For a whole host of reasons, i’m thinking about insurance today.

Thinking about insurance

Insurance is one of those areas we all love to hate. Premiums always seem too high, we hear stories of insurance companies not paying out or the new stories about commissions being too high. After years of dealing with insurance companies and their policies, i am very comfortable to promote the benefits of insurance. There’s usually a claim happening somewhere in our the group of clients our business deals with on any given day, and it’s a reassuring thing to see insurance cover doing what it is supposed to do.

Here’s a video story talking through one person’s insurance experiences. In this case, a fellow was fit and healthy suffered a heart attack.

Thinking about insurance – Insurance can be difficult

Insurance can be difficult for financial planners. In fact, a lot of financial planners choose not to deal with insurance. On the other hand, there are financial planners who deal solely with insurance policies. While i have many years experience with insurance companies and their policies, it remains an area that needs continuous effort to stay ahead. Insurance policies change constantly, as the competition is fierce between companies, and a lot of work is required to establish not only the differences between different companies and policies – but whether or not those differences are worth paying for and how likely they are to remain appropriate for specific client objectives.

Insurance can be difficult for clients, as there is a huge range of policies from a range of well-recognised companies, and even within the same policy there can be a large number of options. I am not suggesting that insurance is beyond the average individual but i am saying that even with way too many years of experience in the industry, i still have to focus a great deal of attention when looking through insurance options.

One of the newer issues when thinking about insurance is legislation. While laws and rules change continuously for all sorts of areas, insurance legislation tends to be fairly long lived. However, there have been some major changes to insurance rules in recent years – especially in the area of insurance in superannuation.

Insurance can be hard to get

One of the more interesting areas when thinking of insurance is the two-sided aspect of an application. It’s a time when wording and definitions of “average” become very important.

Unlike an investment account where you simply fill out an application form and pay your dollars across, insurance involves you asking an insurance company to provide you with their product. If you send money to an investment company, they will happily bank it and then proceed to perform whatever service you have bought. It doesn’t matter if you are rich or poor or knowledgeable or not – if you have the money and fill in the application form then in most circumstances you are going to get the account services you apply for. However, with insurance the insurance company is not obliged to give it to you. In fact, they wouldn’t be doing a very good job if they made it easy for you. As strange as that sounds, it is very much a correct statement and here’s why…

Let’s say you apply for life insurance cover of $600,000.

Whatever premium you pay, it’s likely to be a small fraction of $600,000. Once the company “accepts” you for cover, they must continue to provide that $600,000 of insurance plus any inflation indexing for as long as you continue to pay the premium by the renewal date. In other words, they must assess the likelihood of you dying and the need for a claim to be paid today, tomorrow or any day into the future for as long as that policy is in force. You have to think about insurance in this way before the difficulty in getting a policy in place makes any sense. Many people simply assume that they will be able to get insurance – yet there are a range of factors that the insurance company will take into account before deciding to grant cover. They must do this because their primary job is to manage the “pool” of money from which any claims will be paid. As you would imagine, pools of money have limits and making sure the limit is sufficient to meet a claim is an extremely important job that will impact every person who holds one of those policies.

Thinking about insurance claims – Where does the money come from?

To be able to pay that $600,000 insurance cover the insurance company runs a “pooled fund” where your premiums are mixed with others. Administration costs are taken from the pool and claims are paid from it. Actuaries test the pool to make sure it is able to pay the expected number of claims at any one time now or in the future. As you could imagine, this is not an easy thing to do. When you apply for an insurance policy, it is the “underwriter” who stands as the protective gatekeeper for that pool of funds. The underwriter’s job is to ensure that policies are only offered on terms and to people who will keep that pool of funds in line with the assumptions underlying its long term existence.

For example..

If you are a 40 year old female then there would be an assumed “probability” that you will live a certain length of time or be free of claims against the insurance policy (and therefore the “pool” behind it) for long enough for your premiums to contribute to the stability and longevity of that pool of money backing the insurance policy. So there are assumptions about your being of “average” health, in an “average” occupation and with “average” hobbies and lifestyles. Now we all know that “average” is a fairly vague term but the point is that the insurance underwriter assessing your application for insurance cover will measure you against those averages and if there is an area that makes you “more risky” of making earlier than assumed then the “pool” will need to be bolstered through your paying more premiums – these are called “loadings” in the insurance world and everybody who receives one hates them. None of us like to have it suggested that we should pay more money than “average” and in many cases the loading won’t even make much sense – as the nuances of insurance premiums are very subtle and far from easy to comprehend in a non-insurance mindset.

Sometimes the risk an individual poses to the insurance pool may be one that is deemed too great or too uncertain, such that it is difficult or impossible to work out how much extra money should be paid. In these cases, it is common for an “exclusion” to be offered. An example would be an exclusion for payment of claims related to back injuries or illnesses for someone who already suffered from back problems before taking out the insurance. It truly is a case of every circumstance being different, and this is where the financial planner will do some of their best work – to help the person obtain the best form of cover and by helping the insurance company underwriter understand the risks applicable to the specific client and their specific circumstances.

You can see from this that there is a lot more to comparing insurance companies than simply looking at the cheapest premium – or even the cheapest premium for a similar type of cover. There are issues of longevity and continuation – will the insurance company be around at the time you are most likely to be making a claim? Will the policy be able to be retained with its current suite of features and benefits? Are premiums likely to change materially in the future. These are very difficult questions to answer, and we financial planners often aren’t in a position to make a fully qualified judgement but they are areas that experienced financial planners will ponder or attempt to negotiate or make further investigation into. There are various research houses and institutions that make these type of qualitative judgements, so a planner will have to rely upon these types of reports when looking into policy comparisons at this level, and in this detail.

Why do planners bother thinking about insurance?

Key reasons would be :

• It’s a key part of protecting a person’s wealth and future plans
• Insurance is often a key component of estate planning
• Insurance can be seen as a way of a planner earning more income

All of these make sense in one way or another, so they don’t need a lot of explanation but they do require some attention to detail to bring about a better understanding of financial planners and insurance.

Protecting wealth and future plans

Again this may be obvious but we’ll look at it quickly anyway.

Let’s say you own your own home, have a stable job and money in the bank. You aren’t in a relationship and don’t owe much in the way of loans so why would you need insurance? The most obvious area would be income protection insurance to provide a regular income if you are unable to work due to accident or injury. Money in the bank is quickly whittled away if you need to live off it completely. Most people simply do not have sufficient access to cash or savings to be able to fund a long term loss of income.

Another use for insurance would be to help retain your current position. Let’s say you have sufficient cash or access to funds to be able to provide your living and lifestyle costs if you were unable to work due to accident or illness for a year. However, it may be that you would rather keep those funds than get to the end of the year in good shape to return to work but without that same reserve or backup. In such a case, some form of income protection may be appropriate.

While we all like to think that we are invincible or that we will live a charmed life with time to see all our plans and dreams move to fruition, there is the possibility that this may not be our lot in life. Like you, i’d prefer to think that i’m going to be in the former rather than the latter group – but i certainly wouldn’t plan my life as it it was a certainty.

Estate Planning

I don’t like to think of a world without me – it just sounds, well… less interesting. But if i am going to be honest with myself then there is likely to come a time when i am no longer around to write this blog. If that were to happen then a good financial planner would take a moment to ponder just what impact this is likely to have on the people around me. Aside from those who miss my musings, there may be people who have relied upon me financially – and those people are going to have to cope with a financial impact if i am gone. So a logical part of looking at financial planning for people is to consider what sort of estate they would like to leave for the people that count on them, and what provision would they like to make for their family, children or other dependents.

Life insurance isn’t a comfortable discussion for some people but the financial planner needs to consider this aspect of a person’s financial position, needs and objectives, if they are going to do their job fully. Estate planning involves a complete look at the transition of assets from the deceased person or from entities that they control or entitlements that they may hold, to appropriate beneficiaries.

Many of us will still need time before our financial plans are brought to fruition, so shortfalls between what we’d like to happen versus what is possible can often be made up through insurance policies of one type or another.

Insurance policies usually pay a commission to an adviser

Not always – but usually.

Some advisers will “rebate” any commission that they earn and will instead charge a fee for helping investigate, recommend and put in place appropriate insurance. Others will take commission that is offered by the relevant insurance company. This is a highly contentious issue at the moment, as the payment of some form of commission can be seen as “conflicted remuneration”. In other words, a payment that can influence the advice provided – perhaps leading to the wrong thing being recommended or options being optimised for the payment of commission instead of the best “deal” for the person seeking insurance cover. i’ve covered insurance as a topic in this way previously so i won’t go into too much detail here. There are currently a number of companies looking to make changes to how they pay commissions for insurance and the level that they pay. This is something that i expect will evolve over time, with the most likely outcome being some form of mix of fees for advice or administration being built into the premium. However, any such change will entail large changes for the insurance industry, so i’d expect the final answer will not be known for some time yet.

In the meanwhile, research, advice and assistance with insurance matters will continue to be a key part of the overall services offered by financial planners seeking to help people with their full financial planning circumstances.

Thinking about insurance

This is only a very brief look at a very short list of financial planning issues as they apply to the world of insurances. Feel free to comment or criticise or offer suggestions for future posts on the topic. Insurance remains something of a mystery to the larger part of the population, so i think it’s a good idea to get more information and ideas out into the world for interested people to look through.