Aim: identify the types of risk that can occur and consider a systematic approach that can be used

to manage those risks.

7.1: Risk and risk management process

Two types of risk: Speculative and pure
Speculative arises where there is a chance of a loss or a gain.

Pure risk arises where there is only a possibility of loss or no loss.

Pure risk can be categorised as:

 Personal- matters affect the personal

 Property- loss or damage to property
 Liability- losses suffered as a result of a legal accountability incurred
Risk management: is a brunch of management which provides a systematic approach to the
management of pure risk.

Risk management process:

7.2: Key concepts in insurance
The pooling of risk (principal of insurance) risk
Insurance is based on the principle of pooling risk where individuals contribute resources to a fund
that is used to pay for the adverse consequences suffered by some members of the pool.

Risk pooling is based on the principle that individuals that face similar risks, for example the risk of
the house being burnt down, all contribute to a common pool via insurance premiums

Premium: contribution to the pool

Underwriting: Separating the pool into risk categories and charging different premiums.

Selectively reducing the size of the pool can reduce the average risk profile of the fund but there is a
limit to how small the pool can be reduced to. smaller the pool the less confidence actuaries 保险计
算 员 will have in determining the likely commitments of the fund. As a result, premiums would
eventually have to rise to reflect that uncertainty.

Reducing the size of the pool to reduce the average risk profile of the fund also raises issues of
equity. (道德观)

The insurance marketplace (Participants)

3 types of insurers:

 Life insurers provide a range of risk and investment products: Risk products include
those where a benefit is paid in the event of death or disablement of the person
insured. Life insurance products are examples of non-indemnity type products; that
is, the amount paid out by the insurer does not necessarily relate to the actual loss
incurred.TP
 General insurers provide risk products. policies cover all types of risks, including
disability risks but excluding life covers. property, such as car, home and Contents,
landlord insurance and also liability risks such as professional indemnity and product liability
should their advice or product harm their clients/customer
 Health insurers provide hospital and medical benefits cover.
Intermediaries:

agents and brokers who arrange insurances for a client. The agent is the insurer’s representative
whose function is to arrange covers for clients with the insurer.

Clients:

The Insurance Contracts Act 1984 governs practice in the insurance market and provides protection
to the client. The Act states that its purpose is to reform and modernise the law in relation to
insurance contracts so that a fair balance is struck between those insured and insurers, and that
policy provisions and insurers’ practices operate fairly.
 Regulators:

insurance industry is controlled by two main regulators:

1. the Australian Prudential Regulation Authority (APRA); and

2. the Australian Securities and Investments Commission (ASIC).
APRA overseas the management of the life insurance organisation to ensure that it is financially
viable and can pay claims that it’s customers may make. ASIC is consumer orientated and will
champion for consumers to access advice and products that they deserve.

ASIC deals with consumer-oriented matters and APRA handles prudential regulation.

Insurance policies and the principle of utmost good faith

fundamental feature of an insurance policy is that it is a contract between the insurer and the
insured. The contract relies on the principle of each party entering the agreement with the utmost
good faith.

Section 13 of the Insurance Contracts Act states that: highest degree of honesty is imposed on both
parties to the insurance contract

there is a duty of disclosure on the applicant to disclose to the insurer all the material facts that
would influence a reasonable and prudent insurer in accepting a risk or in setting a premium given
those particular facts. The duty of disclosure exists during the negotiations and up to the time when
a binding contract of insurance is concluded.

duty of disclosure requires the applicant to disclose all material facts except:

it may reasonably be presumed are known to the insurer

ainst

lly ascertain
s by reason of an express or implied warranty in the policy which covers the circumstances
to have constructive knowledge (e.g. facts the insurer would have discovered in its ordinary course of

Misrepresentation: occurs when an inaccurate or untrue statement is made by the insured or the
insured’s agent prior to the conclusion of the contract.

Two types of misrepresentation are recognised:

1. innocent misrepresentation — where the statement is inaccurate but made without

fraudulent intent
2. fraudulent misrepresentation — where the statement was inaccurate but made
knowingly, believing it to be untrue, or where the statement was made recklessly
Terms, standard terms and severity limitations (of insurance contract)
An insurer is able to limit or exclude their liability which would otherwise be provided under
standard cover provided they clearly inform the consumer that such cover is limited or excluded.

Generally the inclusion in a product disclosure statement (PDS) that the level of standard cover has
been modified is seen as sufficient notification notwithstanding the fact that PDS documents are
often long, complicated and unread by the consumer.

Insurers may also seek to limit their liability through the use of severity limitations such as the use of
policy excesses and waiting periods.

7.3 Life, disability, trauma and health risks (Personal risk)

Identification of personal risk
following areas need to be considered in the scope of personal risk: premature death, prolonged
illness or injury, medical costs and business risks.

Premature death (life insurance)

The effects of a premature death will vary according to a person’s responsibilities as far as
dependants are concerned. A dependant is a person who relies on another, financially, emotionally
or in some other capacity.

Prolonged illness or injury (TPD for permanent and Income for temporary)
illnesses of short duration, most people are able to call on existing resources and not suffer any
significant fall in their standard of living. longer duration, the living standard can be affected

Medical cost
Medical costs can vary considerably, depending on the injury or illness suffered

Business risks
several risks for business, and these need to be recognised and provided for:

• Partnership
• Key employee
• Business loans.
Evaluation of personal risk
In establishing an adequate sum insured, 3 things need to be considered:

1. A lump sum amount to meet costs at the time of premature death of the income
earner.
2. A provision to meet the needs of dependants for the period of their dependency
after premature death of the income earner.
3. A provision to meet the needs of dependants and the income earner in the event of
disablement of the income earner.
Lump sum cost

At the time of death a number of expenses may arise, and provision needs to be made to meet these
costs.

The more common items are:

• burial and associated expenses

• estate administration costs
• legal expenses
• taxes (e.g. death is a trigger to incur capital gains tax)
• final medical and associated care expenses:
hospital and medical expenses covered under a health insurance policy will not
always cover all costs.
• debt clearing:
repayment of debts and associated interest places an additional strain on the
dependant’s income.
• adjustment expenses
Provision for dependants

discussion has related to providing for lump sum amounts that usually need to be met at the time of
death. Provision must also be made for the needs of dependants

Two approaches are commonly used to calculate this amount —

1. the multiple approach

 at times is used to calculate the entire amount of cover.
 multiple approach simply seeks to replace the insured’s income by providing
an amount that, when invested, will produce for the dependants the amount
of income the insured was earning.
 Downfall: It assumes everyone’s situation is the same and does not consider
the circumstances of the individual (ignores the individual’s resources and
commitments, and relies on investment rates in the future being similar to
those applying at the time the sum insured is calculated)
 Ignore effect of inflation

2. the needs approach.

 (amt needed to maintain standard of living -resources dependents have for
meeting those needs= Amount life insurance needed)
 requires a more detailed analysis, including the compilation of a budget of
the costs that would be incurred in the future.
 necessary to recalculate the figures periodically to check that the amount
remains adequate.
 Keep in mind that what is being calculated is the provision to be made for the
dependants.
 This section has considered the provision of an income for the dependants.
The amount provided will not be needed immediately so most of it can be
invested, generating further income. This will be necessary as the buying
power of the lump sum amount will be eroded over time with inflation.
Example of multiple and needs approach
Disablement

if the income earner becomes disabled and unable to work, a similar problem arises but this time
with the added need to provide for the income earner.

The costs that need to be met will vary but can include the following:

 Medical expenses. If health insurance is in place, much of the cost may be met but
policies do not cover all areas. There may, for example, be a need for specialised
nursing that goes beyond the amounts provided by health insurance.
 Other costs associated with the disability. These may include the need for house
alterations, the provision of prostheses, and the purchase of wheelchairs and other
aids.
 Provision of an income to support the dependants. This will differ from the
calculation for death, as provision will need to be made for the income earner.
elimination of debts must be included in the calculation of a sum insured as these will place a drain
on the income. An amount to provide immediate funds to help during the adjustment period should
also be included.

Two covers can meet these costs:

3. A total and permanent disablement (TPD) extension on a term life insurance policy
will meet the lump sum amounts, and
4. an income protection policy can provide a regular monthly income.
Control measures for personal risks
Control measures look at what can be done to eliminate the occurrence of risks or to reduce the
impact should the risk occur. In relation to personal risks, these measures are mainly lifestyle
matters, such as keeping fit, eating sensibly and avoiding risk factors such as smoking and drinking
too much.
Financing of personal risk
despite the control measures, a loss occurs, then provision needs to be made for the financing of
those losses. These losses can be financed by retention or transfer.

Retention

With retention, losses are met from an individual’s own resources

Transfer

Transfer of risks involves passing financial responsibility for the loss to another party. The main form
of transfer is by insurance.

*In return for a premium, the insurer agrees to meet the cost of certain specified risks. In relation
to personal risks, the policies used are term life policies, disability policies and health policies.
Term life insurance policies provide a lump sum amount in the event of death, TPD and specified
traumas. Income-replacement policies provide a monthly income in the event of disability, even if
itis temporary.

Term life policies

 term life policy was the original form of life policy. It paid the nominated death
benefit when the person whose life was insured died during the period of insurance.
 offered today usually includes a terminal illness benefit as part of the basic cover.
terminal illness benefit provides that, in the event of the insured person being
diagnosed with an illness or disease or sustaining an injury which is likely to lead to
death within 12 months, the specified lump-sum benefit is payable.
Policy features of term life: basic term life policy has, over time, developed a number of features
designed to make it more attractive to clients. Eg. found in most policies:

1. Indexed sum insured. It is usual for policies to have the sum insured indexed so the
insured has the option of an increase in the sum insured each year. The advantage of
these increases is that they are automatic and do not need a medical examination.
2. Special sum insured increase. Another benefit often found in policies is a provision
that allows for an increase in the sum insured at other times, again without the need
for a medical check. The ability to do this arises at the occurrence of certain specified
events, such as marriage of the insured, the birth of a child or taking out a mortgage
3. Guaranteed renewal. This provision means the policy will remain in force
continuously, subject to any specified age limit, with the insured only having the
right to terminate the policy.
4. Multiple lives. Most insurers will allow more than one life to be covered under the
one policy.
5. Policy duration: 1 day to a term that continues until the insured turns 95 years.
 6. Premiums
Two types of premiums

 Stepped premiums. These are calculated annually and rise each year in accordance
with the increased death risk that results as the insured gets older. Level premiums.
Stepped premiums are good if the cover is needed for only a small number of years.
The problem with a stepped premium is that, if the insurance is needed for a long
period of time, the premiums will rise each year in accordance with the increased
risk of death (as seen in table 7.2)
 Level premium. The cost of the premium is averaged over the lifetime of the policy.
early years, the amounts paid will be greater than the stepped premium for the
same year, but in the later years the amount payable will be less. amount paid in
excess of the ‘death risk’ amount in the early years is invested and the interest along
with the surplus is used to supplement the amount paid in the later years, so the full
risk premium is still received by the insurer.
Convertibility from one type of premium to another: There is generally a provision that allows you
to convert the policy to any other type of policy with the insurer so long as the sum insured is the
same. No medical examination is needed. This can be done at any time to age 95

Policy exclusion: term life policy, the exclusions are few. For example,

 most term life insurance policies will exclude suicide for the first 13 months of
insurance coverage
 Terminal illness. Cover is not provided where the terminal illness is a result of an
intentional self-inflicted injury or disease.
Policy ownership:

A term life policy can be in the name of:

• the life insured

• the life insured but with a beneficiary nominated for the proceeds to be paid to
• a person or company on the life of the person insured.
Disability policies from life insurers
• total and permanent disablement insurance (TPD)
benefit provides that, in the event of the person insured becoming totally and
permanently disabled, the policy will pay the nominated amount. On payment of a
TPD benefit, the remaining amount of cover is reduced by the amount of the benefit.
The definition of total and permanent disablement is the critical aspect of the cover,
and the policy definition needs to be considered carefully. Not all policies are the
same and some are quite restrictive.
• trauma insurance
purpose of trauma cover is to provide a lump sum in the event of the diagnosis of
any of the listed traumas. The cover can be purchased as an extension of a term life
policy or as a stand-alone policy. The trauma cover is generally offered in two forms
— basic trauma cover includes a few traumas only; broader trauma cover provides a
more extensive list.

Eg.
1) cancer — malignant tumours
2) heart attack
3) coronary artery surgery
4) stroke
5) terminal illness.

Some benefits require qualifying periods, that is, the policy will not apply if the
condition becomes apparent within 90 days of the commencement of the policy.

The benefits under the cover are usually indexed to the consumer price index (CPI)
subject to a ceiling, which is usually set at around 5%. Cover is generally available
from age 15 to 65, on renewal to 70. Premium payment can be stepped or level.
Trauma policies generally exclude suicide within 13 months of the policy
commencement, intentional self-injury or intentional infection, and trauma from war
or civil commotion.
• Combined term life, trauma and TPD policies
Life insurance, trauma insurance and TPD insurance can each be taken out as stand-
alone (un-bundled) policies. TPD insurance is frequently included as an additional
benefit within a life insurance policy. additional benefit is sometimes referred to as
rider benefit. Combining two or more insurances into the one policy is generally
referred to as bundling
• income protection insurance
Income protection insurance, also known as salary continuance insurance or
disability income insurance, provides cover in the event of the insured being unable
to work as a result of accident or sickness. The benefit ofindion depends on your
annual salary, waiting period before receiving the benefit and the duration of the
benefit payment.
 Benefit of income protection policy:
This benefit can be an amount that is agreed on at the time the
policy is affected and is generally set at a maximum of 75% of
insured’s pre-diasbility income . Alternatively, the benefit
amount can be equivalent to an indemnity value.

Benefit period: length of time the insurer will pay the benefit for

Partial disablement: With rehabilitation, an insured person may be able to return to

partial duties some time before a full recovery is made. Most policies recognise this
position and provide a partial benefit in this event. FOR EG.

• business overheads insurance.

This cover is a variation of the income protection policy.

policy provides cover for eligible business overheads that accrue while the insured
person is incapacitated, less any income received during that period. Amount payable,
however, cannot exceed the monthly benefit figure nominated by the insured when the policy was
taken out.

policy defines eligible business overheads as recurring costs incurred in the normal
day-to-day running of the business, such as electricity, rent and lease costs.

Amount paid is not the benefit stated in the policy. The benefit stated represents the
maximum amount payable. The amount paid is the total of the eligible expenses that
accrue in that month. Cover can be obtained for 100% of the eligible expenses. Unlike the
income protection policy, the benefits under this policy are paid only while the insured person is
unable to work — no partial benefit is available.

Business overheads insurance seeks to protect the revenue of the business. Since the policy is for a
revenue purpose, the premium will be tax deductible for the business; however, this also means that
any payout from the policy will be taxable.
Health insurance policies

Two types of health insurance:

public system (Medicare) is available to all Australian residents. In addition to Medicare, there is
private health insurance. This is available only to those who purchase insurance from a licensed
health insurer.

Medicare

Medicare provides free treatment as a public patient in a public hospital and subsidised treatment
by health professionals such as doctors, specialists and optometrists for certain services

Medicare provides a range of medical and hospital benefits (patient is attended by doctors and
specialists nominated by the hospital. Most of the cost is met by Medicare).

benefit paid by Medicare is 85% of the schedule fee. The remaining 15% is met by the patient. Note
that many doctors charge an amount greater than the schedule fee. In those cases, patients must
bear the cost of the excess themselves.

Medicare is paid for by way of a levy on income and it is collected with a person’s income tax.

Private health insurance

Private health insurance provides greater flexibility in where and by whom a person is treated.

With private health insurance, patients are able to choose the hospital to be treated in and the
specialist who will provide the treatment. In addition, they have access to private wards and, if
available, individual rooms.

ISSUES: Private health insurance is not cheap.

the people who withdrew were now using Medicare and the increased numbers were causing a
strain on the public health system.

SOLUTION: Once the participation rate for private health insurance dropped to 30%, the government
stepped in with measures aimed at stalling this drop.

Three measures were introduced:

1) the health insurance rebate

2) Medicare levy surcharge (additional surcharge on top of % charge)and
3) premium loading.
*Medicare levy surcharge is in addition to the 2% Medicare levy. The surcharge is applied to people
without private health insurance who earn a high income.
Government initiative due to fewer people subscribe private health insurance:

1) medicare levy surcharge

2) Rebate on private health insurance
3) Lifetime health initiative increases the premium payable by 2 percent for each year
after age 30.

Financing/ Arranging of personal risk management through

superannuation fund
Some personal risk insurance policies, such as term life insurance, can be arranged via the
individual’s superannuation fund and paid out of pre-tax dollars rather than after-tax dollars.

(Sacrifice part of superannuation funds to hold a term life insurance)

Group underwriting
Insurance policies can be either:

1) individually underwritten or
2) underwritten as a group. A group policy occurs when individuals who have a specific
relationship with each other are collectively underwritten
In underwriting a group policy, the insurer calculates the group’s characteristics and sets premiums
accordingly. Group insurance does not consider the risk associated with particular individuals and, as
such, it is a useful means by which individuals with particular health risks can achieve cover at a
reasonable price.

Insurer attempts to manage this risk by insisting on the following:

1) A minimum rate of acceptance

2) Acceptance within a set time
3) The amount of insurance is fixed
7.4 Housing and contents risk management (general insurance)
Financing measures for house and contents risks

Two types of policies are available in the marketplace.

1. replacement value policy (more common)

2. Indemnity value policy
Replacement value policy (often referred to as a new for old policy):

In the event of a loss, this cover provides new items to replace those lost or destroyed, even though
the items lost may be several years old.

In arriving at a sum insured under the replacement value cover, the property covered by the policy
needs to be included at its replacement value price.

Necessary to do a detailed calculation to arrive at an adequate sum insured, as housing may

depreciate. (Building usually land not damage)

EG. Contents that were purchased some years ago for $50 000 may well have a replacement value
today of $100 000. There is no shortcut to the calculation — it is necessary to go through the house
room by room and calculate the total value.

When considering policies, you must be aware that some policies incorporate a co-insurance
clause (or average clause). The purpose of this clause is to penalise policyholders if they fail to
insure for the full value of the property. The use by insurers of this clause is diminishing — many are
electing not to include it in their policies. Where it is used, the effect of this clause is to reduce the
amount of the loss in proportion to the amount of underinsurance

UNDERINSURANCE EXAMPLE:

Calculation made on only 80% of the full value

The application of the clause is shown in the case where a house, the full value of which is $300 000,
is insured for only $160 000, but the partial damage amounts to $150 000. The calculation is as
follows.

The insurance company would cover only $100 000 of the $150 000 loss, leaving the owners of the
house with an amount of $50 000 to cover from their own resources.

*Keep in mind that many insurers do not use this clause so check the policy before taking it out.
indemnity value policy:

This cover, which was the original type of cover, pays only the value of the property at the time of
the loss — depreciation is considered. Generally indemnity value of a building is less than the
replacement value.

House and contents insurance

Three types of policies used in the area of house and contents insurance:

1. policy that covers all risks of loss or damage. Its cover is very broad, and the
premium is more expensive.
2. A policy with listed perils to be covered. The following are included in most covers:
a. fire
b. explosion
c. lightning or thunderbolt
d. earthquake
e. theft
f. vandalism
g. water or other liquid
h. falling trees, branches or aerials
i. damage by animals
j. riot
k. storm, rain or flash flood
l. glass breakage.
3. A policy that provides a cover for all risks of loss or damage in relation to valuables
only. his cover is taken in conjunction with the listed perils policy where a broader
cover is required for property at and away from the premises.

7.5 Motor vehicle risk management (general insurance)

There are two types of motor vehicle risks:

4. damage to the vehicle itself and

5. loss or damage to third parties or their property.
Control measures and financing for motor vehicle risks:

Control measures involve fitting the vehicle with a car alarm and undertaking advanced driving
courses to improve vehicle handling skills. Financing measures are mainly through the use of
insurance policies. Retention would be considered in relation to small losses only; this can be
achieved by taking an excess on the motor policy.

Types of motor vehicle insurance policies

There are four main types of motor vehicle insurance policies:

1. Compulsory third party (CTP) insurance, as its name implies is compulsory by law.
2. Comprehensive motor insurance (CMI), not compulsory
3. fire, theft and third-party property damage insurance (FTTPPD) not compulsory
4. third-party property only (TPPO) not compulsory
INTRO:

social security system in Australia:

 is the means by which the government provides a level of care and assistance to
people in society who need help.
 Redistribute income in the population by raising income taxes and providing benefits
to those in needs.
The government provide basic income support payments to eligible person for:

 Retirement
 Unemployment
 Disability
*Centrelink administers these programs.

ty(10.3) Types of Social security benefits (payments)

(10.4) Pension and allowance benefit eligibility rules
(requirements)
Residenti al requirement

To qualify for a social security pension, a person must be a permanent resident by being:

 an Australian resident for at least 10 years with more than 5 years of continuous
residence, with the exception of refugees
 in Australia at the time of applying.
 Australian resident residing outside of Australia, in a country with which Australia
has entered into an international social security agreement, may still be eligible for
payment.
Means testi ng

Most Social security pensions are subject to a means test to ensure they are paid only to people
most in need. The means test is based on a person’s assets and their income.

(10.5) Age pension (assistance provided to retirees)

Age eligibility for age pension

Pension you will receive is based on your income

(10.6) Means test (determine pension) asset and income test

In order to determine how much benefit is paid to an applicant, a means testing system is generally
used.

Means testing regime considers both an asset test and an income test subject to some important
exceptions. Each test comprises a threshold level and an upper limit with a shade-out zone between
these levels.

Principal rules for assets and incomes tests are as follows:

 Both tests are applied to pension application. Asset and/or income levels that
exceed a lower threshold reduce the level of pension payment. The test on assets or
income that produces the lower benefit is ultimately applied.
 Both tests are applied to allowance applications. Under the assets test, the lower
threshold is a cut-out point which causes the payment to be decreased to zero. No
allowance is payable where the person’s holding of assets exceeds this lower
threshold.
 Some other types of payments are not means tested or are not subject to the
assets test (e.g. family tax benefit).
Assessable assets for assets test

1. Financial assets
 Including cash, bank accounts, listed shares and securities, managed investments
and loans to family members.
 Superannuation investment if not under pension age
 Surrender value of life insurance policies
2. Real estate, including holiday homes
3. Business and farms
4. Gifts above $10000 per income year
5. Market value of personal items and house contents
 Such as clothing, hobby collections, printings, art and electrical appliances (not
fixture eg. stove)
 Motor vehicles
6. Exclude family home and some complying income streams. (Principle home will be
excluded as well)
7. Once a person reaches age-pension age, the account balance under both a
superannuation and account-based pension account is treated as an assessable
asset.
Assets test thresholds

If a single homeowner owns more than $268000 of sum of assets other than family own, it starts to
reduce the age pension entitlement for $3 per thousand and age pension will be $0 when it reached
$585750.

If you don’t get a home, you will have another 200000 extra limit.

Income test (assessable income for social security purposes includes):

 Gross income from wages and salaries

 Income from carrying on a business
 Net rental income and total losses from rental property
 Long term income derived from income stream products
 Deemed income earned from financial assets. (Assets you owned but didn’t earn
anything from that)
Income test thresholds

Deeming rates for fi nancial investments

Deeming rate is when values of all financial assets are added together, and it is assumed that they
earn certain set rates of return.

Bank accounts, shares, managed funds and short-term income streams, gift>10k, etc.

But not superannuation or real assets such as investment properties.

To discourage the practice of pensioners holding large sums in low-earning accounts, such as cheque
accounts, in order to minimise assessable income and thus maximise pension payments, the
government introduced deeming provisions

Deeming provisions apply predetermined rates of return on all financial investments held by a
pensioner to determine assessable income regardless of the actual return generated

People are free to invest their money wherever they like, but they have an incentive to invest in
assets which earn at least the deeming rates. Any return earned above the deeming rates is non-
assessable.

If you own less than $53000 as a single, your prescribe deeming rate would be 0.25%. If you earn
more than $53000 as a single your deeming rate would be 2.25%.
Strategies to increase age pension entitlement (221/236)
(8.1) Superannuation intro (What is superannuation)

Money and assets can enter the superannuation environment by being contributed or transferred
into a superannuation fund. money is contributed to superannuation it needs to be invested to
generate earnings for the member

Contributions to superannuation and earnings from the investments inside superannuation are
subject to tax.

What is superannuati on?

Superannuation is a vehicle of saving and investing to accumulate and generate wealth to fund
retirement, usually in the form of a retirement income stream.

Retirement funding does not, however, have to be formalised via superannuation — many
individuals make saving and investment decisions outside the superannuation environment as a way
of building wealth for retirement.

(8.2) Three pillar policy of superannuation

The key aspect of Australia’s superannuation system, which does have bipartisan support:

• Tier 1 — a taxpayer funded social security pension (a safety net) that is means tested. (Age
pension)

• Tier 2 — compulsory employer contributions to superannuation for employees. (Occupational

based superannuation contribution)

 Superannuation guarantee
• Tier 3 — tax incentives for voluntary contributions to superannuation. (Personal superannuation
contribution)

Basic structure of Australia’s three pillar system ensures clear direction and any proposal for change
must still be based on the three pillars.

Superannuation system
 A long-term saving plan that is designed to provide income support for people after
retirement.
 Investment enjoys significant tax benefits:
a. Reduce the dependency on social security for retirement support
b. Aging population
c. Declining rate of saving of general population
 Restrictions on access the funds
Not a separate invest option: Similar option as investment outside super.
Three stages of superannuation
(8.4) types of superannuation benefits
Defi ned benefi ts funds/ scheme (Uncommon to be available now)

 Under these schemes, contributions are made by an employer into a pooled fund
which is designed to cover the predetermined entitlements accruing to members.
 These schemes can require the employee, as part of their industrial award or
agreement, to contribute a percentage of their pre-tax income to the scheme.
 Highly diverse products and require substantial research before advice
 Investment risk is absorbed by the fund (eg.by employer)
 Superannuation pay-out based on formula
eg. ‘final average salary’ multiplied by a ‘factor’ multiplied by the number of
years worked with that employer.

Accumulati on Funds/account (almost all new plans)

 Investment risk is absorbed by fund members (negative investment returns reduce

the balance of the individual’s accumulation account)
 Contributions by an individual’s employer and the individual’s own personal
contributions increase the balance of their accumulation account.
 positive investment returns of the superannuation fund’s underlying investment
assets also increase the individual’s balance.
(8.3) Regulations and regulators of superannuation in Australia
Income Tax Assessment Act 1997

 Provides tax incentives to save for retirement

Superannuati on Industry (Supervision) Act (SIS Act) 1993

 Regulates the administration of superannuation funds

 Requiring superannuation funds to have a ‘prudential framework’
 Restricting funds from investing in particular areas
 Ensuring members are notified about the benefits
 Requiring trustees to ensure the security of funds
Corporati on Act 2001

 Regulates the companies that operate the superannuation funds

 Disclosure
 Product disclosure statement
 Licensing
 Financial product advisor
 Etc.
Regulators

Four bodies are primarily charged with the regulation and control of the superannuation industry:

 APRA
 The superannuation fund industry
 ATO
 Self-managed superannuation fund
 ASIC
 The fund management industry
 Australian Financial Complaints Authority (AFCA)
 Financial products and industry complaints (including what used be dealt with by
the superannuation complaints tribunal)
conditions of release for access to superannuation benefits
 reaches age 65, regardless of their work status
 reaches age 60 and changes their employer
 reaches their preservation age (explained below) and permanently retires
 reaches their preservation age and continues to work, but is limited to accessing a
retirement income stream rather than the total benefit
 dies (at any age) and their super benefit is paid to their beneficiaries/estate
 has a terminal illness (at any age) where the prognosis is less than 24 months of life
 is permanently incapacitated (at any age) with a diagnosis of being unlikely to ever work
again.
conditions of release that are not as common and these include:

 temporary incapacity (at any age), but access is limited to an income stream
 a temporary resident’s permanent departure from Australia
 severe financial hardship, and access is limited to a lump sum of $10 000
 compassionate grounds, and access is limited to paying some personal expenses
 the first home super saver scheme (FHSS), and access is limited to $30 000.
(8.4) Types of superannuation funds
MYSUPER (Cooper’s review)

Operational requirements of funds

(8.6) Superannuation contributions. Work test
INTRO

Before discussing concessional and non-concessional contributions it should be noted that there are
several conditions placed on these contributions, such as:

 the age of the contributor

 their work status
 the respective contribution caps
 the total superannuation balance cap.
Age on who can make contributi on (age restricti ons on accepti ng contributi ons)

FROM LECTURE SLIDES

(SUFFICIENT)

WORK TEST

 for individual aged 65 over to make voluntary super contribution.

 work test is that an individual must be in gainful employment (i.e. paid work)
working for at least 40 hours in a period of no more than 30 consecutive days in that
financial year in which the contribution is made.
  work test exemption for individuals aged 65 to 74, providing that the individual’s
total superannuation balance is less than $300 000.

superannuation voluntary contributions?

A voluntary contribution is money that you add to your super from your after-tax income or other
money that you can invest.

(8.6) Concessional contribution to superannuation and

contribution cap table
A concessional contribution to superannuation is a contribution for which a tax deduction has been
claimed, by either an employer or the individual themselves (contribution made using before tax
dollar). When a superannuation fund receives a concessional contribution, it deducts 15%
contribution tax.

 Contribution cap ($25,000 per annual)

 Contributions above the cap are included in your assessable income and
taxed at the person’s marginal tax rate
 Contribution tax
 Attracts 15% contribution tax up to the contribution cap if the income is
=/ less than $250k
 Div 293 tax: Additional 15% tax imposed on the lesser of the excess or the
concessional contributions (except excess contributions). Extra 15%
WHEN MORE THAN 250K (income +concessional contribution.)
Applicati on of Division 293 tax (Tax on high income earners)

additional Tax 15% based on amount>250k +15% contribution tax rate based on concessional
contributions

IF you get 25000 contributions per annual, you are actually receiving 85% of that which is $3750 of
the $25000. Net amount your account will be increase is 21250 not 25000. This is due to the 15%
contribution tax, this is different from reinvest income (income tax:15%). Contribution tax is once
only upfront on the capital amount. This is the contribution tax only at the beginning when you are
making concessional contribution.
Examples/Types of concessional contributi ons

 Superannuation guarantee scheme/ charge act

 Salary sacrifice
 Low-income superannuation tax offset (rebate)
Superannuation guarantee scheme/ charge act

Superannuation guarantee (SG) scheme is an arrangement whereby an employee is guaranteed that

their employer will make a minimum contribution to the employee’s superannuation fund.

At the moment is 10% superannuation guarantee.

Salary sacrifice

Employee may decide to sacrifice some

of their pre-tax salary as a contribution
to superannuation. The contribution is
a tax deduction for the employer, the
contribution is a concessional
contribution, and the individual must
ensure that they stay within the
concessional contribution cap

A decision to salary sacrifice is a trade-off between current consumption and future consumption
since superannuation is not likely to be accessible until retirement.

Contributi on cap (look at 17/18)

(8.6) Non concessional contribution (NCC) and total
superannuation balance
non-concessional contribution to superannuation is a contribution for which a tax deduction has not
been claimed. That is, individuals have taken their after-tax dollars and contributed the money to
superannuation.

NCC cap of $100 k per year

 Up to $300k in a year after application of the 3 year bring forward rule. ( Pay
300k every 3 years (Lump Sum))
0% contribution tax if:

 NCC is within the non-concessional contribution cap ($100k per annual); and
 Total superannuation balance is smaller than $1.6 million
Total superannuati on balance

Excess NCC attracts top marginal tax rate + Medicare levy. Eg. 47%

NCC Cap is below $1.6 mil for

0% contribution tax

T8.12 Transfer Balance Cap

[M2021 9.13]
What is the transfer balance cap? Why was
it introduced? What impact does it have on
an individual’s contribution strategies?

Answer
Similar to imposing a minimum pension
withdrawal on account-based pensions the
transfer balance cap restricts the amount of
superannuation that can be rolled over from
the taxable accumulation phase into the tax-
free pension phase. An individual may be discouraged from making additional contributions to superannuation, preferring to keep their
money outside of superannuation if they feel like they are not going to be able access the tax concessions on the total amounts
contributed to superannuation.

Rolling 5 years CC CAP Illustrati on example

On 2020-21 the maximum cap available is $25000 is due to the superannuation balance exceed
$500k.

3 years bring forward rule example

can only make a

total of $300k
through out 3
years

Yes, Paul has exceeded the NCC

cap(300k) with a total of ($370k)

Therefore a penalty (tax bill) of 49%

will be applicable on the $70000
excess amount
NCC: Spouse contribution tax offset and Superannuation co-
contribution
Spouse contributi on tax off set (typically for low-income earner) less att racti ve
because only 18%

government provides a tax offset for an individual who makes a non-concessional contribution into
the superannuation account of a low-income earning spouse (considered as legally married or de-
facto).

The offset is equal to 18%

If spouse has an income of $37000 and contribute $3000 the rebate he or she will get is
($3000*0.18=$540) when contributed to superannuation funds.

Another example:

The offset is payable on the lesser of 18% of:• $3000 reduced by every dollar the low-income spouse
earns in excess of $37 000, or

• the value of the spouse contributions.For example, Sue makes a non-concessional contribution of
$3000 on behalf of her spouse Carl. Carl earns $37 800 p.a. Sue will receive a tax offset of $396
(($540 − ($37 800 − $37 000)) × 0.18). If Sue had made a non-concessional contribution of $2000
instead, then she would receive a tax offset of $360 ($2000 × 0.18) and not $396 (($540 − ($37 800 −
$37 000)) × 0.18).

Superannuati on Co-contributi on (more att racti ve)

If you put $1000 into your own superannuation based on your saving and making less than $39837,
government will put in $500 into your superannuation.
Splitting contribution with a spouse
Superannuation overview
(9.2) T HREE PHASES OF RETIREMENT
1. Active phase
 Still work for part time, more time for pursuits previously constrained by
fulltime work
2. Passive phase
 No longer working in paid employment
 Hobby and sporting interests are less energetic
3. Support phase
 No longer able to care for themselves in their own home even with support
services

THREE TYPES OF FUNDING FOR RETIREMENT PHASES

 Ordinary money
 money is accumulated outside of a superannuation environment
 Ordinary money is after-tax money.
 It could be held in many forms, including cash, shares and property.
 does not have to be released from a superannuation environment before it
can be used for retirement purposes.
 Superannuation money
 money is accumulated inside a superannuation environment
 money is held inside the tax-concessional superannuation environment.
 This money must be maintained (preserved) in a superannuation
environment until a condition of release is reached (look at M07 for list of
conditions of release or lecture slides)
 Age pension and reverse mortgage
PRESERVATION STANDARDS
Three categories may apply to a member’s benefit:
1. Preserved benefits
2. Restricted but non preserved benefits
(eg. retirement benefits outside of superannuation offered by employer, but with
restriction such as must work 10 years in the co.)
3. Unrestricted and non-preserved benefits

Effect of member satisfying condition of release is that all preserved and restricted non
preserved benefits will change into unrestricted+ non preserved benefits.
CONDITIONS OF RELEASE (WEEK 8 NOTES OR W9 LECTURE SLIDES )
Benefits may be paid from a superannuation when a condition of release occurs
 reaches age 65, regardless of their work status
 reaches age 60 and changes their employer
 reaches their preservation age (60) and permanently retires
 reaches their preservation age and continues to work, but is limited to accessing a
retirement income stream rather than the total benefit
 dies (at any age) and their super benefit is paid to their beneficiaries/estate
 has a terminal illness (at any age) where the prognosis is less than 24 months of life
 is permanently incapacitated (at any age) with a diagnosis of being unlikely to ever work
again.
conditions of release that are not as common and these include:
 temporary incapacity (at any age), but access is limited to an income stream
 a temporary resident’s permanent departure from Australia
 severe financial hardship, and access is limited to a lump sum of $10 000
 the first home super saver scheme (FHSS), and access is limited to $30 000- 50000 less
tax
 compassionate grounds, and access is limited to paying some personal expenses

(9.5) OPTIONS THAT A MEMBER HAS UPON RETIREMENT WITH THEIR ACTUAL
ACCUMULATED SUPERANNUATION FUNDS (3 WAYS TO ACCESS SUPERANNUATION
WHEN RETIRE )

1. retain the funds in their superannuation account if the member doesn’t need it yet
(accumulation)
2. Withdraw a lump sum
(Australians preferred to receive lump sum benefits to income streams, such as
pensions and annuities as if the money is spent, they can rely on social security for
modest income)
3. Withdraw an income through a retirement income/pension stream
(eg. use their superannuation and roll over into a retirement income stream such as
account-based pension)
A member can simultaneously have accumulation, lump sum and pensions benefits
Pension can only be created from accumulation and must be payout every year
Total superannuation balance and transfer balance cap are $1.6 mil. This limit pension
account balance and non- concessional contribution.

benefits associated with moving superannuation funds across into a retirement income
stream or pension fund. The main benefits are:
 it provides a regular income stream which can be paid monthly, quarterly, six-
monthly or annually to substitute for the previously regular salary
 all investment earnings generated with the pension phase are tax free when
compared with earnings generated within the superannuation phase which are
taxed at a maximum rate of 15%
 all withdrawals after the age of 60 are completely tax free to the member from a
taxed superannuation fund (taxed element) and at concessional tax rates for an
untaxed element for amounts up to the untaxed plan cap which will be covered
later.

TYPES OF PENSIONS / INCOME STREAM

1. Account based pensions
 No max pay out
 Min 4-14% withdraw depending on age
 Works like super, expect 0% income tax and minimum pay out requirement
(once paid out they can’t easily put back at age 75, because the only way they
can put money back into retirement saving system through employer
contribution and superannuation guarantee)
2. Lifetime and life expectancy pensions/ income stream
TAXATION
Tax depends on:

 Age of the person

 Reasons for the payment
 Source of the payment
 Tax- free component and taxable component
Sequencing and longevity risk (goodnotes)
SMSF (lecture notes)
T7.21 Retail fund vs SMSF [TJ 12.6]
Provide three advantages that a retail fund has compared with a self-managed superannuation
fund.
Answer
Your answer should have any three of the following:
 Retail Superannuation Funds — Self-managed Superannuation Funds
 Offered to the general public — Not available to the general public and generally limited to
closely related parties such as family or business associated
 No limit as to the number of members — Limited to a maximum of 4 members
 Trustee is required to be approved by APRA — No requirement for the trustee to be
approved provided they meet various standards in the SIS Act
 Required to meet a net tangible asset test — No requirement for a net assets test to be met
 Reports about a member’s benefit and the fund operation are required to be published —
No requirement to report to members in most situations.
T8.3 Condition of Release [M2021 9.3]
Differentiate between taxed, untaxed and tax-free superannuation money.
Answer
 Taxed superannuation money has had the 15% contributions and earnings taxes
removed.
 Untaxed superannuation money has not had the 15% contributions and earnings
taxes removed.
 Tax-free money is after tax money that has been contributed by the individual.
T8.7 Age and Tax on Withdraws [M2021 9.8]

Describe the difference in tax treatment between a member aged under the age of 60 who
withdraws a lump sum from their superannuation account compared to a member aged 60 or
over?

Answer
A member aged 60 or over does not pay any tax on lump sum withdrawal from superannuation.
However a member under the age of 60 will have to pay lump sum withdrawal tax on the taxable
component (taxed element) that is over the low cap rate.

T8.8 Types of Income Streams [M2021 9.9]

Outline the main differences between account-based and non-account based income streams.
Answer
In an account-based income stream the individual manages their own superannuation account. The
individual must bear the investment and longevity risk. In return for the tax concessions associated
with being in pension mode they must draw down a minimum income each year – there is no limit
on the maximum amount they can withdraw. Therefore individuals who seek flexibility in the
amount of income they draw down may be attracted to account based pensions. The balance of the
account is an asset of the individual and can be left to beneficiaries upon death.
In a non account based income stream the individual uses a superannuation fund or life insurance
company to manage their superannuation. There is no account as such – instead there is an
agreement with the provider that they will provide a particular income stream in return for the
initial contribution by the individual. Investment risk is borne by the provider. For fixed term income
streams longevity risk is still borne by the individual. For fixed term income streams where the
individual dies before the end of the term an outstanding balance will be determined and can be
passed on to beneficiaries.