Clients with fluctuating levels of income possibly lost the most from the removal of new agreed value income protection (IP) contracts earlier this year. 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 next year.
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.
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. Effectively building 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.
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.
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.
This article is for financial adviser use only.
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