Taking up the burden

One of the big sleeper issues of Australian — indeed, global — financial life is the transfer of risk from government and corporations onto individuals.

This trend is beginning to catch the attention of the International Monetary Fund (IMF), some highly regarded US academics and the former head of our own Reserve Bank, Ian Macfarlane.

And it’s a trend that has major implications for advisers and their clients, in fact, no other profession has the mix of financial and people skills required to teach people about risk and to help them manage it.

As events like the failure of Westpoint and Bridgecorp highlight, without proper advice and counsel many individuals are taking risks they don’t understand and putting their futures at stake as a result.

Many individuals are poorly prepared for the risks they now take. Their retirement savings are inadequate and their debts high. Australians are vastly underinsured and product providers, financial planners and industry bodies need to work hard to make insurance affordable, understandable and easier to buy.

Taking up the burden

Whether it’s saving for retirement, meeting health costs, structuring employment or funding a child’s education, people today bear far more financial risk than their parents ever did.

This risk shift is happening not only in Australia but also in countries such as the US, UK and New Zealand. How individuals deal with these new risks is not an abstract policy debate. It has vital implications for the financial security of individual Australians. As such, it represents a major challenge for financial planners and the whole financial services industry.

The move from defined benefit superannuation to an accumulation model (shown in chart 1) is only one example of the transfer of risk from corporations and the state.

The end of job security

More flexible industrial relations laws, increased female participation, new communications technology and the growth of the services sector have seen a dramatic increase in self-employment over the past two decades. Between 1995 and 2004, the number of small businesses in Australia increased by more than 50 per cent.

The benefit of this trend is a more flexible economy and more flexible employment patterns. The downside is increased financial insecurity for many Australians, especially in the early years of building a business. Figures from Insolvency and Trustee Service Australia illustrate this point. The annual number of bankruptcies rose ten-fold between 1973 and 2006.

Owe is me

As highlighted by former RBA Governor Macfarlane, household debt, whether assessed by the ratio of household debt to the total value of assets or by looking at the amount of interest paid as a proportion of income (the debt servicing ratio), is now at an all-time high.

A thousand choices too many

More than two decades of reform in the financial services sector has given Australia one of the world’s most advanced financial marketplaces.

Part of that development has been a massive increase in the range and variety of financial products on offer. This choice is a sign of healthy competition and gives individuals better access to products that suit their needs.

Yet for many consumers this choice has become a burden.

As Jacob Hacker points out in his book The Great Risk Shift, “we have serious psychological blinders when it comes to estimating risk and acting on what we know”.

A wide choice of investment options is not in itself a solution to increased financial risk. The number of registered managed investment schemes in Australia has increased by more than 50 per cent over the past five years, highlighting the increasing complexity of the choices facing investors today (see chart 2).

One investor surveyed by BT put it this way: “The more choices you have, the more careful you have to be and, therefore, the more you have to know and the more informed you have to be. That’ll come down to [having] too much information; people won’t know what to do.”

Without education and expert independent advice, the range of choice available to investors may actually compound the problem.

Under the safety net

In the past, the provision of government or company-funded healthcare, education and pensions took the costs involved in acquiring these services away from the individual.

However, state-funded education, healthcare and pensions are now backstops rather than comprehensive solutions.

Consumers are now shouldering some of this risk themselves and, as a consequence, must understand the need for more and better investment if they expect to live comfortably between careers, enjoy higher quality healthcare and aspire to a more comfortable retirement and a better education for their children.

Financial planners need to educate consumers so they understand their taxes, Medicare levy and Superannuation Guarantee payments will not necessarily guarantee them the level of education, healthcare and retirement they feel they deserve.

The insurance ‘gap’ and financial planners

According to the Investment and Financial Services Association (IFSA), Australians are underinsured to the tune of $1,370 billion.

As a result, many Australians and their families are significantly underinsured and deeply exposed to the financial risks that flow from injury, illness and loss of life.

Some key facts highlight the situation:

n despite its tax deductibility, nearly 70 per cent of small business people do not have income protection (IFSA, 2006);

n two working parents in their mid-30s need life insurance cover worth around 10 times their taxable earnings. Only 4 per cent of such families have that level of cover (IFSA, 2005);

n one in three Australians will become disabled for more than three months before the age of 65 (calculations based on Institute of Actuaries Australia Interim Report on Disability); and

n one in three males and one in four females will be directly affected by cancer before the age of 75 (The Cancer Council Australia).

It is clear then that Australian consumers are deeply exposed to financial risk that insurance could help shield them from. Why is this so — and what can be done about it?

If I shut my eyes it will go away

Part of the problem is human nature. We are often reluctant to address painful realities. Advisers we spoke to said many individuals genuinely believe that talking about death or disability will bring disaster upon them, and so some advisers shy away from discussion about insurance.

In a time of booming financial markets, it’s a lot easier to focus on the idea of long-term investment and wealth creation. Discussing strokes, heart attacks and cancer is not so simple.

The life insurance industry also has to answer to negative consumer perceptions about cost, complexity and claims ratios.

According to Gerald Kerr, a member of IFSA’s Protection Gap Working Group, there is “prevailing perception by end-consumers that life insurance products will inevitably be too complicated to understand, and that there will also be accompanying fine print”.

Policy lapses

Australians’ ability to manage financial risk would also be helped by better government policy. While both sides of politics have supported retirement incomes reform, policy support for greater insurance coverage has often been lacking — or counterproductive.

Consumer concerns about the cost of insurance are not helped by stamp duties that add to the cost of cover. There is also a growing backlash against over-regulation of the financial services industry, which has made it harder for planners to offer the insurance advice their clients need.

Advisers we spoke to mentioned the many hours it takes to explain insurance to their clients. The burden of post-Financial Services Reform compliance has a vicious side effect — only clients with big policies justify the time it takes to advise on insurance. Many ordinary Australians are denied the cover they need because the costs of providing advice are too onerous.

Danger time

Even a mild recession that coincides with illness or injury could expose previously comfortable families to deep financial hardship. That hardship would not just be a ‘belt-tightening for affected families but, potentially, a real financial crisis that involves the forced sale of assets and dramatically reduced choices in education, lifestyle and retirement.

Easier to buy, easier to sell

So what can financial planners and product providers do to take some of the risk away from families?

Fortunately, the problem of underinsurance is now well understood.

Industry associations like IFSA’s Protection Gap Working Group are helping to promote the importance of adequate insurance to the consumer, as well as lobbying the industry to improve the promotion of insurance products.

One of the areas where promotion is most important is price. On BT’s figures, an ‘average’ consumer could buy themselves over $500,000 of life cover, or income protection that would cover 75 per cent of their annual salary should they become unable to work, for less than it costs to buy comprehensive insurance for the average family car.

Interestingly, the likelihood of the family car being stolen is one in 21; whereas the chances of someone becoming disabled for more than three months before the age of 65 is one in three. How many consumers understand the significance of that cost comparison, when compared to the actual relative risks?

Everything old is new again

So far, financial planners and their allies in the financial services industry have done a reasonable job in educating clients about the new realities and helping them manage some of those risks.

However, the risks are increasingly large, with life expectancies and health costs continuing to rise at a pace that far outstrips the resources consumers are committing to manage that combination in retirement.

Australia’s booming economy and record breaking share market have helped to hide a multitude of sins, but fund managers and planners need to act now, offering new choices and acquiring new skills so they can help their clients attain true financial security. Failure to do so would be a failure of the industry and call into question its role in the community.

Implications for financial planners

Today we change jobs, careers, partners and homes more than any generation in history.

One price of that freedom is increased financial risk — the risk of running out of money between jobs, of retiring poor, or drowning in debt when death, illness and injury strike.

The financial planning industry is ideally placed to use its unique expertise as risk managers to take the burden off individuals and place it in better hands.

Taking up the ‘risk challenge’ offers financial planners a great opportunity if they can embrace its possibilities — new sources of income, enhanced community status, the chance to learn new skills:

n Advisers might consider the ‘Great Risk Shift’ as a chance to redefine their role in the community. Who is better positioned to take up the burden abandoned by companies and governments? Financial planners can use this opportunity to refresh their approach to insurance — do they have the skills to sell it and access to the products that make it easier for clients to buy?;

n Insurance providers can provide training, presentations and marketing material to help advisers meet the needs of their clients. Advisers can join industry bodies like IFSA in lobbying the government for insurance tax relief and other government support; and

n Product providers can improve their offering to deliver insurance policies that are comprehensible, reliable and good value.

Mark Smith is the head of life insurance at BT Financial Group .