Author – Jonathan Gibson, Managing Director, Wells Gibson
There’s an anonymous quote, “You don’t buy life insurance because you’re going to die, but because those you love are going to live.”
Risk is a vital area to consider but one that many people underestimate. By risk, I mean protecting you against the unexpected and eliminating the potential risks from long-term illness and/or disability, critical illness and death by transferring the risk to insurance companies.
Your assets can also be exposed to risks from relationships, taxation as well as business risks if you’re a business owner.
The key thing is to identify where the potential risks are in your life, then define which risks can be mitigated by financial products, and determine how much is prudent and how much is too much.
Worth adding that, mitigating potential relationship and business risks will normally require you to liaise with a lawyer.
The idea of protecting yourself from risk isn’t new – it’s a feature of many parts of our lives. We have car insurance in case we’re involved in an accident. We have home insurance in case of fire, theft and flood. We have travel insurance in case flights get cancelled, the list goes on.
There have certainly been times in my life when I’ve been incredibly glad that I have had insurance. One of the most pivotal was in December 1995. I was living in a first-floor flat in Aberdeen and had returned home late after a Christmas party – I was tired and in need of my bed.
At around 2 am I was woken by shouting on Whitehall Road. I’d been in a deep sleep and felt somewhat disoriented as I moved towards the window to see what the fuss was about, only to hear stones being thrown at my bedroom window. In the street were two young lads, both shouting, “Fire!” I looked below and saw smoke billowing out from the entrance to our granite tenement, below my bedroom window.
There were six flats in my building, with two on the floor above mine, and my first thought was to warn the other residents. I made my way upstairs, only to discover both tenants were away for Christmas. The smoke was choking me as I tried to make it downstairs, and I remember making an effort to stay low.
The fire was so fierce and the smoke so thick and black, I wasn’t able to make it down the stairs to safety. With the smell of burning timber and paint almost overwhelming me, I retreated to my flat. By this time, I could hardly breathe and realised I would need to jump out of my lounge window to reach safety.
I opened the window and shouted to the lads below that I was coming out, in the hope that they’d catch me or at least try to break my fall. I hung from the window sill before dropping and, thankfully, the lads outside did their best to reduce the impact of the fall. I was rushed to Aberdeen Royal Infirmary in an ambulance and treated for smoke inhalation. Shortly after, the fire service arrived and was able to put out the blaze, which I later discovered had been caused by an electrical fault.
When I returned to my flat, the fire service had to help me in through the same window I’d earlier jumped out of. I was relieved to find that the smoke damage was reduced by the fact that I’d left both the window and my front door open. However, my flat still needed full redecoration and the point of my sharing this is, I was thankful that I had insurance that allowed me to redecorate after the fire.
I was also incredibly pleased to learn that the only other resident in the building at the time had made it out safely. It’s a terrifying experience that I’ll never forget. To this day, I’m grateful that I didn’t panic, nor freeze with fear, and that the adrenaline gave me the courage to climb out of the window.
It was a life-changing experience for me, reminding me how quickly things can change and how important it is to be prepared for the unexpected events that life throws at you.
So, why insurance?
Insurance to provide for you and your loved ones if you are unable to work due to long-term illness or disability and to provide for your loved ones in the event of your premature death needs to be considered as part of your Wealth Plan.
However, unlike other types of insurance, it can sometimes be harder to get people to recognise the advantages and benefits to their family of having this type of provision.
I remember one couple in particular whom I met when I was trying to sell life insurance in the early days of my career, in the early ‘90s. They lived in Peterhead, north of Aberdeen. The husband was a fisherman, which was a very dangerous and well-paid job, and his wife didn’t work.
They lived a very modest life and weren’t extravagant or materialistic but had a good standard of living. I remember asking the wife to explain how she would cope financially if her husband had died yesterday. As they were not financially independent, I was not surprised when she answered that it would be terrible, so I suggested that they take out a life insurance policy.
However, despite much probing to establish why she didn’t want to commit, and answering her objections, I just couldn’t convince her. I tried to frame it another way, by relating her husband to the valuable items she would cover through her contents insurance, but still she wouldn’t commit.
That really stuck with me, this idea that she insured the contents of her house, and yet her husband was earning over £100,000 a year and she didn’t want to make provision in the event something happened to him in the North Sea.
The point of this story is that insurance is important. However, the challenge comes in identifying the financial risks you and your family are exposed to, defining what insurance you need, and calculating how much insurance is enough without impacting on other aspects of your financial life that are important to you. This isn’t about protection for protection’s sake. It’s about provision.
The perspective around insurance should be that you have it because you want to secure all that you value, in other words, who and what is important to you. I have insurance in place, for example, because I want to know that my wife and three daughters would be provided for if something were to happen to me.
Identifying risk is an important foundation for your financial future.
The way I see it, identifying risks is one of the most important foundations for your financial future, alongside lifetime cashflow planning and taking that whole-of-life view of your income and expenditure.
When you think of it in terms of building a house, you wouldn’t go ahead and start building a home if you didn’t have the proper foundations in place, and planning for your financial future is no different.
You wouldn’t invest your time and money into a house that was likely to collapse within five years, so why would you invest your time or money into a future with very shaky foundations?
Identifying your risks is key!
You also need to identify the potential risks beyond your personal life, especially if you own and run a business. It’s about considering all aspects of risk in that setting too, not just the obvious ones.
For instance, recently I spoke to a couple who were both dentists and owned their own practice which operated as a partnership in conjunction with another dentist.
I asked them why they hadn’t incorporated their practice and they couldn’t give me an answer.
The thing was, as well as the tax advantages of incorporation, they hadn’t considered how they were putting themselves and their family at risk by operating as a partnership rather than a company.
As a partnership, their personal assets, such as their home and investments, were potentially exposed to the risk of loss if anything went wrong; whereas as owners of a company, their home and investments would generally be protected.
As soon as you recognise that risk, it makes sense to incorporate your business because it limits your personal liability.
Furthermore, as an owner of a practice or business, you ought to have a documented risk assessment which is reviewed regularly to identify the business risks, those who are at risk, as well as the existing controls and action required.
There can also be risks associated with certain actions that you take. For example, you might decide you want to loan or give your children money to help them buy their first property, but you’re concerned about their choice of partner, perhaps because he or she is unreliable with money – what would happen if the relationship broke down? Would their partner leave with a share of the money?
Of course, you can’t control your child’s choice of partner, or whether their marriage lasts, but you need to identify these risks so that you can put measures in place to mitigate them. You’re not expecting the relationship to fail, but you’re planning for the worst, just in case. It’s about being prudent and seeking legal advice.
Within the world of wealth planning, this might be referred to as wealth protection. While I prefer to think of it in terms of identifying and mitigating risks, ultimately the outcome ties back into the concept of stewardship: you’re protecting your wealth and the life that’s important to you.
The question is, do you need financial products to mitigate risk?
Financial products are one way of mitigating risk, and are appropriate in certain circumstances, but they’re not a catch-all solution. There’s no insurance policy out there to protect your money if you’ve lent your child £50,000 to buy a house with their partner and their relationship breaks down, for example.
That said, a long-term client of mine recently reminded me that when he lent money to his daughter to buy a house with her former partner, he registered a Minute of Agreement and also took out a second Standard Security over the property. That protected the loan when they split up, but unfortunately, the 2008 financial crash meant that the value of the property was reduced and he had to take the hit when it was sold since his daughter could not. So even with the forethought, my client still lost out.
But there are situations where financial products can be incredibly useful in mitigating risk. Take a dentist, for example, who relies heavily on their income to support their family. If they are the main earner and are unable to work for a long period of time due to illness or disability, a financial product like income protection or critical illness cover could provide the support they need.
Indeed, one of my clients, who owns a dental practice in Perthshire, has been receiving income over the past two years from an income protection plan and very recently received £400,000 because one of his insurance plans includes Total Permanent Disability.
A friend and highly respected Chartered Financial Planner, Simon Glazier of Stewardship Wealth, shared the following story with me and it illustrates just how useful insurance can be. It’s also a lesson in why it’s always worth submitting a claim.
One of Simon’s friends suffered from a heart complaint when he was in his 20s. Open-heart surgery ensued and the issue was fixed. He had critical illness cover, so Simon took a look at the policy for him, only to discover that the description of the illnesses covered indicated that he wasn’t covered.
However, Simon and his friend discussed the matter and decided to submit a claim anyway. The end result was a £100,000 payout, all for relatively little effort. The moral of this story is that it’s worth submitting a claim just in case.
Practice-owner professionals and business owners should also consider what would happen to their business if they were to die. Would their patients, clients or customers just go elsewhere? If that’s the case, then the business would cease to have any real value.
To make sure that their family is taken care of if they suddenly passed away, having a Relevant Life Plan paid for by their company could be prudent. It will at least mean that their family can be provided for, which will lessen the impact of the business substantially falling in value.
Another way of looking at risk and wealth protection is providing for the people you love. What you’re doing by taking these steps is securing the wealth that you’ve worked hard to accumulate.
You should also evaluate the financial products you have as you go through life. For example, someone who is financially independent will need fewer financial products. They don’t need income protection or life insurance to protect against loss of income, because their lifestyles are no longer dependent on income from paid employment or their business.
In general, financial products that provide for you and your family in the event of long-term illness, disability or death, are more readily used throughout your working life, and thereafter they become less relevant.
And, know this, you can protect your wealth from the taxman.
While Inheritance Tax doesn’t pose a risk to your wealth while you’re alive, it does impact how much you’re able to pass on to your family. Thinking about this as another risk to your wealth is therefore sensible, especially once you’ve embraced the concept of stewardship.
Interestingly, life insurance can help in this instance…
If I have a client who is concerned about Inheritance Tax, but who isn’t in a position to give their money away to reduce the value of their estate, I recommend that they put in place a straightforward life insurance policy that’s written in trust.
What this means, in essence, is that if Inheritance Tax does become payable after their death, that money comes from the insurance policy rather than their estate. It’s simply another tool for reducing the risk to your wealth.
In summary, risk is a vital area to consider but one that many people underestimate. Insurance is likely to be a need during your working life so identify your risks, don’t disregard financial products and remember you can use insurance to protect your wealth from the taxman.
If you have any questions in relation to this blog, please contact the Wells Gibson team.