In this exclusive and thought-provoking insight for IFA Magazine, Gregor Sked(pictured), Senior Protection Development and Technical Manager at Royal London, makes the point that having appropriate protection policies in place doesn’t just safeguard your client’s portfolio but also ensures that their financial planning goals can remain intact too – whatever unforeseen circumstances come their way. Gregor also reminds us why advisers to undertake regular protection reviews in the same way that they are used to doing for clients’ investment portfolios.
The asset class ‘quilt’ as shown below in Fig 1, is a smorgasbord of colours and numbers used to show the returns generated by different investment asset classes in recent years.
Fig 1 – Royal London Annual asset class returns – the asset class ‘Quilt’
Source: Lipper, Royal London, as at 31.08.2024. Other than YTD columns are full years. Past performance is not a guide to the future. Prices can go down as well as up. Investment returns may fluctuate and are not guaranteed so you could get back less than the amount paid in. Mixed Asset return = Governed Portfolio 5. Governed Portfolio returns are net of 1% Annual Management Charge.
This ‘quilt’ is a visual reminder that the future is uncertain and unpredictable. In an investment context it highlights the need to diversify a client’s investment portfolio. Clients can see that this year’s top asset likely wasn’t last year’s and probably won’t be next year’s either. Since the future is uncertain, having a mix of assets helps to smooth out longer-term returns and reduce risk.
The role of protection
Many argue that protection is essential for any portfolio; it is uncorrelated with other assets and unaffected by changes in major banks or global politics. It provides a crucial financial safety net for clients, ensuring they and their families remain financially resilient during unforeseen events, such as premature death, serious illness, or injury. This ensures they won’t have to rely on savings, investments, or other assets to secure a replacement income.
Protection doesn’t just safeguard the portfolio but also ensures that financial planning goals remain intact and in the absence of protection advice, what would the client want to do if the unexpected happened? What would they need to do?
If ill health early retirement is on the cards, your client could find themselves having to delay their retirement goals or take less income in retirement.
Let’s take whole of life policies as an example. They provide the certainty that irrespective of when death occurs, the payout from the claim will be made available and can be used to pay off any expected inheritance tax (IHT) liability. If someone were to try and accrue the funds to pay such a liability through an investment vehicle, for example, how long would it take for them to build up sufficient funds, what do they invest in? and what impact might market volatility have?
Understanding the risk
One of the FCA’s fundamental principles is that firms must give suitable advice to retail clients, and it must have enough information about the client to ensure that this requirement is met. In particular, every client needs to understand the risks that are involved with any investment being recommended to them and how it will meet their needs and objectives.
As Consumer Duty has highlighted, understanding the risks clients face is a key driver behind avoiding foreseeable harm.
In the financial planning world, risk profiling is generally used to help understand the level of losses a client is prepared (and able) to tolerate from a particular investment in return for the prospect of good returns. These risk profiling conversations look at client’s attitude to risk, so how much risk the client is prepared to take and the amount of loss they can afford to bear. But there is also a third area of risk profiling that we can identify. Their risk capacity, so the monetary amount that someone can afford to lose without it endangering their financial objectives. Upon identifying a client’s attitude to risk and capacity for loss we can often define their risk profile.
While this approach is common with investment advice, should we be adopting risk into protection advice? Without addressing a client’s attitude to protection risks, do we risking them walking aimlessly toward foreseeable harm?
Diversifying a client’s protection portfolio
‘Traditional’ protection advice might have consisted of, in the main, decreasing term assurance, often with an element of critical illness cover, the idea being the client has funds available to repay their mortgage debt. But the likelihood of having to take a period off work sick due to illness or injury is higher than dying whilst in employment. So how truly diversified is such protection advice if we’re putting all our eggs in one basket, i.e. just term assurance?
Rebalancing the protection portfolio
Ongoing monitoring of a client’s investment portfolio is an essential part of the advice you provide and, where investment variations have occurred, you’ll likely be rebalancing their portfolio to ensure the funds aren’t pushing the client’s portfolio into a higher risk profile than necessary.
Much the same should be done with protection advice. Ongoing reviews to consider whether a client’s protection risks have increased or reduced should be carried out and evidenced. The outcome of which, could mean no changes are required, an increase or reduction in cover might be needed, or even that a new protection product should be included within their portfolio.
So, how do we ensure clients have a sufficiently diverse protection portfolio?
Premature death, illness and long-term absence from the workplace because of illness or injury are three risks that could derail someone’s financial resilience. Which is why we need to be considering income protection, family income benefit and even critical illness cover within a client’s protection portfolio.
