Insurance affordability has been a key concern in the last year or so. For many clients we planned ahead for this years ago by selecting Level premium structures but were the assumptions we based this strategy on flawed?

With the significant changes in Income Protection insurance coming at the end of September we are having a very close look at how to move forward with both new and existing customers. Unfortunately, we have very little visibility on where this road leads as insurers have been playing their cards very close to their chest. While we have indicators of what these new products might look like, we simply cant see past September 30 so its difficult to plan past this point with certainty, which is a key role of a risk advisor.

How do you work out a Level Premium?

Level Premiums are based on your age when your insurance policy began. Essentially, your premium is averaged out (typically until age 65) so you pay more now and less later, when you are more likely to claim. Stepped premiums are the standard option and increase with your age and likelihood to claim so while it might be cheap to start with you will eventually get priced out, so if you are young, why not pay a little extra to have cost effective cover when you need it? Sounds good in theory but predicting the future can be tough and while insurers still need to make a profit they also need to be competitive in a harsh marketplace.

There are a lot of assumptions used to price this over 30 or even 40 years. I am certainly no actuary but a few factors that appear to have severely been underestimated are:

• Interest rates - The neutral rate is around 6%. It’s been far under that for years now and likely to be for some time. Insurance pools must be held in low risk assets which are seeing neutral or even negative returns.

• Rates of claims - Generous terms, more proactive medical systems and more educated and aware clients mean that new claim rates have been increasing. Plus, people on long term claim tend to stay on claim and receive monthly payments for decades.

• Reduced new business - Legislative red tape strangling advisers and insurers who design and distribute insurance products have drastically reduced the number of new (and healthy) lives that are joining insurance pools.

I am sure that there are numerous other factors at play here and as an adviser I am not privy to what goes on in Life and Reinsurance offices. I do however see recent pricing increases and note that Level premiums are going up around 20% faster than Stepped premium structures and with the focus on Level premiums and have to seriously wonder if this will ever stop. If you are interested in the most recent increase please follow this link to a Zurich update. Zurich are a very well established and historically stable insurance provider in Australia and these premium increases have been lower than many this year but this is not the first time they have applied this in the last 3 years.

The new reality

Even up to 18 months ago, it was a widely accepted rule of thumb that if it was likely you might need insurance cover for over 12 years, a level premium structure was more cost effective as the cross over for when stepped overtook Level was around 12-14 years away. I ran this calculation on a Doctor in his mid 30s last week and it appear this cross over point is now 22 years away. This calculation does not include any future increases such as described above so its quite possible that paying a level premium has no benefit at all. Quite simply, this throws the shop worn knowledge about level premiums out the window.

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What is the outlook?

You can always switch between Stepped and Level premiums at any time. It appears that this option will continue past October 1 but there is still uncertainty there. Its very likely that Level premiums will not be available on new Income protection contracts past this point but existing contracts should be “grandfathered”.

Of course, if you have been paying higher premiums for some time to try and manage future cost this can be tough to walk away from. If this trend does continue its likely that level premiums will quite simply become unaffordable, exactly the same as stepped later in life, its just a matter of when.

If you have held a level premium for a long term, even with these recent increases, switching to stepped may still might increase your premium. You will need a good adviser to assess this for you as each policy and person is different.

As I have said before there is certainly no one size fits all strategy here but it does appear that relying on a cost effective protection strategy based solely on insurance is a thing of the past. Moving to self insurance is down to your unique needs and may take some time to properly establish so while good cover is often essential in the short term, so is reducing debt and building up income producing assets for the longer term.

In a recent release it was confirmed Westpac has sold it’s life insurance Business Westpac/BT Life to TAL Dai-Ichi Life, which will now be the largest insurer on the Australian market by a wide margin. This marks the final separation of Banks and Life Insurance companies in Australia. So where to from here and what does it mean for existing customers? As always, the devil is in the detail so ill try and break this down in key points but don’t miss out on all the embedded hyperlinks.

If you’ve been paying attention, you will know that since the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry began in 2017 banks have been running for the doors. Prior to this BT/ Westpac was well positioned as a life company as not having a large “legacy” book but also having a good quality product with significant new business prospects. This was aided significantly by their associated BT Financial Advice arm which allowed them to distribute their products and they invested heavily in technology and consolidation of funds management platforms such as IOOF, St George, and BT wrap which are only now in the final stages of consolidation into BT Panorama, which has been leading the field in many aspects of platform innovation.

It appears Westpac/BT lost out on the game of musical chairs when they realised a little too late that the music had stopped. Banks have now all exited advice, financial advice red tape went to insane levels while the carrion birds began to circle. The objective of the Royal Commission was to protect consumers (ordinary Australians) but it would appear that in the mayhem the only winners so far have been unregulated channels like bitcoin, gambling and industry super (if you really want to nerd out, see this sitting of the House of reps last week starting at 13:58:15 but my favourite part was at 14:43:21) advisers, product manufacturers and of course consumers have all borne the weight of these changes as the regulations pile on.

BT also made some headlines recently with significant premium increases. They had been one of the hold outs on premium increases as it has been over a decade since a “re rates”. In order to balance their books, and look even half attractive for sale, they opted to increase in one relatively large hit rather than stager over many years as most insures have done. There are numerous factors completely external to BT and life insurance as a whole at play here but the core is that sustainability is in question.

So what does this mean for BT customers?

Well, other than premium increases that were already on the cards not much will change. This sale is yet to complete until end of next calendar year and even then it’s unclear if TAL will continue with BT as a separate brand and business unit as they are doing with Asteron right now or if they absorb it into their own book.

One thing is for sure. If you have a BT contract this can not be changed to your detriment. The very core of “guaranteed renewable” insurance products is that as long as your continue paying your premium they can not be altered. Even if they are not on sale any more as we have seen with the removal of Agreed value income protection last year.

It is however possible that medical definitions will not be upgraded in keeping with current definitions as was dictated by the code of practice as this will likely no longer be an “on sale” product. BT have market leading definitions at this point so its uncertain of how quickly these degrade.

Level premiums and sustainability of legacy products

This type of premium structure is often misunderstood as “your premium wont go up”. This may have been true for some years, or even the past decade with BT, but this is not how it really works. Premiums are based on the age you took it out so yes, theoretically you could begin a policy at age 34 and still be paying the premium of a 34 year old at 64, when you are far more likely to claim, but re rates mean that even 34 year olds are more expensive than they used to be. This is exacerbated with legacy products when there are no new entrants to the insurance pool. This article goes into more detail.

The writing is on the wall, can you self insure?

Current insurance products are simply too generous and with low interest rates, low affordability and high claims its clear that they are not sustainable.

The previous assumption that you could rely on life insurance products such as Income Protection and TPD to cover you for long or even medium term illness throughout your working life appears to be flawed.

Early in your career this strategy may still remain cost effective but over the long term we are seeing a shift away from this reliance to a more balanced approach to risk protection. This involves superannuation savings and debt reduction for extreme cases but also needs to consider grown more liquid assets with time based outcomes such as 3 months, 5, 10 or even 15 years.

I do often hear the classic “I’d have been better off putting my premiums in the bank!” Well, early in life when you have millions of dollars in potential earnings and premiums might be a couple thousand per year this is obviously flawed but the paradigm of being able to rely on an insurer long term is certainly changing.

As always, you should work with a licensed adviser to help you establish a strategy that is right for you. All events that are covered by insurers are financially significant and should be given the gravity that they deserve. Insurance companies of course know this and design products with this in mind and far more often than not act with their policy holders in mind. Not only because they are made up of people who actually care about their claimants and policy holder but also because they are bound by more contract laws and regulations than most other industries.

The reality of this situation is changing every day. We have a significant dates coming up in early October with IP contracts being stripped back to basics and DDO coming into place. If you saw the House Standing Committee on Economics sitting (link above) last week you might agree that there is a slow realisation that red tape has gotten out of control and removing some of this should go a long way to turning back the tide.

With this unclear future, even with rising premiums, if you have a guaranteed renewable contract its nice to know you are well covered while this all settles down.

As usual this is my thoughts based on my experiences and readings. While care has been taken this is not to be relied upon as personalized advice and Shaun Clements and NOR Financial as an authorized representative of Dirigere Advisory has provided this only for education purposes.

There is a lot of misunderstanding about fee structures when it comes to Financial Advice and there are many reasons why this is the case. As we are completely transparent with anyone we talk to, we thought it might be time to dedicate a piece directly to this hotly contested subject and share this information with a wider audience. To keep it simple ill break it down to 3 parts:

1. Insurance brokers are subject to the same rules, licensing and obligations as financial planners, they must work for you.

2. Commissions do not vary from insurer to insurer and they are not “free”. You can not access “retail” cover directly. It always pays a licensee, unless they opt out.

3. Conflicts of interest and how to determine if your adviser is right for you

Please keep in mind that this is just a discussion based on my experience and many other good advisers run their own businesses in different ways for different reasons and each model is not without merit. As you might tell many patients, just because you don’t understand it, doesn’t mean it’s wrong, there are many variables to consider and we rely on experts for their own experience in weighing these up to suit a unique situation.

Your Adviser works for you but it wasn’t always that way

Financial Planner/Adviser is a relatively new designation. In 1997 (when I joined my father’s advice practice as a very green 17 year old) the then Keating govt had just introduced this thing called “Superannuation”. With a compulsory 9% of Australian’s salaries going into an account they couldn’t really withdraw financial institutions wanted to grab as much market share as they could as fast as they could. So how would they do this?

Life Insurance is an old business. Australians are typically more underinsured than their counterparts around the world as the “she will be right mate” spirit shines strong through our sun bleached skin. Life offices were attached to larger financial institutions such as banks and investment houses and had small armies of “agents”. These agents were very highly trained in selling techniques and persuasion that helped them to move more product (insurance premiums and funds under management) and they were heavily incentivised to do so. Paperwork was easy and products were pretty simple so these agents or “brokers” simply acted as a shop front for the bank or insurance company they worked for. If a broker did not properly consider your personal needs and circumstances and you ended up getting into a financial mess it was essentially a buyer beware scenario and you had the same kind of protection as if you bought a toaster than did not work after 3 months. Without oversimplifying the process, the ominous sounding “Agent” became the approachable and caring “financial planner” who asks you about your pets and helps you “achieve your dreams” etc all while taking an ongoing fee of 1-3% on funds under management and getting paid more than you even spend in year one on insurance. If they were very good, they might even get an all expenses paid trip to europe or a fat “volume bonus” for selling a whole lot of one product or fund. This is not to say that these guys were all sharks. I know many advisers, my father was one of them, that had a very strong set of morals and would walk through fire for their clients but for every one that stood their ground and earned a modest living there would be another not bound by such ethical dilemmas, especially with significant financial incentives to help them rationalise their behaviour.

Enter the regulators

In 2012 the Future of Financial Advice (FOFA) reforms were introduced. Essentially this was the first real attempt to deal with conflicts of interest and the cornerstone was around a novel concept known as “Best Interest Duty” which meant an adviser had to consider their clients best interest before their own. This of course is a grey area but this revolved around the concept of a reasonable basis for providing advice and recommending products. Could you reasonably sell life insurance to a widow with no dependents at age 75 for a $15,000 annual premium, even if she asked for it? That one is not so grey if you ask me but it illustrates a point. Advisers had to be appropriately trained and sat a diploma of financial planning which is a 4 part course that could be completed in a few days but at least provided some basis for the adviser knowing what they were doing. Advisers had a complaints body in place that made it possible for clients to be reimbursed for poor advice. This was hard going for many with increasing documentation killing profits and potential claims for misconduct threatening the financial institutions that employed these advisers. The industry was starting to become a profession.

In 2018 the Royal Commission into Banking, Superannuation and Financial Services Industry (RC) began. Still being considered in postmortem, this highlighted some of the weaker points of FOFA but ultimately threw a few advisers and smaller financial institutions under the bus and moved on. What it did make clear is that these rules are in place and they must be followed… or else. Before the RC was even over banks were running for the hills and going into damage control. In the last 2 years almost every single bank and many product manufacturers have disposed of (yes that word is harsh for a reason) and distanced themselves from their advice arm or “licensee”. FASEA and the Code of Conduct came into being and at the end of this year all advisers must have passed the entry exam and be qualified with a an appropriate recognised university degree by 2026. They must also act in a professional manner and there is supposed to be a code monitoring body (yet another regulator) but FASEA actually got dissolved at the end of 2020 so once again we are all left wondering, what next.

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Commissions and how they really work

There are no Commissions on Investment or Super. None. Since 2014 they have been banned and the final holdout products known as “grandfathered" commissions ended on 31st Dec 2020. Fees can be charged through investment or super but this must be opted into at least every year or fees are turned off.

Insurance products do have commissions, advisers can now choose only 2 remuneration options across all insurers:

• An upfront remuneration which is 66% of the insurance premium in year 1 and 22% ongoing

• A level remuneration which is 30% of premium per year.

No exceptions. All insurers are the same. If a policy is cancelled or amended within the first 2 years the adviser must return these funds to the insurer. This is a far cry from the heady days where commissions in year 1 might be 120% up front and this could be cancelled and replaced every 13 months allowing clients to shop around or advisers to “churn”. Advisers can choose to rebate commissions or “dial down” so they receive nothing and charge a fee for the work they do instead. The fundamental nature of insurance is that many policy holders pay a small sum to cover the cost of one claimant needing a large sum to cover their debts or family living costs in the event of their death or disability. This logic is often applied to the insurance pool (insured Australians) as a whole and the idea is that small clients subsidise large clients. Personally, I think we should charge a fair price for work done even if it does mean we have to turn smaller clients away as we are then not overcharging large clients. These are the key reasons for this argument and I cover this with every client. Some are happy to choose the commission model, the majority choose fee for service but it’s always an informed choice, to the point where I am pointing out any commission I might receive with a neon sign and asking “do you understand? Are you sure?”.

Commissions and cross subsidy

If you are an average medical professional you will have an income over $100,000. You might also have a mortgage of $1,000,000 you want to cover. Considering the cost of cover these days for a person in their mid 30s you might spend roughly $4,000pa to cover yourself well for Life, TPD, Trauma and Income Protection using a level premium structure. This pays a $2,640 (66% commission in year 1) which is lower than the $3,500 average fee. The adviser is essentially deferring payment as next year they recieve $880 (22% commission ongoing) and the adviser breaks even year 2. While its a point of contention, there is no obligation for an adviser to do any work to receive ongoing commissions. It is good practice but it’s not required. As your premium increases over the years the adviser collects 22%. This can be rebated but this is complex and can go horribly wrong as it did with McMasters and Big refunds who no longer exist and now nobody collects or rebates that money.

Dialing down and charging hourly or flat rates

Dialing down reduces your premium by 20-30%, depending on the insurer. The average medical professional above would then reduce their $4,000pa premium to $2,900, a saving of $1,100. Based on the standard $3,500 fee this has them breaking even a little after 3 years. That is if the premium does not increase, which it very likely will. There are no clawbacks, you can cancel and modify whenever you like. Assuming you hold that policy for 20 years and it’s not indexed or rates go up, that’s a saving of over $22,000, enough to pay for more than 6 complete do overs at $3,500. If you are coming in every 2.5 years and completely restructuring your cover, this is not a good option. Forgoing the recent rate rises and legislation changes a policy would generally run 5-10 years with minimal intervention and modification.

Note: You can not modify a policy to “rewind the clock” after its been set. It’s either commissions or dial down. In some cases you can use a “dollar for dollar” dial down where the premium is reduced by the same amount as the commission but this policy has to be held for some time and takes a good adviser to navigate this…or you might get lucky and be able to do this yourself.

Claims

The widely accepted argument is that this ongoing commission covers claims which may have been true some time ago as costs were very low to run an advice practice and essentially a long standing risk business simply had to “farm” clients and keep them relatively happy each year and process claims which can range from simply submitting a form to over a years worth of highly skilled work and advocacy. We charge based on the work we do and costs range from $500 to $14,000. One thing that has changed over the years is that insurers often provide a “financial planning benefit”. Typically, if a claim is over $100,000 as a lump sum this benefit pays the adviser $2,000-$10,000 to manage the claim for you. Considering this benefit covers most costs and the majority of clients don’t claim, we think collecting commissions for this promise is not in our clients best interest.

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So which is the right choice for you?

Choosing between Commissions and Fees is one part of the picture but this is something your adviser can help you determine. Before you get there though you need to know a few things.

Is my adviser qualified?

Does you adviser have the education they need? Have the passed the FASEA exam? If they don’t by the end of the year they will have their license stripped (This might not be great for a long term plan but it doesn’t mean they cant do the job now). A great resource to check all this is on the Asic Adviser register. You can see who your adviser is licensed by and their education and experience plus any bans or disqualifications they might have. If your adviser has finished their diploma only and started practicing in Nov 2020 and is telling you they are well equipped to handle complex retirement and investment planning I’d be a bit cautious.

Who does my adviser work for?

The old adage used to be if you went to McDonalds you weren’t going to walk away with a bowl of noodles. AMP was up until recently the dominant force in advice in Australia and when you went to them for advice more often than not you would walk away with an AMP super fund, AMP insurance and maybe a squeaky toy. Since the royal commission the onus to consider all products in market from all product providers has been significantly increase and policed. So yes, your adviser might work for a licensee that is owned by a bank or insurer but this doesn’t mean they are not working in your best interest. It doesn’t pay to match that knowledge, available on asic register again, with the advice you receive. Oh and worth mentioning that “independent” or “unbiased” is a restricted term. If your adviser receives commissions for you or any other client they can not use these terms to describe themselves. As we work under Dirigere Advisory, which is not owned by a bank or financial organisation, we are able to proudly call ourselves “Non Institutionally Aligned” which does not have the same ring to it.

Ask around, find a fit, follow your gut

Who do your colleagues use? Are they happy with them? Google is an advertising platform so googling “Financial Advice for Doctors” will likely find you the firm that is happy to bid the highest for advertising space...that you will ultimately pay for. If you are an employee at a hospital with simple needs do you need a firm that runs its own world class accounting and legal support and wants to sell you an investment property to go with it all?

At NOR we operate a business model designed specifically for doctors and their families. All of our clients very similar and this allows us to provide specialised advice for this specific demographic and our pricing model is designed to suit that. We are not trying to be everything to everyone which allows us to keep the costs for specialised advice low. We wont deal with direct shares, we currently wont give you complex retirement planning or deal with clients with over 5mil to invest. We dont sell properties or scheme and most important of all, like many of our sole trader or contract clients, if we don’t do work, we don’t get paid.