Top Strategies to Manage Insurance Under SMSF Loans

Insurance Requirements Under SMSF Property Loans

When you borrow through a limited recourse borrowing arrangement, the property held in the bare trust must carry adequate insurance. The trustee of the SMSF holds responsibility for ensuring the asset is protected, even though legal title sits with a separate holding trustee until the loan is repaid. This obligation applies whether you borrowed for commercial property or have an existing grandfathered residential LRBA.

Consider an ADF member stationed at Edinburgh who purchased a small commercial unit in Salisbury through their SMSF before the August ban. The property is leased to a veterinary practice unrelated to the member. The SMSF trustee arranged building insurance covering replacement value, public liability insurance, and loss of rent cover. When a storm damaged the roof, the building insurance paid for repairs without the fund needing to draw down additional capital. The loss of rent cover maintained cash flow to meet loan repayments during the repair period.

What Type of Insurance an LRBA Property Must Hold

Building insurance is compulsory for any real property held under an LRBA. The policy must cover the full replacement value of the structure, not just the outstanding loan balance. Most lenders require evidence of insurance before settlement and will monitor renewal annually. Public liability insurance protects the fund against claims from third parties injured on the property. Where the property generates rental income, loss of rent insurance covers loan repayments and other expenses if the tenant vacates or the property becomes uninhabitable.

Contents insurance is only relevant if the SMSF owns fixtures or fittings not covered under the building policy. Strata insurance applies where the property is part of a strata scheme, but the SMSF trustee must confirm whether the body corporate policy covers the full replacement value or if top-up insurance is required.

Who Arranges and Pays for the Insurance Policy

The SMSF trustee arranges and pays for all insurance from fund assets. The holding trustee may be named on the policy as an interested party, but the SMSF remains the beneficial owner and must control the insurance arrangement. Premiums are a deductible expense for the fund where the property is held to generate assessable income. The cost of insurance reduces the net rental return but protects the fund's capacity to meet loan obligations if the asset is damaged.

The lender will specify minimum insurance requirements in the loan agreement. These typically include building insurance with the lender noted as an interested party and public liability cover of at least $10 million to $20 million depending on the property type. The fund cannot use borrowed money to pay insurance premiums. Premiums must be paid from existing fund assets, rental income, or member contributions.

How the Residential Ban Affects Insurance Obligations for Existing LRBAs

Grandfathered residential LRBAs entered into before approximately 10 August 2026 remain compliant provided all conditions continue to be met. Insurance obligations for these arrangements do not change. The SMSF trustee must maintain building insurance, public liability cover, and any other policies required under the loan agreement. A lapse in insurance coverage could breach the terms of the LRBA and may trigger a default under the loan.

If you refinance a grandfathered residential LRBA, the ATO has not yet confirmed whether certain changes would create a new arrangement subject to the post-commencement rules. Switching lenders while maintaining the same asset, loan purpose, and limited recourse structure is likely to be treated as maintaining the existing arrangement rather than entering a new one. Increasing the loan amount or changing the asset held in the trust would end the original arrangement.

Insurance Obligations for Commercial Property LRBAs

Commercial property that satisfies the business real property definition under section 66 of the SIS Act can still be acquired using an LRBA. Insurance requirements for SMSF loans for ADF members purchasing commercial property are generally higher than for residential arrangements. Lenders assess commercial property as higher risk and require more comprehensive cover.

A small industrial warehouse in Gepps Cross leased to a logistics company would require building insurance based on reinstatement value, public liability insurance covering the tenant's operations, and potentially machinery breakdown cover if plant or equipment forms part of the lease. The fund must ensure the insurance remains current and adequate as the property's replacement value changes over time. An underinsured property exposes the fund to a shortfall if the asset is destroyed and the insurance payout does not cover the outstanding loan balance.

Insurance and the Sole Purpose Test

All insurance arrangements must comply with the sole purpose test under section 62 of the SIS Act. The fund must be maintained solely to provide retirement benefits to members or their dependants in the event of death. Overinsuring a property beyond its replacement value or insuring for risks unrelated to protecting the fund's capacity to meet its obligations could breach the sole purpose test.

Insurance payouts are treated as assessable income of the fund where the property is held to generate rental income. If the payout relates to damage to the building, the fund can use the proceeds to repair or replace the asset. If the property is a total loss and the payout exceeds the outstanding loan balance, the surplus becomes a fund asset and must be applied consistent with the fund's investment strategy.

What Happens When an Insured Event Occurs

If the property is damaged or destroyed, the SMSF trustee lodges a claim with the insurer. The payout is made to the fund, not the lender, although the lender may require the funds to be held in a controlled account until repairs are completed or the loan is repaid. The trustee must decide whether to repair or replace the asset, sell the damaged property, or use the payout to discharge the loan and wind up the LRBA.

Where the property is repairable, borrowed funds cannot be used for improvements under the LRBA rules. The insurance payout and existing fund assets must cover the full cost of reinstatement. If the payout is insufficient, the fund may need to rely on rental income, member contributions within the relevant caps, or the sale of other fund assets to meet the shortfall. This is one reason adequate insurance based on current replacement value is critical.

Interaction Between Insurance and Division 296 Tax from 1 July 2026

Where a member's total superannuation balance exceeds $3 million at the end of the financial year, Division 296 tax of 15 percent applies to the proportion of earnings attributable to the amount above that threshold. An insurance payout that increases the fund's assets contributes to the member's total superannuation balance and may push earnings over the threshold or increase the taxable portion.

Outstanding LRBA amounts entered into on or after 1 July 2018 are included in the total superannuation balance in certain circumstances, including where the LRBA is with an associate of the fund or where the member has met a condition of release with a nil cashing restriction. The insurance obligation itself does not affect the balance calculation, but the interaction between the payout, loan repayment, and member balance requires attention for members approaching or exceeding the $3 million threshold.

Insurance When Leasing to a Related Party

Business real property leased to a related party of the fund is excluded from the in-house asset rules provided the lease is on arm's length terms. The SMSF trustee remains responsible for building and public liability insurance even where the tenant is a related party. The lease agreement should specify whether the tenant is required to reimburse the fund for insurance costs as part of the rental arrangement, but the trustee cannot delegate the obligation to maintain insurance to the tenant.

If the related party tenant causes damage to the property, the fund's insurance policy responds in the same way as for an unrelated tenant. The insurer may seek to recover costs from the tenant depending on the terms of the policy and the cause of the damage. The trustee must ensure the insurance arrangement does not provide a benefit to the member or related party beyond what would apply under an arm's length commercial lease.

Defence Loans works with ADF members across South Australia to structure SMSF commercial loans that meet legislative requirements and lender expectations. We coordinate with SMSF specialists, conveyancers, and insurers to ensure your fund's property is protected from settlement through to loan repayment. If you hold an existing residential LRBA or are considering a commercial property acquisition, call one of our team or book an appointment at a time that works for you.

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