Taking the right risks with investments

While the issue of life insurance will usually crop up at some point in discussions with a client, HELEN TROUP believes that a discussion of risk should cover the well-being of clients as much as their investments.

Many investment advisers have recognised the importance of providing an integrated financial planning service for their clients and have introduced risk insurance specialists into their practices. More importantly, they have identified that there is more risk attached to the security of an investment portfolio than just traditional investment risks such as market volatility and inflation.

Although an investment recommendation will have accounted for the need for accessible funds, the financial risks associated with illness, injury or death can still jeopardise an investment portfolio. For example prolonged illness can prevent a client from returning to work and they may begin to draw on investments to meet daily expenses. Medical treatment and major lifestyle changes are substantial costs that could also be incurred.

When the ability to meet financial obligations is affected by disability or death, appropriate risk insurance will help protect assets against loss. Traditionally this protection has covered earned income in the case of disability, and assets such as the family home in the case of death.

A greater awareness of financial investments as an alternative to investments such as property means that the range of asset types needing insurance protection has broadened. A well-constructed insurance plan can provide financial support that reduces the need to withdraw cash from investments in order to meet financial commitments or medical expenses.

With income protection insurance replacing up to 75 per cent of your client's income, money is available for daily expenses. Trauma insurance will provide a lump sum that can be used for any purpose, from eliminating debts such as a mortgage to financing medical requirements such as ongoing therapy or equipment. Term life insurance will protect major assets such as the family home and investments that have been established to provide future security or an ongoing income.

Clients generally do not make investment decisions lightly. They expect their advisers to be knowledgeable about strategies, products and market trends, to be aware of and responsive to their financial goals and prepared to understand their attitudes to investing and investment risks.

As such when establishing a client's risk profile, having them confront their attitude to cashing in their investments because of financial pressure can reinforce their commitment to an investment strategy.

The following range of investment scenarios raise issues a client needs to address when investing and demonstrate the value of risk insurance in the preparation of investment strategies.

Investing to produce an income - the client intends to use the income from investments to support and add quality to their lifestyle. How do they feel about using the capital to meet expenses associated with long term disability? How do they think they would cope with consequently losing this source of income? If they did not withdraw the capital, could they survive adequately on the income from this investment?

Wealth accumulation - an income-earner decides to make monthly contributions to their investment so that their initial small investment can build into a substantial future asset. The long term nature of this investment and the regularity of the contributions are vital to the achievement of your client's objective. How would they maintain monthly contributions if they were unable to work because of illness or injury? How would they feel about withdrawing the investment in order to meet financial commitments or unexpected expenses?

Special-purpose saving - saving for a special purpose such as a child's education can be an emotional as well as a financial investment for your client. Would they be comfortable jeopardising their savings goal by having to draw on their investment to replace income lost due to illness or injury?

Investing for retirement - superannuation investments need to be protected against being withdrawn before retirement. What is your client's attitude to relying on government benefits while waiting to access their super if they are disabled over a long period of time? Do they understand the implications of having to rebuild their super from scratch when they return to the workforce?

Risk insurance plays a vital part in an integrated approach to financial planning.

Having appropriate income protection, life and trauma insurance in place means that your client may not need to draw on investments that were set up to provide long term benefits.

Case Study

Sylvia is a 38 year old widow who has $450,000 to invest from her husband's life insurance. With two primary school aged children to support on her salary, Sylvia's main concern is to clear the mortgage on the family home. This leaves her with just over $330,000 to invest.

Her adviser acknowledges Sylvia's twofold concern - that the investment needs to supplement her income (particularly as the children enter the expensive teenage years) without reducing the capital. She has made it clear that as parents, she and her husband had considered the children's financial future when planning their life insurance. Consequently she is reluctant to access more than the amount needed to clear the mortgage.

An analysis of Sylvia's financial circumstances and objectives reveals several facts:

- sick leave entitlements do not accumulate and are limited to 12 days per year

- she has four weeks holiday leave available and is not yet entitled to long service leave

- her only superannuation fund is through her work and the disability protection within this super is restricted to total and permanent disability only

- her "emergency" bank account has been accessed to pay for time away with the children after her husband's death.

Sylvia's adviser recommends income protection insurance to provide 75% of Sylvia's salary if she is unable to work for an extended period of time due to illness or injury. This means she will not have to rely on her investment income to meet day to day expenses. To reduce the cost, the waiting period takes into account any leave entitlements Sylvia may have at work.

Trauma insurance will provide a lump sum if Sylvia suffers from one of the critical conditions listed in her policy. With only minimal savings left in her "emergency" account, the lump sum from her trauma policy could be used to meet large medical expenses and pay for rehabilitation or medical equipment, eliminating the need to draw on her investments.

Sylvia's existing life insurance and other assets are assessed in light of her children's future needs, including their education and ongoing care if she dies before they are able to care for themselves.

Sylvia's adviser has now structured an insurance plan that will support Sylvia's objective of protecting her investment regardless of future financial circumstances.

Helen Troup is national marketing and product manager at Royal & Sun Alliance Financial Services.<I>