When we review insurance cover for our clients, we often find issues arise due to cover not being established correctly or that the clients situation has changed and cover has not been modified accordingly. Most of these problems are not identified until it is too late.

Some of the most frequent errors that we encounter are discussed below.

Incorrect levels of cover

It is very common to see medical professional’s with very high levels of income protection under an “indemnity” contract. This is often through Superannuation or via a direct insurer, that does not financially underwrite their policies. The danger here is that at claim time this insured value needs to be proved. For employees this may mean simply providing historical payslips (minimum). If you were self employed or a business owner this involves the release of company accounts including compilation of profits and losses etc. If there is any “unearned income” such as investments or other buisness income that did not require personal exertion, this could also offset the claim amount. A nasty surprise when you are quite possibly lying ill or injured in a hospital bed and having to provide these financials before payments begin.

There is also a tendency to only cover debt and replacement income in the event of death or total and permanent disability. This is more often than not insufficient. Factors such as housing modifications, employing carers etc etc need to be considered. As a general rule of thumb 12 times your living expenses is normally what would be required in these circumstances, though this is a very simplistic solution and does not take into account your unique circumstances. 

It’s not always just about you

Even if your family members do not earn an income, it is still a good idea to insure them. If a family member is injured or ill you will likely have to cover medical expenses or take time off work to care for them, thereby reducing your own income. From a long-term perspective if a spouse is no longer able to care for your young children or keep the home running alternative arrangements may need to be found and funded. Insurance such as trauma cover is often the simplest solution. It is key to also consider cover not only your spouse but also your children and even other members of your family if they are financially dependent on you.

Stepped vs Level premiums

Are you planning on holding cover for a long period of time? Medical professionals tend to work well into their 60s in at least some capacity. If you do still require some insurance cover at this age and use a “stepped” premium structure (which bases its premium on your age) this will become extremely expensive. Using a “level” premium structure means that your premiums are based on the age at which you established your insurance cover. If you started early enough this can mean that cover is much more affordable later in life, when you are far more likely to make a claim.

One of the common errors is often taking an “all or none” approach and having all cover on “level” or all cover on “stepped” structures. A blended approach involves making use of both types of insurance. Utilizing some “stepped” insurance to establish cover for debt and other short/medium term needs, the aim being to reduce this over time when high levels of cover are no longer required. At this point you would still have your “level” cover remaining as the baseline for long term protection.

Consider your tax structure

As most people know income protection is tax deductible, however using Superannuation to fund this type of cover means you might miss out on a personal deduction. As an alternative Life and Total/Permanent Disability insurance can be owned inside superannuation (linked policies allow TPD Own Occupation definitions to be used) and then a tax deductible contribution can be made to cover the premiums, often with a 15% tax rebate to the fund. If you are not maxing out your concessional contributions each year (currently $25,000 for the 2018-19 financial year) this can be very handy. It is also worth keeping in mind that TPD held inside superannuation is taxable if it is paid out and this needs to be accounted for.

Who does money flow to?

Following on from above, if you have insurance within your superannuation fund you will want to ensure that it is paid to the right person if a claim is made. This is done by completing “nomination of beneficiaries” paperwork, that instructs the trustee of the superannuation fund exactly who you want money to be paid to. A binding nomination like this must be followed by the trustee. However some superannuations don’t allow for these kind of binding nominations and a persons requested recepient is only seen as a “suggestion” by the trustee.

Far too often a nomination will include children and although they can accept the money paid at claim, they are probably not able to manage this at a young age. Other pitfalls are nominating adult children, siblings or parents - they are not considered dependents for superannuation purposes, which means this payout would be taxed. In extreme cases lack of a nominated beneficiary can result in funds being paid to ex partners in accordance with the law and almost certainly against the wishes of the deceased.  

The right legal documentation is critical

Insurance cover is intended to provide funding for a specific purpose in specific circumstances. This ranges from the very personal e.g. funding your loved ones living expenses if you die, to the professional e.g. succession planning and funding an exit strategy for a business, ensuring that other partners are not left with debt and have access to funds to cover your position.

All of these arrangements require legal documentation to be completed upfront to ensure that insurance payments are paid appropriately e.g an up to date will. In the case of succession planning other factors such as agreement on the valuation methods to be used, who exactly gets access to funds, how they can be used etc etc are vitally important and again this needs to be documented appropriately. We see time and time again businesses and practices being established on a handshake agreement but unfortunately this is seldom how they end.

Get the right advice

All of the examples used above are for illustration purposes alone and should not be taken as specific advice. When putting together risk protection strategies an adviser, or panel of specialists, should take into account all elements including your family, business and any trusts or superannuation structures used. They must then consider how these different elements might work together to form specific advice just for you. 

At a conference in Sydney this weekend I overheard another adviser telling a story about a client who came to him late in life with significant assets that, based on their moderate lifestyle, they would have trouble spending before they died. He told them that they had only a small portion of their assets in Super and had they moved more over when they had the chance they would have saved significant tax but that ship had sailed. This client then said, “oh that’s unfortunate, so you are saying that if we had of seen you 20 years ago we would have far more money to live on?” the adviser replied “absolutely not, you have taken some huge risks that have paid off well for you, I would have advised caution so you would like have less, of course, this was just pure luck”

Financial advisers are not the keepers of a secret rule book that details how to get rich. They have some tools that help them to analyse and compare the VAST range of options for investments and other financial products but ultimately all this information is publicly available and though they might have their ear close to the ground, they cannot predict the future either.

Advisers use tried and tested financial products that produce predictable results and go through a significant vetting process before they are added to the advisers approved product list. Advisers cannot recommend the house down the road or a penny mining stock that their mate at the pub says is sure thing. These kinds of investments can be highly volatile which means that although they could potentially make you a lot of money, they could also lose it, advisers can’t gamble with your money.

ETFs and Robofunds are taking a lot of the arduous work and cost out of investing. These investment options have been in vogue for around 10 years, which has been essentially a bull market since the GFC, and have been giving the more expensive and hands on active managers a run for their money. Selecting a custom designed portfolio can take a lot of time and effort and this can help to provide significant downside protection that might be critical to your needs, but this will not make you money.

Insurance is a big part of financial planning. Unless you have a rich family or a very significant investment portfolio, any investment plan is based on your ability to earn an income. Without income this all falls apart pretty quickly so taking a small percentage of this income to ensure this continues as best as possible is a no brainer. If an insurable event occurs, this is often a significant event and the time off work will mean that event with great cover you are likely not going to be in a better financial position had you not fallen ill or been injured etc. There are a diverse range of insurance products available from different providers but there is one guarantee across all of them, you will pay a premium. So, in most cases, insurance won’t make you money either.

Advisers don’t work for free. Getting to know you and providing you with recommendations that suit your needs takes time and expertise. Advisers more often than not have staff on their payroll, or they outsource documentation and compliance work. They also have significant professional indemnity cover that means that if they step wrong, you get to lodge a claim against them to rectify any financial harm. Once again most of the rules and strategies that an adviser will use are publicly available and you can do this yourself. You pay an advice fee to ensure that you are not missing anything and don’t get caught out and while you might send less to the tax department and avoid making losses due to wise investment decisions this won’t make you money.

Ultimately, YOU are the person who decides if you will “get rich”. If it was easy everyone would be doing it. You can find out what you are good at and work hard at it. A good adviser might help you take an objective view to this process and make you aware of potential pitfalls, but they can never know your job and your aspirations as well as you do. They can also provide you with the tools to help you spend less and save money but this is down to your habits and lifestyle, something only you can control.

Shaun Clements - June 2018

I know what you are thinking, why is a financial planner writing about wine. Though I do like the adventure of finding a great bottle of wine for a fraction of the price through trial and error, that is not what I am writing about today. Anyone who has been though the process of setting up good quality insurance cover will know very well what this is about. Most people would not react well to someone you don't know asking you very personal questions, as it is none of their business. This blog aims to help illustrate why insurers ask these kind of questions and explain that they are not just "being nosy". 

Background

Unlike private health insurance in Australia, where there is no discrimination on whether you are young and healthy or older and unhealthy, life insurance and its associated products such as income protection etc is based on the simple idea that people pool their money to protect against financial loss.  If something bad should happen to you, the insurance company steps in and helps you or your family pay the bills and help you through what is usually tough time. 

What is a clean-skin?

The term "clean-skin" is used in the insurance industry to describe someone who has no health or financial issues and essentially "ticks all the boxes". Put simply, insurance companies are not charities. They base their premiums on projecting how many people will claim. In order to do this they use a meta analysis of sorts that combines data from multiple sources including their own experience and larger sources such as the bureau of statistics. It is important that they get this right as life insurance contracts are often held for a long time and nobody likes a premium increase, especially a large one.

If an application is made that indicates that this person might be more likely than most to make a claim an underwriter has the option of a "loading" (increase premium to match the additional risk) "exclude" (not cover the specific condition or risk) or "decline" (no cover offered). A "clean-skin" has had no medical concerns, works in a job that has a predictable risk and doesn't go base jumping on weekends. More often that not, an application made by a clean skin involves little or no fuss and is approved immediately. 

Why you don't get better with age

It has been said that age 30 is your "peak" in terms having the brain processing power that you had at age 18, coupled with enough experience to use it well. Whether this is true or not it is quite common that after age 30 things start to change with our health. This could be simply wear and tear on joints (you cant quite make that jump shot like you used to) or a change in diet and long hours at work. In my experience people usually start looking after themselves a little better around this time as they realise they cant continue the lifestyle they did in their 20's without paying the price (that couple of bottles of vino shared with a friend at dinner does slow you down the next day now). It is also the time that you invest more into looking after yourself, which might involve a yearly check up at your GP.

Where previously you would only see the family doctor if you needed something specific, now you might find yourself at your local medical centre for relatively minor things such as a renewed prescription. A good GP will help keep you on track to a long and healthy life. Sometimes the harsh reality could be that you are a little too heavy and your family and friends don't have the heart to tell you, it could also be that they spot something a little off that could be easily rectified. For example, in Australia we spend a lot of time in the sun and consequently we have one of the highest rates of skin cancer in the world. The majority of these cancers are very simple to treat as long as they are not left too long and many can be dealt with right there and then depending on your doctor's speciality.  

Any investigation that a doctor or specialist might conduct goes onto a medical record and helps the insurer decide what premium you might pay based on your likelihood of a claim.  They ask these questions during the application process and if they feel that further investigation is required, they might request this medical report or ask for an updated test to ensure that they can price you accordingly. 

So when is the right time to get covered? I don't want to pay for insurance that I might not need for 10 years!

In the majority of people's lives there comes a time when you need some type of insurance as you have a family and/or debts and want to ensure you keep earning an income to cover these, even if you cant work.  The majority of clean-skins do not have these concerns as they are still studying or just started work and really have no major financial commitments. What they do have is a lifetime of earning potential.

Based on the current average Australian wage ($81,947), without any increases, if a 25 year old worked to age 60 they would earn over $2.8 Million dollars. Once you start applying pay raises and CPI increases this number becomes even more impressive, and that's if you actually want to retire at 60, many don't. So lets assume this 25 year old is working in an office, is fit as fiddle, does not smoke, and has not a care in the world (other than the boss asking for this month's TPS report before it is even due). For illustrations sake, lets say he covers his income and some of his potential future income of $1mil. He could cover this at just $193pm not bad right, probably less than his car insurance and if he has to take more than a month off work he would still be able to pay his rent and other bills without going back to the bank of mum and dad and if he were unable to work at all would have an additional $1mil on top of 75% of his income until he reaches age 65.  If he were 10 years older the same cover would be roughly twice the price. 

Now this is where a skilled risk adviser really makes a difference (yes i'm going to get technical/nerdy now). Most quality insurers will offer a level premium that essentially "locks in" today's premium so it does not increase as you age. The average age a person makes a significant claim due to poor health is age 51 so lets say you had a crystal ball and knew this was when you would make a claim and were fit and healthy up to the year beforehand, at age 50. Covering the same amount would cost you $863pm, almost 8 times the cost. The truth is that nobody has a crystal ball and not many people have and this kind of money spare in their budget as this would mean around 10% of your income at the time. If he had chosen a level premium at age 25, this would be just under $300pm and would continue to be pretty much the same (adjusted for inflation) to age 65, when the initially cheaper option would skyrocket to $5,761pm no that is not a typo. So at the time when you are most likely to claim, you are paying roughly 1/20th of the premium. 

I am not saying that you should rush out and get yourselves all the cover you can right now while you are fit and healthy. Getting a good quality "base line" of cover that can be expanded upon through features such as "Guaranteed future insurability" which lets you increase cover when you get a promotion, buy a house or have children (with no medicals) and the like can help future proof against developments in your health and helps you plan for the future. If you do fancy walking through these options, this is my speciality and I do this with every single client I meet. 

Shaun Clements

27 July 2017