How to determine the insurance needs of a client

Col Fullagar looks at the steps required when determining the insurance needs of clients.

A question that is of fundamental importance to advisers is what is the safest and most logical way in which to provide advice?

When an advice, as distinct from a no-advice, sale is being made, the need for some form of fact-finding is not in dispute.

A series of questions should be asked of the client so the adviser can identify if the client’s financial plan is at risk of interruption if any death, sickness or injury occurs.

The answers to these questions will be used to establish a need for term, trauma and total and permanent disability (TPD) insurance.

Further questions should be asked in order to identify the extent of the need. The answers to these questions will be used to establish the benefit amount that should apply for the term and trauma cover.

The adviser or the paraplanner will undertake the necessary analysis of the information obtained from the client so that the adviser can present the client with a Statement of Advice (SOA) that will contain the appropriate recommendation.

Compliance is often credited (a nice way of saying ‘blamed’) with requiring the adviser to make a so-called optimal recommendation in the first instance. The optimal recommendation is theoretically everything the client needs in the area of risk insurance protection irrespective of constrictions such as a premium budget.

So for example, if the client’s circumstances are such that $2.5 million of term, trauma and TPD and $15,000 a month of income protection and business expenses are potentially needed, this is what should be recommended.

The fact that the client will be quite unable to afford this level of insurance is effectively ignored. Once this optimal recommendation has been discussed with the client and it is discovered that it is well outside the client’s level of affordability, adjustments can be made at the direction of the client.

The well intended and somewhat logical reason for the ‘optimal’ approach is, however, that by placing this recommendation in front of the client, the adviser is better protected.

A paper trail will exist in which the adviser is seen to have provided a totally sound and comprehensive recommendation notwithstanding this recommendation is subsequently rejected by the client due to price constraints.

The concern for the adviser is twofold:

• the adviser may know instinctively that the optimal recommendation will be little short of a waste of time; and
• there is a concern that by presenting an obviously unrealistic recommendation, the client’s trust in the adviser and the adviser’s advice will be adversely impacted.

From time to time advisers have questioned the above approach on the basis that it would seem more logical and natural to make the initial recommendation taking issues such as budgetary constraints into account.

A possible solution may lie in repositioning part of the current understanding of risk insurance recommendations, specifically the part to do with the calculation of the benefit amount.

The calculation of an appropriate benefit amount within some areas of risk insurance advice is quite objective. For example:

• Income protection insurance — generally (but certainly not necessarily always) 75 per cent of earnings is insured. Earnings is a known amount, therefore, an objective recommendation can be made.
• Business expenses insurance — up to 100 per cent of the ongoing fixed expenses of the business are insured. Fixed expenses are known, so again an objective recommendation can be made.
• Term insurance — in the area of business needs, the quantum of the business debt can be objectively ascertained, while the replacement cost of a key person and the amount of insurance for business succession purposes, whilst somewhat subjective, are calculated using an objective formula.
• Again in the business area, the TPD need will be much the same as for term insurance, and in some areas of personal need, such as debt reduction, an objective recommended benefit can be calculated.
• With trauma insurance — there is a level of objectivity about the average medical costs of the more likely to occur of the insured events (ie, heart attack, stroke and cancer), while insurance amounts to cover certain matters associated with lifestyle changes (eg, debt reduction, pre-funding retirement, overseas holiday, etc) can be calculated with reasonable accuracy.

If the issues set out above represented everything that needed to be protected, an objective recommendation could be made and the ‘alleged’ compliance position might be better justified. Often, however, there is more to the risk insurance recommendation than this.

While some areas of need can be objectively calculated others cannot, as they are dependent not just on the insured event occurring but also on the unknowns of what causes it to occur or how severely it occurs.

TPD is a good example. While part of the purpose for TPD is to cover the business and personal needs set out previously, its primary purpose is to cover the additional capital and revenue expenses that would arise if the insured was rendered permanently unable to work as a result of a sickness or an injury.

Capital costs might include:

• the cost of home or car modifications;
• the cost of a new, more suitable home or car; and
• the one-off costs of medical equipment or medical care, and so on.

Revenue costs might include:

• the cost of ongoing maintenance around the home — the things the insured used to be able to do but can no longer do because of their medical condition;
• the cost of mobility — it may be that the insured is unable to drive, making the use of taxis necessary; and
• ongoing regular medical and rehabilitation care.

It would not be unusual for the capital and ongoing revenue costs to add up to many thousands of dollars. But whether or not the extent of this expenditure is minimal or considerable will be greatly dependant on the type of sickness or injury that causes TPD and the severity of that sickness or injury.

If an electrician is permanently unable to work because of the loss of several fingers on one hand, there may be some capital and revenue costs associated with this.

However, if the same electrician is permanently unable to work as a result of multiple sclerosis or the early onset of dementia, these costs would be much higher.

Similarly, when the need for trauma insurance is considered, should the adviser stop at making a recommendation revolving around the three most likely trauma insured events to occur or should other insured events be considered?

• For the younger, more active client, should an allowance be made for the paralysis risk?
• For the more mature client, should the cost of dementia be protected against?

In other words, unless the client and the adviser know in advance what sickness or injury is going to lead to the payment of a claim (which clearly they cannot), it will not be possible to arrive at an objective or optimal benefit amount recommendation.

Fortunately, there is a way forward. When undertaking fact find questioning, the adviser might ensure that not only are the areas of risk insurance exposure identified but also the client’s order of priorities in mitigating these exposures.

If all the areas of exposure can be objectively measured, the adviser might be able to provide an optimal style recommendation.

If, however, some of the areas of risk exposure have a subjective calculation basis, it will not be possible for the adviser to arrive at an optimal recommendation.

In these situations, which are likely to be encountered in the majority of occasions, the adviser will need to identify one more piece of information: what the client’s budget range is in regards to the total premium cost.

This range can be calculated as a proportion of total earnings (e.g, 1.5 to 2 per cent) or it can be a dollar amount (e.g, $8,000 to 12,000).

Having ascertained the client’s budget range, the adviser simply starts to consider the various risk insurance needs identified by the client in the order of priority, again identified by the client. Issues are attended to until they either have all been resolved or the premium budget has been expended.

If the issues have all been resolved within the budget range, the adviser can return to the client with the Statement of Advice and tell them that all identified issues have been resolved but there remains some premium budget that can be expended on further issues (that would also be identified) if the client so wishes.

If the premium budget has been expended before all issues can be resolved, the adviser can return to the client, indicate what has occurred (i.e, what issues have been resolved and what issues remain) and then indicate to the client how much additional premium would be needed to resolve the remaining issues.

The process is quite natural and may even be compliance friendly.

Note: The above process is presented for discussion purposes and should not be used without appropriate sign-off by the adviser’s licensee or legal adviser.