Can advisers feel safe recommending new DII products?

ANALYSIS

Col Fullagar acknowledges the difficulties faced by risk insurance advisers in recommending the new range of DII products and says the key is whether, weighing all the facts, such recommendations are safe.

“Is it safe?” …… the harrowing question asked of Dustin Hoffman by Laurence Olivier in the 1976 classic film, Marathon Man.

The same question is arguably never far from the frontal lobe of financial advisers particularly those who engage in the noblest form of financial advice; Risk Insurance ……. and for any who struggle with that last statement, tough – my article, my bias – LOL !!

The question “Is it safe?” gives rise to two follow-ons:

• What does safety look like?

Despite any precautions taken, no one can be certain that one day, with the wisdom of hindsight, a client will not commence a third-party challenge about the appropriateness of some aspect of the risk insurance advice previously given.

Thus, safety does not manifest as an iron-clad guarantee but rather as risk reduction ie a reduction of the likelihood of a challenge occurring and, if it does occur, a reduction in its chance of success.

• How is risk reduced?

Suggestions about how to achieve the desired outcome of risk reduction may differ but will likely include:

• Adhering to the regulatory requirements of compliant advice; to fail to do so not only increases risk but may leave the adviser bereft of professional indemnity insurance protection;
• The possessing of experience and qualifications; wiser and well-qualified advisers are arguably less likely to fall foul; and
• The presence of good intentions; having and displaying a genuine desire to do the right thing carries weight.

All the above and similar will unquestionably assist in reducing risk but it is contended that something else is required, i.e. each and every recommendation made must be underpinned by logic and that logic must in turn possess certain qualities:

• It must be capable of being learnt and taught – adviser focus; and
• It must be capable of being explained and, if challenged, defended – client focus.

The phrase “each and every recommendation” recognises that risk insurance advice includes multiple recommendations, for example:

• The types of insurance products and the insurer providing those products;
• The insurance medium to be used; retail, employer-sponsored group, public-offer superannuation and even direct insurance,
• The premium structure and ownership of recommended products;
• The benefit amount; and
• In regard to in force/existing risk insurance, whether to replace, retain or amend those policies.

Each of these “recommendations” warrants its own focus but this article will only consider the last, i.e. the treatment of existing risk insurance; specifically, and topically, if a client has in force pre-APRA income protection insurance, on what logical basis might a recommendation be made to replace, retain or amend that cover?

Disclaimer – What follows is a generic suggestion, the appropriateness of which must ultimately rest with the financial adviser after considering the specific client’s unique needs.

Always and Never !!

The presence of an underlying logic means that two words should rarely appear in a recommendation; always and never. The use of either of these words can immediately render redundant any otherwise logical basis for the advice.

The only time always and never are validly used in a recommendation is when they refer to absolutes i.e. ”I always present a recommendation in such a way as to enable the client to make an informed decision.”

Thus, notwithstanding the significant differences between pre and post-APRA income protection insurance policies, the temptation should be resisted to take a position of retention at all costs or, in effect, to advise the client to “Never replace the existing cover”.

The Process

Again, despite the considerable pre and post-APRA differences, the process undertaken to reach a recommendation of whether to replace, retain or amend existing cover is fundamentally the same as that which would have been undertaken in the past with the only difference being that the new policy choices are considerably less attractive than was the case pre-APRA mandating.

In regard to the generic process, mention is made of an article available online ie “Replacement Business Is No Joking Matter” – Money Management 24 March 2019.

The Risks of Replacement

Because of the extent of the differences between pre and post-APRA income protection policies it is crucial to clearly, concisely and consistently document and enunciate those differences to the client such that the clients are enabled to make an informed assessment about the risks of replacement of existing cover.

Whilst all material differences should be considered, typical APRA-mandated differences include:

• Indemnity cover, the only option

To the extent that agreed value income protection insurance is no longer available, indemnity cover becomes the only option.

The indemnity impact is that, if there is a reduction in the insured’s earnings between when the policy started and when a claim starts, the benefit payable may be based on less than the full insured benefit.

Whilst the above might be considered “reasonable” if the reduction in earnings was long-term and/or permanent, short-term temporary reductions can occur for many reasons resulting in financial prejudice to the insured being more likely and to a greater extent.

• Reduced flexibility in Pre-Disability Earnings (“PDE”) calculation

PDE was, and often will continue to be, averaged over a 12-month period, however, post-APRA there is greatly reduced flexibility in the calculation basis. Instead of “Any 12 consecutive months since the policy start date”, a typical PDE calculation will become “The 12 consecutive months immediately prior to the date of disability”.

The impact of this change is that the likelihood of less than the insured benefit being payable is greatly increased, for example if there is:

• An economic or industry downturn;
• A change in employment status;
• The insured taking long-service, sabbatical, maternity or paternity leave; or
• An illness or injury that impacts on earning capacity but not to the extent of validating an income protection insurance claim, for example, a long-term, chronic condition such as multiple sclerosis or musculo-skeletal deterioration

Additionally, issues leading to claimant detriment can arise out of a claim starting within 12 months of:

• Someone commencing work, for example, a graduate;
• An existing insured effecting an increase in cover subsequent to an increase in earnings coming out of a new role or promotion in a current role; and
• An insured returning to work after an income protection insurance claim but suffering a new insured event.
• Two-year Own Occupation

In many post-APRA policies, after two years on claim the basis of assessing total and partial disability changes from Own Occupation to Any Occupation ie reasonably suited by education, training or experience.

The result is that the extent of subjectivity in the claim assessment process is exponentially increased.

The insurer being enabled after 2 years to redetermine the occupation against which the claim is assessed brings with it considerable uncertainty for the insured not only in regard to what occupations the insured might be deemed capable of performing by way of their education, training or experience but also what happens if an occupation is considered reasonably suited but there is no available opportunities for the insured to be employed in that occupation.

A further pragmatic issue is the length of time the ETE assessment process may take and what happens to benefit payments during this hiatus particularly if there is a disagreement between the insurer and the insured after the 2 years of Own Occupation payment has ended.

In summary, the risk to a client of replacing existing income protection insurance cover with post-APRA cover is the loss of any or all of the above.

The Risks of Retention

Whilst the risks associated with replacement of existing cover are clearly considerable, there is also a risk in retaining existing cover with the risk being the likelihood of considerable and unaffordable increases in the premium that compromises the insured’s ability to retain current and/or appropriate cover

It would be logical to assume that if existing income protection policies were causing insurer losses to the extent that there have been significant premium increases to such an extent that APRA felt the need to intervene, these losses may well continue, leading to more and even greater premium increases.

The position may even be exacerbated by the fact that the existing income protection portfolio will be closed to new business. If the outcome of is was that healthy lives move their insurance to more affordable cover elsewhere, the morbidity experience of the remaining portfolio may deteriorate further leading to more frequent and larger premium increases.

The risk of retention is thus, at what point does any increase in the premium cost of the existing income protection insurance begin to compromise the financial ability of the client to retain appropriate types and levels of insurance cover, not only income protection but across the client’s entire risk insurance portfolio?

The impossible challenge is, of course, that the adviser does not know what future premium increases will occur and the insurer, even if it knew, is unlikely to communicate details in advance.

Faced with the unknown and impossible, an alternative is to work with that which is known and possible ie assess by how much would the insured’s income protection insurance premium need to increase before it compromised the integrity of the client’s risk insurance portfolio?

The above is feasible because the current income protection premium and premium for the balance of client’s risk insurance portfolio are known. Also, client affordability is a traditional component of the risk insurance advice process.

By assessing the % increase required and considering the theoretical chance of that increase occurring in the next 12 months, a logical recommendation, albeit not an entirely robust one, can be based on the risks associated with retaining existing income protection insurance cover.

If a relatively small increase, for example 5%, in the income protection premium would cost-compromise the existing risk insurance portfolio and it is reasonably considered that an increase of this magnitude could occur prior to the next risk insurance review, a recommendation of REPLACE might be made.

If, on the other hand, a relatively large increase, for example 50%, in the income protection premium would be required to cost-compromise and it was reasonably considered that an increase of this magnitude is unlikely to occur prior to the next risk insurance review, a recommendation of RETAIN might be made.

If the extent of any increase required was such that no clear way forward was evident, a recommendation of AMEND might be made with this manifesting as, for example:

• An increase in the waiting period;
• A reduction in the benefit period; or
• A reduction in the insured benefit amount.

Notwithstanding the above, the words Always and Never must be recalled in that, despite a compelling issue in regard to affordability existing, the client’s unique circumstances may mean that a contrary recommendation is made. Circumstances warranting this action might result from:

• The client’s health being such that the chances of a claim being made in the foreseeable future are increased; or
• The client’s financial position being such that affordability, either by way of improvement or detriment, could soon materially change.

Summary

As indicated, the above is only one suggested way of approaching the challenge of advising in regard to replacing, retaining or amending pre-APRA income protection insurance cover. There are no doubt others but the crucial point remains …….. whatever the basis of the recommendation, the question must be asked “Is it safe?”

Col Fullagar is the principal of Integrity Resolutions Pty Ltd