Matching clients' risk insurance needs with solutions

Financial advisers still face some high hurdles in trying to match clients’ risk insurance needs with solutions but there are ways of overcoming these challenges, writes Col Fullagar. 

Henry Ford (1863-1947), famed for the mass production of Model T’s, made the position clear when it came to consumer choice: “A customer can have a car painted any colour he wants so long as it is black.” 

The financial services equivalent was in the 1970s when Homus Agentus similarly made the position clear when it came to a product recommendation: “A client can have any policy they want so long as it is whole of life.” 

When there is only one product option available and the choice is simply to purchase or not purchase, a claim that the product is being adapted to the client’s unique needs is less than compelling, ie, it is more likely that the client’s need will be required to adapt. 

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Of course times have changed since Henry and Homus stated their position; there are now more cars than you can poke a gear-stick at and within financial services there is a plethoric range of risk insurance products and options. 

As a result, one would be forgiven for thinking that when it comes to risk insurance advice, even the client with the most unique needs client would be able to access a similarly uniquely appropriate product solution. 

A closer examination however, might reveal otherwise. For example, is the advice process helped or hindered by the presence of: 

• Up to 65 insured events within trauma insurance contracts;  
• Income protection insurance products jam-packed with ancillary benefits; or 
• An endless range of subtly different contract definitions and benefit descriptions, all of which witter on for pages within the policy and Product Disclosure Statement. 

An argument could certainly be mounted that today’s financial adviser still faces significant challenges in trying to match risk insurance needs with solutions. 

Occasionally, however, a pleasant surprise may await the astute adviser, with a quiet product achiever lurking, ready to be found. Arguably an example of this is OnePath’s instalment benefit feature with optional Value Protector. 

This facility is little known, possibly in part because its promotion has been handled with the same panache as the wedding of an actuary to a corporate counsel. Despite this, however, it warrants closer examination. 

To better position the examination, there is merit in first looking at the generic purpose and problems of lump sum risk insurance. Bearing in mind space limitations, this examination will only be undertaken for the personal (ie, non-business) needs. 

Purpose and problems of lump sum risk insurance 

The simplistic purpose of lump sum risk insurance can be cited as “to protect a financial plan against the adverse impact of: 

• The death or terminal illness of the life insured;  
• The life insured becoming totally and permanently disabled; or 
• The life insured suffering an insured medical trauma (as defined).” 

The “adverse impact” manifests as the continuation of existing expenses which are no longer supported by a revenue stream and the appearance of new expenses not budgeted for within the current revenue stream. 

The nature of these expenses can be one-off and/or on-going. 

Typical one-off expenses might include: 

• Debt repayment; 
• Estate equalisation; 
• Final expenses; 
• Charitable bequests; 
• Finding and receiving the best possible, specialised medical care;  
• “Bucket List” expenses; and 
• Expenses such as car and home modifications or possibly a new home or car. 

The logical and appropriate way to mitigate the impact of one-off expenses is by way of a one-off, lump sum payment such as that traditionally provided by term life, TPD and trauma insurance. 

The basis for the first half of the benefit amount recommendation is the total of the one-off expenses. 

So far, so good! 

The complication arises in respect of providing a solution for the impact of on-going expenses such as: 

• For death, an allowance to replace the income of the breadwinner; 
• For terminal illness; an allowance for recurring medical expenses;  
• For TPD, an allowance for loan repayments, school fees, maintenance expenses, etc; and 
• For trauma insured events, the cost of ongoing medical or institutional care. 

If the traditional lump sum product solution is recommended, the basis of the recommendation is no longer straightforward as it will theoretically require the adviser to: 

• Identify any existing and/or new on-going expenses that cannot be extinguished by a one-off lump sum payment; 
• Identify the quantum and duration of the expenses; 
• Estimate likely rates of inflation over the duration; and 
• Calculate the present day value of the necessary lump sum. 

The lump sum so calculated would form the basis of the second half of the benefit amount recommendation, with the final benefit amount being the sum of the one-off and on-going expenses components. 

The complications, however, do not end there.  

The client might find it difficult to see how the on-going expenses would be met by the payment of a lump sum at the time of a claim.

Further, the total recommended benefit amount might appear unjustifiably high, in turn leading to the client making an arbitrary reduction. 

And then, as if to add insult to injury, the position would become even more complicated when a claim was made. 

The one-off expenses would no doubt be satisfied by the lump sum component of the benefit payment, but when it came to using the balance to meet the on-going expenses, problems could arise. 

The lump sum would have to be invested at an appropriate rate of interest such that periodic drawdowns of interest and capital could be made at an amount sufficient to meet expenses and taxation liabilities, with appropriate caution being shown to ensure the invested lump sum was not fully dissipated prior to the ongoing expenses ending. 

As if all the above wasn’t bad enough, there was a final coup de grace: on-going expenses tend to increase over time with inflation but the less than predictable nature of interest rates is such that returns on an invested lump sum fluctuate over time. 

If anything approaching the desired outcome was to be achieved, a considerable amount of regular monitoring would be required, possibly leading to an adviser fee being added to the on-going expense need. 

Clearly, there was a material risk the desired outcome would not be achieved. 

Clearly also, the use of a lump sum solution might not be the most appropriate way to solve an ongoing expense need. 

Thus for the adviser, being able to provide a unique solution in this situation is not in the least bit enhanced by having an ever-expanding range of traditional lump sum risk insurance products. 

An alternate solution is required - one that is designed specifically to solve the on-going expenses problem. 

The logical solution is a product that provides for regular, on-going benefit payments, ie, by way of instalments. 

Instalment risk insurance 

Once the generic shortcomings of lump sum insurances are recognised, the appeal of an instalment alternative can better be appreciated:  

Clear and compelling purpose 

The purpose of the instalment alternative can be simply and clearly enunciated, ie: “This insurance is designed to take care of the ongoing personal expenses that are likely to continue and/or arise if you die, become terminally ill or totally and permanently disabled, or suffer a major medical trauma.” 

Complementary purpose 

The instalment facility is complementary to its lump sum cousin, enabling new and existing insurance portfolios to be structured or restructured without the fear of creating gaps in cover. 

Marketing opportunities 

Recent years have seen a dearth of fresh marketing opportunities that capture adviser imagination. An instalment risk insurance facility might assist to open up new markets and fill gaps in existing markets. 

Simpler and safer advice

The instalment facility might provide much needed simplification to the advice process with expenses and durations forming the basis of the recommendation and, importantly, with the recommendation being made and locked in at the time of advice rather than at the time of claim. 

The initial advice link between the need and solution will be clear and the desired outcome at the time of claim is more likely to be achieved, without the same need for on-going, complex monitoring and adjustment. 

To the extent that a solution more appropriately fits the need, safer advice is facilitated. 

Product features 

The OnePath instalment benefit feature is available as an alternate basis of cover at the time of application. If the need is identified as being for $5,000 a month, application is made for this amount. 

Instalments are payable for a pre-set duration, ie, either three, five, 10 or 15 years.  

Previously a facility existed for benefits payable to a pre-set age, eg, 60 or 65. However, this was recently (and unfortunately) withdrawn. 

If a claim is being paid by instalments and the beneficiary dies, any remaining instalments are commuted to a lump sum and paid to the estate. 

It is possible to alter a traditional lump sum policy to instalments during the policy duration, unless a claim occurs, which could be advantageous for insureds over age 50, for example.  

As and when the lump sum cover becomes too expensive, a change to instalments can be made. In later years, a reduction in the instalment duration will further assist to control insurance costs. 

The Value Protector option, available at a small additional cost, provides for the instalment payments to index at 3 per cent compound each year, an important facility for mid- to longer-term durations. 

Taxation 

A tax ruling has been obtained by OnePath which, simplistically states, in respect of the instalment facility: 

• Premiums are not deductible; and 
• Benefits are not assessable. 

A ruling in regards to the various business insurance needs has not yet been obtained. 

As indicated, this is a “simplified” position and the tax position for a specific client should be appropriately researched. 

There are various ways to consider the comparative cost of the instalment option: 

Interest on lump sum 

If the need is for $5,000 a month, a lump sum of $1 million invested at 6 per cent would give rise to a return of $60,000 p.a. or around $5,000 a month. 

At age 40, for a male: 

• $1 million term, the annual premium is $722.00 (non-smoker), and 
• $5,000 a month instalment with Value Protector, 15-year term, the annual premium is $670.00 – a saving of around 7 per cent. 

The not-inconsiderable advantage, of course, of the lump sum is that it would remain intact at the end of the instalment payment term but, if the lump sum is not required at the end of the payment term, why pay to retain it? 

Also, 3 per cent compounding on $5,000 a month means that $1,116,000 will have been paid over the 15 years with the instalment facility. 

Interest and capital drawdown 

As an alternative to the above, provision can be made for a capital and interest drawdown, thus reducing the lump sum benefit required. 

If assumptions were: 

• Interest; 6 per cent, and 
• Capital and interest drawn down over 15 years,   

a lump sum of $730,000 term would be required at an initial annual cost (as per above) of $610. 

The instalment premium facility annual premium would remain at $600.91. 

The key advantage of the instalment facility over an invested lump sum, however, is that the instalment payments are not taxable (based on the provided tax ruling). 

On the other hand, interest earned on an invested lump sum generally is taxable.  

Therefore, to achieve an after-tax return on the invested lump sum equivalent to a non-taxed instalment benefit payment, the invested lump sum would need to be grossed up in line with the client’s applicable rate of tax. 

A further consideration is the interest rate environment.  

When rates are low, the lump sum necessary to achieve a set investment return is greater than when rates are high. Thus an instalment facility might have additional appeal when rates are low. 

Summary 

The ability to provide unique solutions to unique needs is not so much driven by the number of product options available. More, it is driven by the design of the product and its ability to be adapted to specific client needs. 

Subsequent to that, the provision of unique solutions is driven by the ability of the adviser to recognise the need, be aware of the range of possible solutions and then skilfully link the most appropriate solution to the need.  

As implied above, it is likely that neither a lump sum nor an instalment solution will be solely the best way forward – but by linking both together within the recommendation, a uniquely appropriate solution might be made available to the client. 

It is not the purpose of this article to endorse a product or payment facility at the expense of the alternatives, but simply to open up some pros and cons for discussion, and, of course, the content of this article is general in nature and the examples provided are indicative only, thus the above should not be taken to constitute financial advice. 

A final word, however, for trivia buffs: it is a little-known fact that Henry Ford mandated black as the colour of the Model T Ford because of its faster drying time. 

Col Fullagar is the principal of Integrity Resolutions Pty Ltd. (Note: This article was prepared with the assistance of OnePath).