What are the options for reducing life insurance premiums while maintaining the integrity of core coverage?

Inflation – are we looking through the wrong lens?

“May you live in interesting times” is an English expression, full of irony and often claimed (without evidence) to be a translation of ancient Chinese curse.

Regardless of its uncertain provenance, it seems a more than accurate summation of the current challenges faced by consumers around the world.

Investment markets are well down, and volatility is up. Interest rates are up, not enough to earn a decent return on cash, but enough to send mortgage repayments skyward while property prices crash. And then there is inflation. Thanks to a perfect storm of climate related emergencies, war in Ukraine, geopolitical tensions with China and the continuation of Covid related supply chain issues, inflation has been rocketing, around the world.

The terms ‘cost of living’ and ‘crisis’ are increasingly appearing together, like the latest Hollywood celebrity couple.

From an advice perspective, these times are especially challenging. For the year ended 30 June 2022, the cost of a comfortable retirement for a couple rose by over 6%, forcing retirees to to eat into more of their likely shrunken capital just to maintain the stats quo^[1]. Stock market losses are likely to force pre-retirees to keep working longer than they had planned. Families in large households are being particularly hard hit by mortgage stress, rising petrol and electricity prices, and school fee increases which seemingly defy gravity.

Most recent commentary about inflation in the financial media has centred on its impact on the sharemarket, and how advisers might rethink and restructure client portfolios to best survive and thrive in the current climate.

But this emphasis on the investment response to current challenges, while important, perhaps overlooks the far more fundamental need clients have right now – for help and guidance on how to manage their cash flow and savings. It might not be exciting, but in the context of ‘holistic’ advice, helping your clients get the household finances in order might be the most important thing you can do currently to keep their financial plans on track, preserve wealth, demonstrate value, and protect your client relationships.

What exactly is happening with inflation?

The causes have been well discussed, but where exactly have the impacts of inflation between felt?

ABS data for the June 2022 quarter^[2] showed prices climbing by 6.1% – the fastest annual pace since 2001.While prices across most categories are rising, the largest increases over the last 12 months have been^[3]:

• automotive fuel 32.1 per cent
• oils and fats 14.0 per cent, coffee, and tea 9.3 per cent, breakfast cereals 8.8 per cent, bread 7.2 per cent, soft drinks 7.6 per cent
• vegetables 14.6 per cent, beef 9.4 per cent, lamb 7.1 per cent, milk 5.3 per cent
• furniture 8.5 per cent, floor coverings 6.9 per cent, home maintenance 5.9 per cent, cleaning products 8.0 per cent
• domestic travel and accommodation 7.8 per cent

Of course, averages can sometimes be misleading, and just as the impact of inflation varies from state to state, so too different demographic groups feel the impact of price rises in different ways.

One group hit hard is retirees

One group of particular relevance to advisers – and particularly challenged by inflation – is retirees. Indeed, in a recent global survey^[4], 49% of advisers said that underestimating the impact of inflation was the number one error made by people when planning their retirement.

In Australia, an often-quoted benchmark is the cost of a ‘comfortable’ retirement, as calculated each quarter by the Association of Superannuation Funds of Australia (ASFA).

As of the June 22 quarter, ASFA estimated the cost of a comfortable retirement to be $66,725 for couples and $47,383 per year for singles^[5], representing an annual increase of 6.2% for comfortable couples and 6.7% for singles. In lump sum terms, ASFA now estimates the comfortable retirement benchmark to be $640,000 for a couple, and $545,000 for singles^[6] (Of course, these figures are national and don’t reflect differences between states, or between cities and regional areas).

Reflecting their different life stage, relative to young singles and working families, ‘retiree inflation’ is influenced more by healthcare costs and less by rent and mortgage costs.

Whilst age pensions are pegged to CPI, the number of retirees receiving the pension continues to fall, meaning more people who are self-funded and therefore without this automatic ability to keep up. According to ASFA, only 40% of new retirees receive an age pension, down from 60% a decade ago and 80% when compulsory superannuation was first introduced^[7].

Mortgage stress is about to go through the roof

Perhaps even more impacted by inflation – and the associated efforts to curtail it through inflation rate rises – are those families with large mortgages, especially those in major capital cities where property prices are much higher.

In one widely publicised survey^[8], up to 65% of respondents said they held some level of concern they could default on their loan at some stage due to interest rate increases. Homeowners in NSW (38 per cent) are more likely than those in Victoria (27 per cent), Queensland (24 per cent), and South Australia (23 per cent) to feel ‘very’ concerned.

The same survey also found that more than one in six homeowners have little or no clue how the lift in cash rates will impact on their budgets, while almost a third do not consider increases in the cash rate at all when budgeting for a home loan.

Of those who did factor interest rates in, 40% had budgeted for a maximum cash rate of 3%, beyond which they would experience ‘significant’ mortgage stress. (At the time of writing, most bank economists expect rates to rise to 3.3% and beyond^[9]).

Some observers are also concerned that the average 3-month processing lag – the time it takes for RBA rate rises to actually be reflected in higher repayments – means that the true impact of even the first tranche of aggressive hikes is yet to be felt.

Clients with large families are more likely to hold larger mortgages (on larger properties), and have larger educational expenses, especially if they have children in private schools in Sydney, where fees have risen 50% in the last decade – and are expected to hit $70,000 per annum within 15 years^[10] – or in Victoria, where parents are paying the highest median private school fees in Australia^[11], with a price tag this year across all high- and low-fee non-government schools of over $14,000.

What do they want? Advice on cash flow. When do they want it? Now.

It seems then that two groups in particular, established families and retirees – both of whom are significant advice client cohorts – are seeing their financial and mental wellbeing come under additional pressure in the current climate. Meaning they need additional help.

Expert advice in managing household cashflow and budgeting is arguably the most foundational type of financial advice you can give to clients. Traditionally this has been to form the building blocks of lifelong wealth building. Right now, however, this advice is needed to protect the wealth already accumulated and keep their financial plans on track.

From a client perspective, demand for this type of advice has always been strong, not just for younger clients, but across all age groups, with over one quarter of Baby Boomers and 40% of Gen X clients saying it is a service they value^[12].

The need for help in getting household budgets under control is likely stronger now than it has ever been, and consumers around the world are turning to advisers, and financial institutions for help.

Recent UK research^[13] found that 57 per cent of mass affluent people have sought guidance or advice on managing the increased cost of living. This same group was found to have been twice as likely to consult a financial adviser for this guidance.

At the same time, a survey of US bank customers^[14] revealed that their widespread expectation that their bank would support them during these difficult times was equalled only by their widespread disappointment in how little their bank had communicated to them over recent months, beyond general ‘economic updates’,

All of which is likely to ring true in Australia.

As AFCA Chief Ombudsman David Locke said recently^[15], ‘there was a lower level of hardship complaints in FY22 which reflected the work the banking sector has done to support consumers in recent years, however we’ll be working with industry and consumer groups as we monitor the impact of cost-of-living pressures and higher interest rates on financial services consumers in the coming year’.

So how can financial advisers help?

Those experiencing financial challenges are twice as likely to encounter mental health issues according to a new report commissioned by ASIC and Beyond Blue^[16], and perhaps the first port of call for advisers is to have calming, coaching conversations with their clients. Find out how your clients are coping and if there are any particular stressors.

Secondly, consider offering your clients help in managing their cash flow. This could involve formal advice, or the provision of budgeting tools (e.g., My Prosperity) that clients can use, either by themselves or in conjunction with you).

Many advisers will also be in a position to provide direct assistance in a third, and major way, helping clients with their mortgage costs through refinancing (if you are aligned with a mortgage broker), and/or their life insurance premiums.

Strategies to optimise life insurance premiums

Life insurance provides crucial financial protection, and arguably becomes more important during challenging times. As such, maintaining coverage in the form you recommended it should always remain a priority. Realistically however, there will be times where retail policyholders – your clients – have no choice but to seek opportunities to trim premium costs. Many clients will be tempted to seek to reduce their sums insured, or cancel their cover altogether, simply because they perceive these to be the only options available. As an adviser however, you are privy to a far more extensive range of alternatives, and here is where your expertise can come to the fore.

Fundamental to understanding where to look for these cost saving opportunities is knowing how premiums are actually calculated. Beyond age, gender (neither of which you can change!), retail life insurance premium factors you may be able to influence are:

• occupation
• sports and past times
• health status
• sum insured
• premium type and payment frequency
• extra cost options
• linked or non-linked
• super or non-super
• income protection benefit periods and waiting periods

Savings opportunities possible with existing policies

1. Review loaded premiums

Premiums can be loaded because your client smokes, has a high-risk occupation or hazardous pastime, or because of the state of their health, all of which may have changed since they first took out their cover and therefore may be eligible to be removed by request. They may have retired from their sport, or changed to lower risk occupations, for example becoming office based rather than field based. Sometimes this can occur as a promotion at the same company, so try and stay up to date with your client’s specific work duties, along with their title and job status. Similarly, they may have stopped smoking, or got over an issue with their blood pressure, both of which attract removeable loadings.

2. Income protection waiting and benefit periods

Work by Zurich^[17]shows the impact on IP premiums of changing benefit and waiting periods. For example, the premium difference between a 30-day waiting period and 90 days could be as much as 41%. Finding alternative ways for your client to survive those early months of a claim (e.g., through available liquid assets or taking some/all of their accumulated sick leave) could allow significant savings without needing to reduce the benefit amount, which could be critical for more serious, longer-term claims.

Similarly, a 6-year benefit period can be as much as 26% cheaper than age 65. With KPMG statistics^[18] suggesting the average IP claim is 14 months for cancer and 18 months for mental health, however for many claimants, transitioning back to full time work can be a journey, taking time and involving extended periods of rehabilitation, which over the course of a claim can extend to many months and even years. As a result, and with the possibility of longer-term partial disability claims, it’s important for advisers to consider the appropriateness of supplementing reduced benefit periods with lump-sum total and permanent disability benefits.

3. Removing optional extras

Extra cost options that are frequently added to retail policies include claims indexing, boosted coverage for certain predefined events, and trauma reinstatement. Removing these may be preferable to reductions in core coverage.

4. Re-assess sum insured and decline indexing if appropriate

There can be a variety of reasons why the sum insured under some or all of your client’s policies may exceed their needs (equally, there are reasons why cover could now be inadequate, but the focus here is savings!). Their circumstances may have changed, for example they have moved and reduced their debt levels, or they have changed jobs and their income is permanently lower. Or the sum insured has got ahead of their circumstances through the effect of CPI indexing over the years. Either way, a regular review of the appropriateness of cover amounts should be a priority and may open up opportunities for savings.

5. Linking policies

Standalone covers offer more protection than ‘linked’ policies because a claim for one benefit doesn’t reduce the sum insured for other benefit types. However, for that reason they are also more expensive than linked covers. Just like changes to IP benefit and waiting periods, changing from standalone to linked coverage represents a meaningful reduction in overall coverage, however it may be one where circumstances make it a viable strategy for reducing cost without lowering the sum insured for the first claimable event.

6. Structuring through super

Death, TPD and IP can all be written through retail risk-only super products, and paid for via rollover, with obvious benefits for a client’s cash flow (there are downsides in that super-based policies have less generous benefits and definitions, e.g., TPD can only be ‘any’ occupation). Whilst some may argue this is merely about payment method rather than premium savings, some policies do benefit from the passing back of a 15% fund tax deduction, translating into lower premium rates for the equivalent cover.

7. Payment method

Payment method changes allow either the opportunity to save on premiums (by switching from monthly to annual), or smooth cash flow (switching from annual to monthly).

8. A last resort

For those clients with very temporary, but extreme, financial challenges, a premium holiday option – offered by most insurers – could be worthy of consideration. The obvious downside is that the client has no protection while the holiday is in effect, the upside is that cover recommences once the client starts paying premiums again, making it considerably more preferable (especially for older or non-cleanskin clients) to cancelling cover, then needing to be re-underwritten.

As can be seen, the options available to match appropriate cover levels with client budgetary constraints are numerous. The way some of these options are offered may vary from insurer to insurer, meaning the pathways available for each client will require specific investigation as needed.

Conclusion

Consumers around the world are facing a cost-of-living crisis, with pressure on household finances the highest it has been in decades. Two large advice cohorts – retirees and established families – have been more impacted by these challenges than most, increasing their need for a more foundational type of financial advice around their cashflow management. As well as providing clients with much needed guidance around their cash flow management, advisers are ideally placed to help clients unlock potential savings with their life insurance, by finding ways to trim premium costs whilst minimising any compromises to core coverage.

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References:
[1] https://thenewdaily.com.au/finance/superannuation/2022/08/21/superannuation-jumps-in-july/
[2] https://www.theguardian.com/news/datablog/ng-interactive/2022/jul/27/cost-of-living-australia-price-changes-inflation-2022-sydney-melbourne-brisbane-interactive-data-explorer-june-quarter
[3] https://nationalseniors.com.au/news/finance/retirement-spending-is-up
[4] https://www.financialstandard.com.au/news/2022-is-the-hardest-year-to-retire-report-179796726?q=cost%20of%20living
[5] https://startsat60.com/media/news/seniors-dealt-another-blow-as-the-cost-of-a-comfortable-retirement-increases
[6] https://nationalseniors.com.au/news/finance/retirement-spending-is-up
[7] Ibid.
[8] https://www.realestatebusiness.com.au/industry/24277-cash-rate-rises-cause-for-concern-for-65-of-aussie-homeowners
[9] https://www.canstar.com.au/home-loans/interest-rate-forecast-australia-2022/
[10] https://www.smh.com.au/national/nsw/sydney-private-school-fees-jump-50-per-cent-in-a-decade-20220906-p5bfuy.html#:~:text=Fees%20at%20Sydney’s%20private%20schools,expensive%20schools%20within%2015%20years
[11] https://www.theage.com.au/national/victoria/victorian-private-school-costs-rise-to-nation-s-highest-as-pandemic-fee-freeze-ends-20220126-p59r9w.html
[12] ‘My Generation Report’, ING, 2019.
[13] https://www.ftadviser.com/your-industry/2022/08/24/half-of-savers-turn-to-advice-and-guidance-amid-cost-of-living-crisis/
[14] https://www.businesswire.com/news/home/20220630005108/en/Customers-Demand-More-From-Banks-as-Cost-of-Living-Crisis-Bites
[15] https://www.professionalplanner.com.au/2022/07/less-complaints-about-bad-advice-but-more-on-product-interpretation-afca/
[16] https://www.professionalplanner.com.au/2022/08/more-services-needed-to-improve-financial-wellbeing-asic-beyond-blue/
[17] https://www.zurich.com.au/advisers/tools-and-resources/change-navigator/individual-disability-income-insurance.html
[18] https://home.kpmg/au/en/home/media/press-releases/2020/06/joint-study-reveals-large-rise-life-insurance-claims-costs-22-june-2020.html

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