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Can clients really “self-insure”?

November 19. 2018

Advisors will often say their clients are "self-insured." But because insurance is, by definition, the pooling of risk, no one can actually self-insure. Having insurance means not having to shoulder the burden alone if things go south. It's hedging your bet so that, if the wheels fall off, someone else is there to help put it back together. So, when a client "self-insures," they are taking 100% of a given risk, and have enough money to absorb a potentially very significant loss.

But "Can they?" and "Should they?" take on risk are two entirely different matters. A responsible fiduciary should test that assertion with some tough questions:

  • Is your client comfortable potentially absorbing a significant reduction in their assets?
  • What risk are they "self-insuring"—Market risk? Long-term care? Loss of income? Longevity? A combination of several or all the above?
  • To what degree is your client "self-insuring" for each of these risks? 100%?
  • Should your client truly assume complete risk for all these issues or seek ways to mitigate them?

If most clients are being honest, they don't want to see their portfolio take a big hit during bear or down-market cycles. If such a loss comes in the last few years before they retire or right after retirement, it will have a significant impact on their retirement. A poor sequence of returns can mean delaying retirement or decreasing lifestyle (either pre- or post-retirement). It also has potential implications for the legacy they will leave their children and other heirs. These are risks most clients do not want to take and life choices they don't want to make. When presented with low-cost, commission-free insurance solutions that can help address these risks, many clients find them highly appealing, and far better than nervously watching the market.

This is why, according to a Cerulli study, of the 20 unsolicited client product requests to advisors, 2 of the top 5 are insurance–long-term care (74%) and annuities (51%). While many advisors will brush insurance to the side because of preconceived notions about the transparency and pricing of products, their clients are eager for the security it provides. Commission-free insurance products allow fiduciary advisors the ability to deliver the solutions clients are seeking rather than refer them away or have them find their own source for insurance.

Take a situation where a "self-insured" client is the primary wage earner and has a $5,000,000 portfolio. The client passes away and shortly thereafter the market becomes a "bear" and experiences 30% losses. The spouse is 60 years old and living off the portfolio, but suddenly their own medical issues arise, and they require long-term care. If they are "self-insured" it gets ugly fast.

In that same scenario, by allocating a portion of the client's portfolio to insurance products with principal protection and guaranteed income streams, the portfolio's value wouldn't take as much of a loss, and the client would have a reliable guaranteed income stream in place. A much better outcome for the surviving spouse. (Many planning software programs can model the value of annuities in a financial plan).

Finally, it's important to mention that when clients "self-insure" it also means your firm is self-insuring future assets and revenue streams. Advisory firms have their own fiduciary responsibility to their partners and other owners to protect future revenue. In a world where clients experience dramatic loss in portfolio value, an advisor experiences a proportionate loss in revenue.

With the advent of commission-free insurance, clients and their fiduciary advisors have access to insurance products that align with the fee-only business model they value. Advisors are able to seamlessly incorporate insurance into financial plans to mitigate sequence of returns risk, loss of income, and market downturns.

Clients don't have to take on all the risk themselves anymore. Commission-free insurance has been repriced, reducing the cost so clients don't have to—and, in most cases, shouldn't—"self-insure." They now have an efficient and fiduciary friendly way to hedge their bets, their lifestyles, and their nest eggs.

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