Safe as houses

Author: Richard Webb, Policy Advisor, Financial Planning and Superannuation

The east coast of Australia has been subject to some of the heaviest flooding on record over the last two years. There have been multiple incidents of tragic flooding affecting large areas of south-east Queensland and coastal New South Wales. Among the affected areas has been two of our nation’s most bustling capital cities: Brisbane and Sydney. 

For property investors, these two cities have typically been safe havens. Strong price growth, solid rental returns and low vacancy rates have attracted capital from across the nation and many have bought real estate assets in these locations within their self-managed super funds. 

It’s understandable there will now be some investors who are nervous about what has occurred in these cities, what the future might hold and how to protect themselves. It’s here where trustees would be wise to think more carefully about the importance of insurance.

Insurance is of course a necessary part of what it means to have an SMSF and is a bulwark against risk that already forms the backbone of an investment strategy. However, for most trustees, the focus has traditionally been squarely on the areas of insurance typically associated with superannuation, whether that be death, TPD, income protection or a combination. In other words, trustees usually spend plenty of time considering insurance designed to protect members – but what about insurance designed to protect assets?

The decision to start an SMSF may have come about as a pragmatic way to hold specific assets that are not necessarily easy to include in an APRA-regulated superannuation fund.  A particular property may be on this list.  In this case, the trustees absorb all the regular duties associated with such an asset, such as obtaining tenants to lease the home and maintaining and repairing the property. 

The trustees also acquire additional duties like regular valuations for reporting purposes, as well needing to consider on an ongoing basis whether owning the asset is consistent with the fund’s investment strategy, sole purpose test and members’ best financial interest duty.

Part of trustees’ ongoing duties to members is to ensure that an investment property is adequately insured against damage, fire, theft and any potential default by renters. This sounds trivial in theory, but in practice this matter has become a great deal more complicated due to the impact of climate change. 

As weather patterns change and flood activity becomes more severe – and our cities sprawl into areas which may have a higher risk of disasters – the likelihood of super funds owning properties in riskier locations will rise.

Along with the rising risk, homeowners across the country are likely to scrutinise their own insurance policies and coverage. This could likely lead to an increase in the amount of risk insurers will take on. The knock-on effect of these events is a rise in insurance premiums. Trustees renewing their insurance in the months to come may start to see these costs rising. This is likely to inspire new interest in what has been, up to now, a relatively mundane cost faced by funds. 

Rising insurance costs are not likely to just fall on homes in risky locations. Insurance works by pooling different levels of risk. Consequently, even properties in locations unlikely to flood may face higher premiums.

There is no set time each year that trustees need to review their insurance arrangements, however they do need to review them. The cost of asset insurance should be assumed, at a minimum, to be the cost of retaining property and other insurable assets in one’s fund.  A fund should be reviewing their investment strategy annually to ensure that the decision to invest in assets such as property – and any accompanying costs such as insurance – is considered as part of the requirements on trustees to consider the overall risk, return, liquidity and diversification aspects of the fund.  

If the shock of a higher premium is what it takes for some trustees to reconsider their arrangements, such consideration should be documented properly by trustees, rather than treating this as a cost-cutting exercise.

It may also be appropriate at this time to consider other asset insurance that the fund might have in place. In particular, insurance over collectables and personal use assets, which need to be insured within seven days of the fund acquiring them, could be covered under the same policy.  Ultimately, the trustees are required to ensure that the fund’s assets are properly insured against financial loss or liability. 

A fund benefits from their insurance by helping manage their risk and improving peace of mind. But the best results are reached when properly considering insurance as part of the fund’s overall risk management.

If the cost of insuring a risky property means the trustees believe there is better value elsewhere, this may just be the right outcome.