While we regularly profile a client’s attitude to investment risk, what about their attitude to protection risks? Gregor Sked, senior protection development and technical manager, Royal London considers the implications with a case study example.
As a father to an 11-month-old son, my baby-proofing skills are being put to the test. Most parents can attest that young children’s desire to explore doesn’t factor in any perception of risk, whether they’re climbing stairs, jamming things into electrical sockets, or opening drawers and cupboards. It may be a sleep-deprived thought process, but this got me thinking about how clients are made aware of the risks that they face and the measures they could take to prevent foreseeable harm.
Of course, the financial advice process is less about installing stairgates, but instead involves explaining risk to clients and providing them with appropriate solutions to match their attitude to risk and to reach a desired outcome. Risk profiling is a commonly used technique to help identify clients’ future financial objectives, the resources available to help them achieve the objective, and their ability to tolerate any losses along the way.
While risk profiling tends to be used during investment advice, the principle can apply to other areas of financial planning, such as protection advice.
The role of protection advice
Historically, protection advice has been viewed as the distant relative of holistic financial planning. It is often only considered if a mortgage is being arranged, resulting in a misconception that it’s purely a transactional conversation.
In reality, protection advice should be viewed as the foundation on which holistic financial advice is built. After all, failure to acknowledge mortality and morbidity risk could have a profound impact on the entire family unit’s financial resilience if they encountered some of the most common protection risks – premature death, serious illness or long-term absence from work caused by illness or injury.
By profiling a client’s attitude to protection risks, it can help them to understand whether they have suitable provisions in place to deal with certain life events and allow you to identify and address any protection needs they have.
Profiling protection risks
To be able to profile a client’s attitude to protection risk, we need to know three things.
1. Risk appetite – how willing is the client to take risks to achieve a particular financial objective? Are they wanting to ensure their family can repay a mortgage debt or cover an inheritance tax liability on death? Do they want to be able to maintain their standard of living if they’re unable to work due to illness or an injury?
2. Risk tolerance – how much risk are they prepared to take with their money? This can depend on a few factors, for example, the amount of time they have to reach their financial objective, their age, and their experience of dealing with risks. A younger client might find they have a higher risk tolerance than an older client who might be looking to protect more of their capital ahead of retiring.
3. Risk capacity – what financial loss can the client afford to lose? What resources will they be able to fall back on if disaster struck? Do they have adequate savings, a secondary income, existing insurance or even employer sick pay arrangements?
Exploring these three areas can help categorise clients in a similar way we might categorise a customer’s investment risk approach: adventurous, balanced, or cautious.
Case study
Mark and Lynsey are both aged 36 and married with one dependent child. Mark is an IT analyst, and Lynsey is a marketing manager. Combined, they have an annual income of £95,000.
The couple own their own home valued at £300,000. They have a repayment mortgage with an outstanding balance of £260,000 and term of 20 years.
Both of their employers offer a three-month full pay, three-month half pay sick pay scheme, death-in-service benefits of four times their annual salary and a workplace pension which both Mark and Lynsey are members of, investing in the scheme’s default fund.
Mark and Lynsey consider themselves to have a balanced attitude to risk and see their ability to maintain their standard of living a key financial objective.
While they have high outgoings, they do have some disposable income left each month. They are not utilising any savings vehicles and have no financial protection arrangements in place.
Their employer’s sick pay and death-in-service schemes will offer some financial resilience, but only if they remain in employment. Their workplace pension scheme will provide them with retirement provisions and a capital sum on death while in employment. However, the lack of any other financial provisions to replace their incomes on death, illness or injury suggest that they might have a more adventurous attitude to protection risks, which doesn’t quite match the attitude to risk that they believe they have.
Final words
By adopting the protection risk profiling approach, it should not only make protection advice an easier conversation to have by being able to identify clients who are potentially underinsured, but it should also help you evidence that your holistic financial advice is taking into account the Consumer Duty requirement to avoid future foreseeable harm.
