I’m a wealth specialist at Zurich, writing about and presenting on tax, trusts, investments, pensions and IHT (with a spot of whole-of-life thrown in), and I was recently asked to add a protection string to my bow.
I was a little reticent at first but remembered some advice I’d received long ago: “Stick to what you know and adapt it to your current situation.”
This set me thinking about the investment world and if any of it reads across to the world of income protection (IP). I quickly realised there are several similarities, especially the challenges in getting clients to buy.
‘Past performance is no guide to the future’ is a common phrase used for investments, and it applies to IP too. Why do some clients believe that, just because they’ve been healthy in the past, they won’t suffer a serious illness or injury in the future?
Of course, in the investment world, we tend to look at this with a medium- to long-term horizon (certainly beyond five years and typically five to 10), but when thinking about ill health, clients either assume it’ll never happen to them or, if it does, it will be way into the future. Wrong!
More than 131 million working days were lost to sickness or injury in 2017 according to the Office for National Statistics, and one million people in the UK found themselves unable to work due to a serious illness or injury according to the Association of British Insurers.
Other sources show that 40% of the working population have less than £100 in savings, only 10% have any form of IP (personal or employer), and just 19% of those with a mortgage have IP in place.
The Drewberry Protection Survey 2018 suggests that, after protecting their car and home, people prioritise their pets ahead of themselves and cover their gadgets before their income (which pays for those gadgets in the first place).
Attitude to risk, capacity for loss
Looking at attitude to risk and capacity for loss is a central part of an investment fact-find that, amongst other things, helps people understand the potential impact of investment returns on their goals and objectives.
It easily reads across to income protection, though here it is more about someone’s perception of risk (the likelihood of loss of income due to illness) and financial resilience (how quickly they can recover from an unexpected situation).
People struggle to comprehend this because of a psychological phenomenon called the ‘availability heuristic’. In its simplest form, this means we perceive risks more acutely if we can quickly bring examples to mind (such as we’d recently lost our phone or been in a car accident).
The upshot of this is that we feel more motivated to protect ourselves against the risks we perceive to be greatest (whether they are or not). Nuclear power or sunbathing – which do you believe people perceive as posing the greater threat? Research suggests we’re more afraid of nuclear power (especially if we’ve watched Chernobyl), but dying from skin cancer is in fact the bigger risk.
This is compounded by a further phenomenon known as ‘temporal discounting’, which means that the ventral striatum part of our brains assigns a ‘value’ to each risk/option being considered with reference to a ‘reward pathway’. We tend to focus on immediate and shorter-term rewards (most people would prefer to receive £50 a month rather than wait a year for £1,000).
This is a generational thing, with younger generations wanting the new shiny thing sooner rather than later (even if it must go on credit), while older folk tend to consider whether they need or want it and wait until they can afford it.
They say IP must be sold, not bought. One approach to help clients overcome unhelpful perceptions is to draw four boxes entitled ‘phone’, ‘car’, ‘house’ and ‘you’. Ask them to write a value next to each one – these could be £1,000 (phone), £10,000 (car) and £230,000 (house), but what value do they place on themselves?
Some put their mortgage or life assurance value, some their salary and others simply some arbitrary figure, but it should be their salary multiplied by the remainder of their working life (say, £40,000 x 25 years = £1 million). Which is most valuable and should be protected?
You can also question perceptions of value by challenging thought processes. For example, use a budget planner to emphasise the impact of lost income and the affordability of IP (relative to spending on coffees and take-aways, say).
Real-life examples of family, friends or clients who have experienced a loss of income can also help. You could draw upon the experiences from the ‘7 Families’ initiative.
IP sales in 2018 were up 22.6% and at their highest level for 14 years, according to the Swiss Re Term & Health Watch 2019. This reflects demand from self-employed and gig economy workers, employees whose company schemes have possibly been reduced and diminishing state benefits.
However, to put this into perspective, it equates to 148,000 IP policies sold – less than the 200,000 people who went to Glastonbury this year.
From a wealth background, I believe it’s about positioning the need to everyday reality, so here are some of my conversation starters, albeit in simplistic form, for you to develop as appropriate with your clients:
- Homeowners – how long could you pay the mortgage, even if it reverted to interest only?
- Generation rent – how accommodating is your landlord?
- Buy-to-let landlords – how accommodating would you be?
- Shopping – even if your mortgage/rent/bills are covered, how are you going to eat?
- Budgeting – have you calculated your income shortfall and how much you spend on coffee?
- Part-time/gig economy workers – are you a worker with no workplace benefits?
- Self-employed – what would happen if you couldn’t work?
- Protect your goals – how will you save for that car, holiday, wedding, with loss of income?
- Topping-up statutory sick pay/employment support allowance – would £73.10 or £94.25 per week be enough to live on?
- Stopping company IP – what will happen after three or six months when it reduces or stops?
- Extended warranty – why not take one out on yourself, as well as on those electrical goods?
In many of these situations, people will typically say that friends and family will help, but moral and day-to-day support only goes so far.
A new take on intergenerational planning
It is worth considering whether older and wealthier clients, possibly among those facing an inheritance tax (IHT) liability, could help their adult children (and grandchildren) while keeping control of capital by paying premiums (possibly using normal expenditure out of income subject to the Office of Tax Simplification IHT review) on an IP policy for those children.
These generations often don’t appreciate the need for IP or are unable to afford it, whereas their parents can and do. Ask them what might be the financial implications on them if their children were unable to work, suffered a critical illness or died?
Paying the premiums on an IP policy for their children not only passes on wealth in a controlled and IHT-efficient way, but also protects their capital, as well as safeguarding their children’s income and the financial stability of future generations.
Andy Woollon is a retail specialist presenter at Zurich