What is Grandfathering?
You may have come across the term 'grandfathering' when researching financial products. Without a finance or law degree, this can be quite a difficult concept to grasp, so we’ve broken down the facts for you.
Grandfathering is a legal principle that allows an old rule to continue to apply to certain existing situations, while a new rule will be applied to new or future cases. So, when a new law is made, it may include a ‘grandfather clause’ which provides an exemption to certain existing arrangements, such as change to what types of insurance or superannuation benefits are payable.
Essentially, 'grandfathering' allows an existing operation or conduct to continue legally even when a new operation or conduct of that type would actually be illegal under the new law.
Grandfathering in the insurance world
So how does this relate to life insurance?
While changes to laws are sometimes necessary to avoid negative impacts or to close a loophole, this must be balanced with the adverse impacts (political, economic and financial) of disrupting existing arrangements. As you can imagine, this can be quite tricky.
One of the methods of trying to balance these adverse effects while still making necessary legislative changes includes the implementation of grandfather clauses.
Let’s take a closer look at a specific example of how grandfathering works in the life insurance space.
Example: Insurance Purchasers and SMSF Trustees
Prior to 1 July 2014
Before the amendment came into effect, life, total and permanent disablement, and income protection insurance could be — and often were — held through a superannuation fund. Many people found this attractive as it could bring about taxation and cash flow benefits.
The problem, though, was that if you claimed on a policy through a super fund you would go through two steps:
- The member had to meet the policy conditions in order to claim. If they did, the insurer would pay the claim to the trustee of the fund.
- A condition of release must be satisfied in order for the trustee to release the claim from the superannuation fund to the member.
The problem lay in the fact that the conditions of the claim did not always align with the conditions of release, which defeated the purpose of having insurance in the first place. Often, a claim would be paid by an insurer but might end up “stuck” in the superannuation fund because a superannuation condition of release could not be met.
After 1 July 2014
Due to these problems, the law was changed so that trustees of regulated super funds could no longer provide members with insured benefits other than those that would also satisfy a condition of release. This removed the risk of the benefit being trapped in the super fund.
However, under a grandfather clause, members who have an existing arrangement that does not meet the new requirements can maintain that arrangement if they wish to do so, keeping in mind that they will still risk failing to meet the conditions of release. The legislature, however, does not force them to renounce their existing arrangements.
We are not legal experts, however, we know our stuff when it comes to life insurance. So, if you want to discuss your options with our team of specialists, give us a call on 13 54 33.
References: RiskInfo Magazine