Considering the risks of trauma in super

Finding the right structure for insurance cover is critical to ensure that the right amount is paid to the right people at the right time. When insurance cover is structured in super, two considerations need to be considered that are not relevant in other structures:

• Will my clients be able to satisfy the trustee of the fund that they meet a superannuation condition of release? And,
• What tax will be payable on the benefit?

Claim time is when you most want the cover you recommended to deliver against that promise, so getting it right is critical.

Structuring trauma cover in super throws up another hurdle, as there is no natural connection between the policy definition and the superannuation conditions of release - unlike the connection between Income Protection cover and the ‘temporary incapacity’ test in super.
 

Tom Gordon

National Technical Sales Manager - Product

Copyright © 2013 AIA Australia Limited (ABN 79 004 837 861 AFSL 230043). All rights reserved. This information is intended for financial advisers only and is not for wider distribution. This information is current at the date of distribution and is subject to change. This is general information in summary only, without taking into account the objectives, financial situation, needs or personal circumstances of any individual, and may not be exhaustive. It is not intended as financial, legal, medical or other advice.

Summary

As you can see, there is no certainty that the client will be able to access the benefit even if the insurer pays the claim. The option for younger clients is even more limited as they are restricted to accessing it via the ‘temporary incapacity’ or ‘permanent incapacity’ test only.

Consider a scenario where a client is paid a trauma benefit because of an early stage diagnosis for prostate cancer. The client has never ceased work and where the doctor has not recommended surgery. This would not meet either of the above conditions.  

Consider the implications of how the benefit will be taxed. While those aged 55+ have greater flexibility to access the benefit, the tax consequences of these options should be considered.

Structuring insurance in super means looking beyond the cash flow benefits and/or the tax deductibility and considering:

- Whether the benefit can be released by the fund trustee when the insurer pays the claim, and
- Whether tax is payable and if the sum insured should be grossed up to compensate.

From July 2014, the Government’s Stronger Super reforms will only allow trustees to offer insured benefits which align with one of four conditions of release – death, terminal medical condition, permanent incapacity or temporary incapacity.  This will limit the ability to structure new trauma policies in super after this date.

[1] Based on the ATO’s proportioning rule for disability lump sum payments.

[2] Includes Medicare levy.

Meeting a condition of release

If the claim meets the trauma policy definition, the insurer would pay the benefit to the trustee. The trustee must also be satisfied that the payment meets a superannuation ‘condition of release’ for the benefit to be paid to the claimant. There is no ‘condition’ that specifically deals with trauma, however it could be released under one or more other conditions:

• Can the client satisfy the ‘temporary incapacity’ condition (e.g. ceased work due to illness or injury but the disablement is temporary), or
• Can the client satisfy the ‘permanent incapacity’ definition (e.g. the client is unlikely ever to work again in any occupation for which they are reasonably qualified by education, training or experience).

If they can’t, what other condition could they meet? 

The client could apply under ‘Severe Financial Hardship’, however the maximum benefit is limited to $10,000 per year and the application process can be onerous.

If the client is aged 55 or older they have more options:

• They could declare that they have ‘permanently retired’ and can then access their full super benefit including the trauma payment, or
• They could start up a ‘transition to retirement’ (TTR) pension and draw down a maximum of 10% of their super each year.

However, that relies on the client not making a claim before turning 55 or not needing access to the money until they turn 55, which is not the sort of bet you’d want to take odds on.

Taxation considerations

How the payment is taxed will depend on which conditions of release they meet and how the client elects to receive the payment:

a. If paid as an income stream (i.e. met the ‘temporary incapacity’ condition) then any payments are taxed as income at their marginal tax rate.
b. If paid as a disability lump sum (i.e. met the ‘permanent incapacity’ condition) then some of the benefit will be deemed tax free and the rest taxable[1]. The taxable component is taxed at up to 21.5%[2], depending on age.
c. If paid as a ‘retirement’ lump sum (i.e. has ‘permanently retired’) then the whole benefit is deemed to be in the taxable component and will be taxed at up to 21.5%, depending on age.