Advisers need to be fully aware of the challenges that can come from disability income insurance in superannuation as it is possible for someone to have no benefits payable at all, Kelly Cox writes.
The benefits of holding life and total and permanent disability (TPD) cover inside super are well documented and relatively uncontroversial. The same cannot be said of disability income insurance (DII).
Superannuation regulations prohibit trustees taking new cover from 1 July 2014 which provide insured benefits that are not aligned with the conditions of release for death, terminal medical condition, permanent incapacity, or temporary incapacity.
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DII within superannuation is typically aligned with the temporary incapacity condition of release and the associated payment rules, which include:
The member has ceased to be gainfully employed because of temporary, physical or mental, ill-health. This can include where the member continues to be employed, but has temporarily ceased receiving remuneration from their employer; and
Any benefits must be paid as a non-commutable income stream for the purpose of continuing the remuneration the member was receiving before the temporary incapacity. The income stream can only be paid while the member is incapacitated.
The payment rules limit the range of benefits that can be offered under a DII policy held within super, compared to non-super DII policies. They can also present a number of challenges where cover is held solely within superannuation.
1. RANGE OF ADDITIONAL BENEFITS
DII policies available within superannuation generally cannot provide all the same benefits and features as policies available outside superannuation, including for example:
· Specific injury benefits: a specified medical event such as a fracture, or loss of sight in one eye; and
· Extra benefits: cover for home care, rehabilitation expenses, or trauma cover for specific medical conditions.
Superannuation law requires that temporary incapacity benefits can only be paid where gainful employment has ceased because of ill-health, which may be in conflict with policy benefits payable without a requirement to cease work.
Furthermore, temporary incapacity benefits must be paid as a non-commutable income stream, which consists of at least monthly payments, with payment variations limited to the lesser of the inflation rate or five per cent per annum. Additional benefits cannot be paid as a lump sum.
The temporary incapacity condition of release requires a member to have ceased to be gainfully employed because of their ill-health. Clients who are unemployed at the time of disability may have ceased their employment for a reason other than ill-health, for example because of a redundancy, a fixed term contract ending, or changing employers.
DII policies taken out within superannuation from 1 July 2014 typically include a requirement that the insured person was employed at the time of disability--if unemployed, no benefit would be payable.
Bill is an IT contractor who has been doing contract work for several years. After finishing one contract, and prior to securing his next contract, Bill becomes ill and is unable to work for several months. Bill's employment ceased because his contract ended, rather than because of his ill-health.
As the DII cover within Bill's super fund was taken out after 1 July 2014, Bill is required to be employed at the time his disability occurs for the insured benefit to be paid, so no benefits will be payable.
3. CONTINUING EMPLOYMENT ARRANGEMENT
For insured benefits to be paid under the temporary incapacity condition of release, superannuation law requires gainful employment to have ceased, at least temporarily, due to ill-health.
Fund members who are unable to work because of their illness or injury, but continue to be in paid employment, may also have difficulty accessing DII benefits where the policy is held within superannuation.
This may present a challenge for members who are still receiving some form of income from their employers, such as paid sick leave, or who have simply reduced their working hours because of their ill-health.
Superannuation law does not define the meaning of temporary cessation of employment, so different superannuation funds may have different policies on this issue. For example, some funds may require members subject to a continuing employment arrangement to take at least one day of unpaid leave as a result of their illness or injury before paying a benefit.
Melinda has accumulated a large amount of sick leave with her employer. She becomes severely injured and requires two months off work to recover. Melinda has enough sick leave to cover her entire absence.
Melinda returns to work after two months, but only works part-time because of her injury.
While Melinda has not been working, she has been on paid leave and is therefore unlikely to meet the superannuation law definition of temporary incapacity. Further, as the cover in Melinda's fund was established after 1 July 2014, the policy also requires Melinda to have ceased, at least temporarily, to receive remuneration from her employer.
4. FLUCTUATING INCOME
Superannuation temporary incapacity benefits must be paid as a non-commutable income stream which continues the ‘gain or reward the member was receiving before the temporary incapacity'. The benefit paid cannot exceed the income being received prior to illness or injury--their ‘pre-disability income'. Fund members with fluctuating income could be disadvantaged if disabled when their income is low.
As there is no guidance on the period over which pre-disability income should be measured, the amount of benefit payable may depend on the particular fund's interpretation of pre-disability income. Some funds use the average of monthly income received over the 12 months prior to the disability, whereas other funds use the potentially more generous, highest average income for any 12 month period in the 36 months prior to the disability.
Robert is a self-employed builder. His income varies depending on how much work he can source. This year his income is around $90,000 ($7,500 per month), but in the prior two years it was $120,000 ($10,000 per month) and $150,000 ($12,500 per month).
Robert has DII within his superannuation fund. He would like to know if the temporary incapacity benefits potentially payable from his fund will be impacted by his lower income in the current year.
The fund uses his highest average income for any 12 months in the 36 months prior to disability to determine the claimable income. So the maximum benefit payable by the fund will be $12,500 per month.
However, if Robert's fund used a narrower definition, such as average monthly income in the 12 months prior to disability, only $7,500 per month would be used to determine the maximum temporary incapacity benefit payable.
5. PERMANENT INCAPACITY
For DII benefits within superannuation to be paid under the temporary incapacity condition of release, the member must have ceased to be gainfully employed because of their ill-health, but the ill-health must not constitute permanent incapacity.
The superannuation law states that permanent incapacity occurs if the trustee of the fund is satisfied that, because of the member's ill-health, they are unlikely to engage in gainful employment for which they are reasonably qualified by education, training, or experience.
Those members who are permanently incapacitated at the time of the fund's assessment cannot meet the requirements for temporary incapacity, and a temporary incapacity benefit cannot be paid.
However, if the member meets another condition of release, such as permanent incapacity, it may be possible for DII benefits (paid into the fund by the insurer) to be paid out of the fund as a permanent incapacity or other benefit.
There is also conjecture whether a superannuation fund can continue to pay a temporary incapacity benefit to a member who becomes permanently incapacitated, after meeting an initial assessment for temporary incapacity. If a fund held the view that temporary incapacity benefits had to cease upon a member becoming permanently incapacitated, the member would need to satisfy another condition of release in order to continue receiving their DII benefits.
PRE 1 JULY 2014 COVER
The requirement for insured benefits to be aligned with a condition of release applies to cover established within superannuation from 1 July 2014. DII cover taken out before this date is generally not subject to the same restrictions as cover established on or after 1 July 2014. Furthermore, the level of cover for a pre-1 July 2014 policy can be increased or decreased on or after 1 July 2014.
However, where a pre-1 July 2014 policy provides a benefit that falls outside of the temporary incapacity condition of release (for example a claim can be paid where the insured is unemployed at the time of disability), there is a risk that the trustee will be unable to release the insurance proceeds to the member. In this situation, the insured benefits will be held within the member's superannuation fund until a condition of release is met.
While there are some advantages (including cash flow) to holding DII within superannuation, it is important financial services professionals are aware of the challenges that can arise. The superannuation law requirements generally mean that DII cover available inside super is basic in terms of the options available.
Furthermore, benefits payable may be limited, and in the worst case scenario (eg for someone who is unemployed) no benefits may be payable at all.
One way of overcoming these challenges is to take DII cover outside of superannuation. Alternatively, consideration should be given to split cover arrangements, where part of the cover is held inside superannuation with the remainder held outside superannuation.
Kelly Cox is the senior manager at Macquarie Technical Services
Read more at http://www.moneymanagement.com.au/features/tools-guides/%E2%80%98dii-super%E2%80%99-challenges#.VwcHIAyF9MA.twitter