“The secret of all victory lies in the organisation of the non-obvious”
— Marcus Aurelius, Financial Services Lawyer
With the considerable changes to insurance since the Life Insurance Framework and changes legislated by APRA in the last few years, insurance is an area that we are seeing advisers approach less and less.
While this may be understandable from a commercial perspective, there are some situations where the importance of insurance simply cannot be ignored.
In particular, gearing is an area where we see advisers miss the mark with insurance through poor risk needs analysis, not preparing for potential adverse underwriting outcomes, or by not addressing insurance needs at all.
In the real-life case study to follow, we will explain why asking the right questions, and taking action in the right order, is critical in order to create an insurance strategy that helps protect gearing advice.
The Relevant Personal Circumstances
- Newly de facto female, 45 years old
- High disposable income (salary $300,000 pa, approximately $50K pa surplus)
- No financial dependants at this stage
- Owes most of the mortgage on her principal residence (just under $1M debt on appx $1.35M home valuation)
- Small at-call cash savings appx $20K
- Employer superannuation with just under $900K Life/TPD insurance and appx $400K accumulated balance
- Used to have salary continuance cover with previous employer but recently started a new job and has not provided details about whether or not there is any salary continuance cover with her new salary package
- No Trauma insurance
The Considered Recommendation
Originally it was decided she would wait and save for a deposit for an investment property. However, a recent salary increase and moving in with her partner has since changed this position:
- Borrow against principal residence to fund the deposit for the purchase of an investment property, bringing both the principal residence and investment property up to maximum LVRs;
- Investment property is positively geared and stress tested for interest rate increases;
- Rollover all but $10,000 to a new superannuation fund with the remainder in BT superannuation to keep insurances in place;
- See an insurance adviser to go through a risk needs analysis and consider more insurance.
At first glance, it looks as though a gearing strategy would be great … if all goes according to plan.
However, we all know that even the best laid plans can fail.
Complications and Consequences
Just for a moment think about what would happen if:
- Client becomes permanently disabled (or suffers a serious Trauma event);
- They lose their ability to repay the mortgage on the principal residence;
- There is no allowance for medical costs, modified housing needs, prostheses, carer allowance, and other expenses beyond whatever would be offered by Centrelink or the NDIS;
- Since the existing TPD cover is insufficient to discharge the debt on the principal residence, in a longer term claim the home has to be sold (possibly the investment property as well), potentially as a distressed sale, at one of the most vulnerable points in the client’s life;
- While the accumulated superannuation balance could help meet some expenses eventually, the above situation may already have become material to the client before she meets a condition of release from superannuation.
While there are some obvious issues here, like many things in life, the devil is in the detail. Order matters with this kind of advice, particularly where we are significantly increasing the overall risk of a client portfolio by increasing debt.
A Better Approach
Reverse the order of how the advice is being positioned and provided; either by involving your specialist risk adviser first, or ensuring that comprehensive risk advice is provided as part of your gearing strategy. The client could have been better off seeking risk advice before this strategy was recommended for a number of reasons:
The Fact Find noted that there were medical conditions that needed to be discussed as a part of the insurance needs analysis in order to help determine whether or not the client could obtain new insurances at all, or whether it would be offered but with loadings or exclusions.
We know that not every client will remember every medical event they’ve been through right away. However, a well-prepared underwriting pre-assessment goes a long way to asking the right questions to help assess how likely it is that the client could get new insurance, and therefore how well they could be protected in the event of a disability event.
Automatic Acceptance cover
The existing product provider had automatic acceptance cover available:
- Maximum levels of automatic acceptance cover could be applied for prior to applying for retail cover;
- In this way, the client would already have in place as much as they could reasonably expect to have without undergoing any underwriting yet;
- This is so important, particularly as the client is under-insured, because if the new cover is applied for and declined, it may be too late to go back to the superannuation fund and ask for automatic acceptance cover to be increased, as they will usually ask the member “Have you ever had insurance declined, or offered with substandard rates or exclusions”;
- In this situation, the client could be left with no choice but to maintain what insurance they already have and decide whether or not they are still prepared to implement the gearing strategy.
Impact to cashflow and projections
- Assuming that the client can obtain appropriate levels of insurance, the adviser has not yet factored into the gearing strategy the cost of any additional insurances and how this might impact the client’s goals;
- This could result in the client believing that the benefits of the gearing strategy are greater than they may actually be.
The catalyst effect of the above factors means that the client could do very well if they never become ill, but potentially be much worse off if they do.
Bringing it all together
We’re not saying that gearing advice is inherently bad; it certainly has its place for the right clients, for the right reasons at the right times.
What we are saying is that, in the context of gearing advice, insurance remains a crucial component of managing the risks inherent in a borrowing strategy.
Risk advice specialisation is indeed itself an art, and we aren’t saying that every adviser needs to be a specialist. However, with some careful planning and knowing the right questions to ask, the amount advisers can do to help protect their clients’ ambitious wealth creation strategy is tremendous.
Please contact us at firstname.lastname@example.org if you would like to better understand how we can help you with approaching your advice strategies.