Australia: Superannuation funds: TPD insurance covers – the way forward for trustees and insurers

As explained in our Legal Update Superannuation funds: tax deductibility of TPD insurance premiums cut back (14 February 2011), trustees of complying superannuation funds will not be able to claim a full tax deduction for premiums paid to purchase broadly worded total and permanent disability (TPD) insurance covers in the 2011-12 and later income years.

We said that in the superannuation context, the days of "own occupation" and other broadly worded TPD covers appeared to be numbered.

Many fund members can be expected to want their present form of TPD cover to continue. So where do trustees and insurers go from here?

Three options

Trustees and insurers wishing to facilitate the continuation of broadly worded TPD covers for fund members have 3 main options, all outside the operation of the superannuation fund,¹ as follows:

• option 1 – the insurer issues a single policy to the trustee, who with the insurer's approval issues a third party beneficial interest in that policy to the member;
• option 2 – the trustee arranges the issue of a policy by the insurer to the member; and
• option 3 – the trustee merely refers the member to the insurer, who issues a policy to the member.

Each of these options is briefly explained below. Each option involves the trustee engaging in new insurance activities, in addition to its existing superannuation activities.

Of course, "any occupation" cover can still be provided through the fund – although if other TPD cover is being provided outside the fund, the preferred course may be to move the any occupation cover outside the fund as well, so that all TPD cover is contained in a single policy.

Option 1 – trustee issues third party beneficial interest

As mentioned above, under this option the insurer issues a single policy to the trustee, who with the insurer's approval issues a third party beneficial interest in that policy to the member. (The member is not a party to the contract of insurance, but they are entitled to be paid a benefit under it.) The policy needs to be appropriately worded so that the member can claim directly against the insurer. ²

This option:

• most closely resembles current arrangements where the trustee uses fund assets to purchase a single policy which provides broadly worded TPD cover, to augment the superannuation benefits that are paid out of the fund upon a member satisfying a condition of release; and
• largely for the reason that the insurer only issues a single policy, is administratively the simplest option in the long run.

Some features of this option are:

• where the trustee holds, or is required to hold, an Australian financial services (AFS) licence, the licence will need to include authorisations to "issue" and provide "financial product advice" in relation to "life risk insurance products". ³ Where the trustee does not already have these authorisations, consideration can be given to the insurer appointing a number of individuals from within the trustee's administration as authorised representatives of the insurer, as an interim measure until the trustee obtains its own authorisations;
• an AFS licensee-trustee will also need to have an internal dispute resolution procedure in place and be a member of the Financial Ombudsman Service Limited; ⁴
• an AFS licensee-trustee will also need to have arrangements for compensating retail clients – which essentially means having professional indemnity insurance cover that is "adequate"; ⁵
• the insurer, as the product issuer, will need to prepare a Product Disclosure Statement (PDS) ⁶;
• the insurer will need to take "reasonable steps" to ensure that the PDS is given to the member before the member elects to be covered; ⁷
• the trustee will need to give the member a Financial Services Guide (FSG). ⁸ If the trustee is acting as the insurer's representative, this can be combined with the insurer's PDS in a Combined FSG/PDS; ⁹ and
• the trustee will be able to collect premiums for the broadly worded TPD cover from members or employers, for transmission to the insurer. However, these premiums are not superannuation contributions and must not pass through the fund.

Option 2 – trustee acts as arranger

Under this option, the trustee arranges the issue of a policy by the insurer to the member. This option is administratively more complicated than option 1 because the insurer issues a separate policy to each member, instead of a single policy to the trustee.

The features of option 1 set out above also apply to this option, except that the obligation to give the PDS to the member falls directly on the trustee. ¹⁰ (This will make no difference in practice, as under either option it will be the trustee who gives the member the PDS.)

Option 3 – trustee acts as mere referrer

Under this option, the trustee merely refers the member to the insurer, who issues a policy to the member. The idea of this approach is to keep the trustee's insurance activities within the confines of one of the two "mere referrer" exemptions to the AFS licensing requirement in the Corporations Regulations 2001 (Cth). ¹¹ Briefly stated, this option involves the insurer, not the trustee, selling the policy to the member.

From the trustee's perspective, this option has the advantage of not requiring insurance authorisations on the trustee's AFS licence. On the other hand, under this option the trustee cannot collect premiums for the broadly worded TPD cover, as this goes beyond the scope of the mere referrer exemptions.

This option is the furthest removed from current arrangements and is the most cumbersome and inefficient in terms of retaining business.

Other considerations

This Legal Update provides a high-level view of the options which may be available to trustees and insurers, depending on their particular circumstances.

There will be other considerations, which again will vary depending on the particular circumstances. These other considerations will (or may) include:

• any constraints in the trustee's constitution;
• compliance with the "No other business or commercial activity" licence condition which the Australian Prudential Regulation Authority imposes on all RSE licences; ¹²
• compliance with other RSE licence conditions;
• compliance with the trustee's AFS licence conditions;
• compliance with the "financial services laws", ¹³ including the requirements that apply when dealing with client money (here, premiums) before the financial product is issued; ¹⁴
• the qualifications and experience of the trustee's responsible managers;
• the training and competence of the trustee's representatives;
• the additional obligations that attach where "personal advice" is given; ¹⁵
• the existing death and TPD insurance arrangements; and
• the Future of Financial Advice reforms.

Take away point

Given the looming 30 June 2011 deadline, trustees wishing to facilitate the continuation of broadly worded TPD covers for fund members will want to engage in urgent and open consultations with their insurer, select an option and act quickly. Each option demands innovative thinking.

It's time to think outside the square!

1 As the activities contemplated by these options would be conducted outside the operation of the superannuation fund, the question of compliance with the "sole purpose" test in section 62 of the Superannuation Industry (Supervision) Act 1993 (Cth) does not arise.

2 At common law, the rule of privity of contract still applies to insurance contracts: Trident General Insurance Co Ltd v McNiece Bros Pty Ltd (1988) 165 CLR 107 per Brennan J at 127; Deane J at 143-4, 152; Dawson J at 158; and Gaudron J at 162. The Insurance Contracts Act 1984 (Cth) does not confer on the life insured a right to claim directly against the insurer for this kind of policy.

3 The characterisation of the "financial product" that the member acquires as a "life risk insurance product" is consistent with section 1012H of the Corporations Act 2001 (Cth).

4 Section 912A(1)(g) and (2).

5 Section 912B and Corporations Regulations 2001 (Cth), regulation 7.6.02AAA. See also Australian Securities and Investments Commission, Regulatory Guide 126: Compensation and insurance arrangements for AFS licensees (December 2010).

6 Section 1013A(1)(c). As the financial product is a life risk insurance product, the new "short and simple" PDS regime in Subdivision 4.2B of Part 7.9 of the Corporations Regulations that applies to superannuation products will not apply to it.

7 Section 1012H.

8 Section 941A(1).

9 Regulation 7.7.08A(3).

10 Section 1013B(3).

11 Regulations 7.6.01(e) and (ea).

12 In the case of public offer RSE licensees, general additional condition A.6(a). In the case of non-public offer RSE licensees, general additional condition A.4.

13 Section 912A (1)(c).

14 Section 1017E and the regulations made under that section.

15 Division 3 of Part 7.7.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.