life and Total Permanent Disability cover, self-owned IP clients can receive direct tax deductions for premiums paid.

Importantly, retirement savings are quarantined from IP premium erosion, thereby aiding underlying contribution strategies/retirement planning. These factors may be helpful when canvassing self-owned IP, as a structure with such clients, particularly against a backdrop of ever-changing super and tax regulations and laws.

¹In accordance with APRA’s sustainability measures for individual disability income insurance, announced 2 December 2019. These measures address product design aspects and include a Pillar 2 capital charge for insurers and reinsurers.

Self-Funding Mechanisms for Income Protection

Here, BT reflects on a few different strategies advisers might consider in the wake of the disappearance of Agreed Value IP cover from the Australian market and focuses on alternative funding mechanisms for self-employed clients…

 

Clients with fluctuating levels of income possibly lost the most from the removal of new agreed value income protection (IP) contracts in 2020. And while an indemnity IP policy can provide some cash flow certainty in the event of disability, the actual monthly insured benefit may be of little value if the illness has happened amid, or following, a prolonged slump in business income. This will be even more profound given the restrictive APRA-prescribed calculation of pre-disability income set to apply from mid to late 2021.

To address this risk, it may be prudent to put in place dedicated ‘funding mechanisms’. These could help normalise cash flow if and when the monthly insured benefit has been severely impaired by reduced levels of business income in the period leading up to the trigger event. This paper explores several of these funding mechanisms.

It is acknowledged that the design of these ‘next generation’ IP policies is far from final. However, certain planning points are beginning to emerge which don’t involve a significant departure from conventional technical/strategic planning, while at the same time fundamentally respecting the policy intent of the APRA measures.

Utilising existing corporate structures

Take self-employed clients that have an existing company/corporate entity within their group structure. The company may be the entity out of which the business is operated; or it may have been set up as a passive investment vehicle, separate and quarantined from the operating entities of the business, capable of receiving distributions from other entities within the group from time to time.

If cash flow permits, and in consultation with the client’s accountant, there may be merit in directing extra capital/distributions to that company over time. This effectively builds a pool of capital within a vehicle that allows access to funds if and when required. Ultimately, the capital retained within the company may provide comfort that funds are readily accessible, as a counter to the impact of lower levels of business income on the calculation of a future monthly insured benefit.

When required, funds could be ‘streamed’ out of the company to qualifying shareholders, which may be the policyholder and/or members of the policyholder’s family group. That may provide a useful boost to cash flow during a temporary illness. Expert advice would of course need to be obtained to determine the impact that this arrangement may have from a tax and claims perspective.

Having a pool of capital to draw down on may also provide a meaningful safety net, given the stricter disability definitions that APRA wants insurers to explore, in order to better manage the risks of longer payment periods.

Super contributions

Alternatively, if the life insured and their spouse is of (or near) preservation age, then there may be merit in simply maximising contributions to either of their super accounts where this is not already occurring. Some qualifying clients may even be able to utilise unused portions of the concessional contributions cap from 1 July 2018. Being of preservation age, there would be an ability, at the very minimum, to draw funds out via a non-commutable income stream if funds are required to normalise cash flow during a temporary disability.

Sole traders

For sole trader clients without elaborate group structures and entities, it may be a case of simply building a pool of capital in the name of a lower-income tax paying spouse. It’s clean, transparent and simple to explain to the client. A degree of asset protection is also afforded.

There may be an array of other funding mechanisms that could work for you and your client. The aim here is to provide a starting point by examining some intuitive options, taking into account the current entities and structures that self-employed clients are likely to already have in place.

Part 1 in this series was written by Steve Craig, Head of Adviser Distribution, Life Insurance, BT. Parts 2 and 3 were written by Ben Martin, formerly Senior Manager – Product Technical, Life Insurance, BT, and who is currently Senior Technical Manager at AIA Australia.

 

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