Difficult Conversations - Planning for what can go wrong
As a financial adviser I have a unique relationship with, and insight into the lives of, the clients I have the privilege to work with. Our relationship focuses on the goals that are important to them which ultimately form the basis of the my advice. Generally the discussion of goals and current financial position is quite easy and enjoyable however a financial plan also has to recognise and incorporate the risks that exist which can prevent you from achieving your goals and unfortunately this is much less enjoyable to discuss. This article looks to highlight the risks we each face in our lives and what we can do to ensure we are prepared and able to avoid at least the financial impost these risks involve.
It won't happen to me
As humans we suffer from numerous cognitive biases including the optimism bias; this is a belief that we as an individual are less at likely to experience a negative event compared to others. Ask any smoker and they will be thinking they will be one of the lucky ones who can smoke without lung damage and cancer. As well as cognitive biases that affect our thinking we also just generally dislike spending too much time thinking about what could go wrong. These two factors contribute to many people being unprepared and taking a greater level of risk than they can tolerate. This unpreparedness led to me having the hardest conversation with a prospective client I have had, I was approached by someone after suffering a stroke, they were unable to return to work and were going to have to sell their house and I couldn’t provide any serious solutions to their problems. So let’s throw discomfort to the wind and look at the risks each of us face and what can stop us from achieving our goals.
The value of your income - Your largest asset
For most of us our greatest asset is our ability to produce an income. If you were to compare your career to an investment that will to provide your annual salary up to age 65 it would be valued at something like this:
Unless you have inherited considerable wealth or got very lucky along the way, your earning capacity is most likely your largest asset. For most, your personal income is what you rely on to pay for your day to day expenses, make your mortgage repayments, fund the kids school fees, as well as pay for everything else you plan and hope to do in the future. The loss of capacity to work for even a relatively short period of time can have a devastating impact on even the best laid plans.
Research has shown that a significant proportion (38%) of working Australians could survive less than one month without their income before needing to sell assets and unfortunately illness and injury can (and does) happen to anyone at any age as illustrated with the following extract from the Zurich income protection claims register:
To illustrate just how large an impact a period of incapacity can have I have modelled what would happen should one of my younger clients be forced to take three years out of the workforce at age 30 due to a temporary illness or injury with only Centrelink to supplement their lost income.
While it is only three years of lost income when this is added to the additional cost of drawing down on debt to make it through the recovery time and all of the flow on effects the impact on their position at retirement (age 65) is they will be $407,000 worse off in today's terms. Hopefully this highlights the financial impact of the temporary loss of income due to illness. With this it is easy to see the impacts of a permanent loss of income due to total disability or death will be significantly greater on you and those who are financially dependent on you.
Other assets to consider
After your income, for most the next largest assets includes houses, contents and personal assets like cars. Should these be destroyed, damaged or stolen the financial impact will also be considerable, fortunately this is one area that most people have existing insurance in place to protect.
Other medical events
I have previously discussed the loss of income resulting from an illness or injury but I didn't consider the direct costs associate with any treatment. Depending on the medical condition there can be considerable costs associated with medical treatment and even where you are not unable to work as a result to get the best treatment you can expect some financial cost. Using an extract from the same Zurich report you can see the wide array of serious medical conditions that have been claimed on by their policy holders across all age groups:
The cost of these medical events vary depending on the type and the severity of the condition but for an example of the main conditions assuming you have an adequate level of private health insurance Rice Warner Actuaries determined the out of pocket costs to be as follows:
The rates of incidence of these types of events vary according to each condition but they still do not discriminate and while the older you get the greater the prevalence of these conditions there are still forecast to be 800 cases of cancer in those in their 20’s in 2017 and 1,640 cases of cancer in those in their 30’s, each one these will result in a significant financial burden on those suffering and their families.
Strategies to plan for these risks
Having acknowledged the risks that we face when planning for our future we have really only two strategies to protect us from the financial burden they would result in:
Transfer the risk to a third party
You can always do nothing and hope that nothing bad happens. This isn't really a strategy but it's the one employed by many people.
Self insurance involves setting aside a pool of money to be used if any unexpected events occur. For smaller risks like damage to a car it is not unfeasible that you could accumulate sufficient funds to cover these costs, it may also be possible to cover many of the financial burdens faced after one persons death with their superannuation balance and their other investments and personal assets. Self insurance though become much less suitable for those risks which have much larger associated financial burdens for which few would have the money to cover.
Where you do not have the funds available to readily meet any unexpected costs that may be faced then self insurance is not suitable and unless you want to do nothing we need to look to transfer this risk to a third party through the use of an insurance policy. There are different types of policy that can pay out lump sums, regular income streams and even vary based on severity of the event that is experienced to ensure you get what you need when you need it.
The final consideration
Insurance will ensure any financial impacts of these events can be minimised and or mitigated but in the event of the complete loss of mental capacity or your life it is incredibly important to have an up to date will, enduring powers of attorney, and valid and binding nominations within superannuation to ensure you and your dependents are protected and will be provided for with the least amount of stress placed on them.
If you would like to talk to us about your own finances please contact us here.