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

In recent years there has been a lot of attention given to robo advice and the changing face of financial advice. But what is it all about and how did we get here?

Gone are the days where an adviser could provide low cost “templated” advice to clients that suited their needs. The increase of compliance requirements, legislation changes and the complexity of financial products are increasing each year. This means that good advice slowly slips away from the “lower end” of the market who are unable to afford the sometimes significant fees to get good quality advice and implement and maintain this for them.

This opened a space in the market for “direct insurance” yes that stuff you see on midday TV that promises easy cover with no medicals etc. Without going into detail, these type products tend to have a very significant decline rate when it comes to actually paying out. This is quite simply because the insurer will ask questions at time of claim, rather than upfront, this provides a much greater scope to decline based on “non disclosure” among other things.

This has all lead to significant investment by many major financial institutions into how to systematically approach the advice process and how to “automate” this in an effort to provide good advice that doesn't involve a face to face fact finding process with a skilled and qualified adviser. This will become more and more prevalent in the coming years as these systems get introduced to the general public, one would assume this would start at the banking level and grow outward.

BUT MACHINES ARE SO ACCURATE, HOW CAN A SYSTEMATIC APPROACH BE A BAD THING?

The trouble with even the most intuitive technologies is that they are only as good as the information that is put into them. Until we reach the singularity any system is going to interpret information that is entered into it in a logical manner to produce a logical result. So what is the problem with that? logic is good right? Here are a couple of dilemmas that these systems are yet to overcome (in my, and many others, opinion).

PEOPLE ARE INDIVIDUALS

How one person understands a question on a screen and produces an answer is often vastly different from the next. A classic example of this is one of risk in investments. When asked the question “On a scale of 1-5, 1 being pure cash with almost no risk and 5 being high risk speculative investments, where would you like to invest your money?” Most often when this direct question is asked an investor will tend to the more conservative 2-3 value, this happens regardless of age. The reality is this question is directly linked to asset allocation and, over a 30 something year period, returns of “low risk” portfolios are greatly outperformed by “high risk” portfolios, with a negligible increase in risk. As the time frame gets shorter, this risk increases. As an adviser I have found that in most cases an investor will give a completely different answer after this concept is clarified to them.

It is reasonable to assume that unless time is taken to understand this concept the average robo advice consumer would just click “next” without giving it a second thought. The impact of being low risk in a 30 year Superannuation investment could mean the difference in paying off your mortgage in retirement or having to downsize. Many people don't realise this until the time to act has long passed. I highly doubt that a popup on your screen will carry the weight that it should.

PRODUCT PROVIDERS WANT YOUR BUSINESS

Any investment, insurance or superannuation account you open is essentially a “product” and in a competitive marketplace everyone works to get as great a share of the marketplace as possible and will do anything to get it. While lowering prices and adding benefits is a great place to start there are much easier ways to do this.

No product provider is going to tell you what they are NOT good at. As a seasoned adviser I have worked with a wide spread of products and the actual employees of those companies. One year a provider can be efficient to work with and offer a great product and, just 6 short months later, be having major administrative issues after losing key employees or implementing new systems etc. More often than not, these kind of concerns are not publicised, people just stop using them.

For some time now, professionals have been using “research providers” that provide a rating of one provider against the next given specific criteria. This is a great place to start as you want to ensure that you are providing the best possible option for your client and it is very difficult to scour through and compare every PDS for a few dozen providers each time they are updated, sometimes a few times a year. Great right? Well sort of.

It is possible for a provider to add benefits that are of no or very little benefit to the consumer in an effort to “fool” these rating systems. As an example, it might be a point of differentiation that an insurance product provides an increased cover for smallpox victims it is essentially moot point, as this is extremely rare in modern times and due to immunisation has not seen a case since 1977, other than bioterrorism which would be excluded as an “act of war” it is hard to see how this might be a tangible benefit, though a system adding up bullet points might see it as one.

THE QUESTION IS “DOES A PIECE OF SOFTWARE HAVE MY BEST INTERESTS IN MIND?”

There are of course times where an efficient service, to provide a consumer who is aware of all the options and wants a low cost solution, is called for and Robo Advice would be ideal in catering for this. Advisers look forward to the development of any systems that can help us to provide good advice to consumers at lower cost. That said, it is always important to ensure that a human element guides this process.

We believe that it is going to be quite some time until we see the death of advisers such as myself providing good advice that is in the best interest of the client. In the vast majority of cases when a person seeks advice they do so with their life savings in mind and the cost of seeing professional is minimal when compared with the downside of losing what they have worked so hard to build.

Shaun Clements

23 November 2016

As a financial planner, the concept of "Risk" is one that is front of mind every time I speak with a client. Let us for a moment take away the connotation of risk as a negative and look at it for what it actually is.

In the financial world, the mathematical term "standard deviation" is often substituted for the plain English "risk". This is quite simply talking about the value of an asset going up or down from its current position. Most investors are happy to see things increase in value but not decrease. As the chart below illustrates, the higher the standard deviation, the higher the return. The most important caveat here is time frame. 

So put simply, "audentes Fortuna iuvat" (fortune favours the bold) when it comes to investing. As an adviser, my primary job is to establish what level of risk is appropriate to your goals. If you are retiring in 5 years and wish to pay off your mortgage at that time, investing in 100% in small caps might make you a good return, but you might have less than what you started with, this is an unacceptable level of risk. If you just started work and have 30+ years to retirement, the probability of your investment being worth less than where you started is drastically reduced. 

This mind set also extends to areas such as business partnerships. You start a business with your best mate, things are going well and you have a gentleman's agreement on each of you owning 50/50/. Simple right? This is how a good majority of major disputes start when someone decides to exit a business. This could be through poor health or just deciding to go in a direction that you do not both agree on. Then how do you sell your half, what is it worth? Putting this on paper can vastly reduce the risk of a dispute, yes it might cost a little in legal fees and time to get a solid agreement down on paper but this changes both of your position from "I don't know" to "check the agreement". Sure we cant have an agreement for every eventuality but as an adviser I greatly dislike the unknown and planning ahead reduces this risk substantially.

A classic example of risk comes up when we talk about insurance. A regular question is, what if I pay all this money for insurance and never use it? Well my first response is always, "lucky you!!"

Lets use an example where you earn $100,000pa (with a 5% pay raise each year) and spend $2,000pa to ensure this amount would continue if you were unable to work or deceased (income for your family). If you start at age 35 and work to age 65 you would have earned $6.64 million dollars!!! No small sum. If you did not pay to protect yourself you would earn $6.77 million that's over $132,887 more in your pocket at retirement. If we use the same example, but you were unable to earn and income and forced to retire at age 50, you would have earned only $2.20mil a loss of $4.57 million. Is the risk worth the reward here? Considering how many claims I have seen and dealt with, not at all. 

Whether you see an adviser, have a mentor or go and speak to your mates father who is an astute businessman. Breaking down problems in terms of risk and return is crucial to getting ahead in life. Many "risks" are completely invisible until they present themselves, you could be just in the right place at the right time and find yourself at the top of a multi million dollar company. Or you might invest your life savings in a "sure thing" only to see it go up in smoke.

Experience and knowledge are key in identifying risks before they occur. Once these are identified, you can confidently move ahead and take those risks that allow you to succeed in life, but still have a plan for the worst.  

Shaun Clements - North of River Financial