Client Affairs

Where Insurance Fits In Wealth Risk Approaches

Jackie Bennion Deputy Editor London 28 October 2020

Where Insurance Fits In Wealth Risk Approaches

As part of a series of articles on the intersection of risk management and insurance, this news service talks to experts in areas such as behavioural finance and private banking.

In a recent survey of UK business leaders on the long-tail risks of the pandemic, nearly two-thirds said that the event has exposed new vulnerabilities that require significant changes in how they prepare for threats. Aon consultancy group, co-partner of the study, suggested that businesses not only need to be widening the range of threats being considered but rethink who in their firms are responsible for anticipating these threats and insuring against them.

So what does this mean for wealth managers?

“To use insurance effectively in the client solution requires taking a completely holistic, client-centric perspective,” Greg Davies suggests. WealthBriefing spoke to Davies, a behavioural scientist at research group Oxford Risk, and others from different sectors about managing risk and what can be learned from the insurance industry in particular.

“Even with common types of insurance, such as longevity risk, annuities or life insurance, these are seldom incorporated into wealth advisory solutions quite as well as they could be," Davies continued. He says that wealth managers don't lack the skills to use every tool at their disposal, but rather that those skills are compartmentalised when managing clients' needs. “Investing is often seen quite separately from planning, and insurance knowledge is on the far side of both”, he said. In other words solutions for clients are often found in isolation.

Davies' comments come at a time when different ways of thinking about risks and how to manage them are under a harsh spotlight because of the pandemic and the associated market and economic fallout. This news service is examining the ways wealth managers could and should address risk management, such as revisiting the toolbox of insurance. 

Davies also sees “emotional insurance” as another factor wealth managers need to get to grips with, ie, “taking the cost of time and effort to prepare clients effectively for times of volatility so they don’t incur much larger costs from selling at the bottom and over-trading, for example.”

Where he believes the insurance industry has used behavioural finance effectively is in encouraging people to become healthy in return for lower premiums. Another is using in-car devices to track and improve driving behaviour and safety.

There is also a lot of behavioural finance in insurance pricing, although pricing outcomes aren’t always positive based on people’s actual behaviour. "But they can influence people to change to less risky behaviour,” he said.

Senior partner and head of risk settlement at consultancy group Aon, Martin Bird, says that wealth planners can learn a lot from how pension funds use insurance products to manage risk. Longevity insurance is one example. In an ageing society where people are living much longer than in previous generations, the measure gives sponsoring employers and pension trustees a degree of certainty about how long they will have to make payments to members.

Bird agrees with Davies that understanding the behavioural decision-making of buying risk insurance are critical. In research the consultancy did last year to assess trustees’ understanding of longevity risk and what biases might be affecting those decisions, “regret aversion” was a common problem, Bird explained. This is where trustees don’t want to make a decision that may prove to be a mistake and one the client will regret.

“Also trustees may have reservations about using insurance to reduce their risk because the risk never materialises, or they could have actually gained from running the risk,” he said.

Estate planning tools
Mark Tucker, global head of Wealth Advisory at Barclays Private Bank, believes that insurance is essential for multi-jurisdictional estate planning. He said that advisors and planners at the bank work alongside private bankers to identify insurance solutions for clients.

“Given international client mobility, where clients are investing in increasing numbers of jurisdictions, the value of insurance has never been as great,” Tucker said, arguing that many private banks under appreciate its value.

“It is often an interesting solution to a wide range of potential problems facing high net worth and ultra-HNW clients. Many of our clients have increasingly complex succession planning needs because of having footprint in more jurisdictions, both in terms of investments and physical presence. Insurance is a useful tool to settle liabilities that often arise as a consequence," Tucker asserts.

He also raises the importance of insurance in liquidity issues.

“Entrepreneurs worldwide are often illiquid because they are continually investing in operating businesses. Insurance can provide liquidity to achieve estate equalisation during the critical stage of wealth transfer to future generations."

“Take an entrepreneur with a business worth $100 million whose only other asset is a $20 million portfolio of financial assets. The entrepreneur has three children, only one of whom will take over the business. The entrepreneur wants to bequeath equal amounts to his three children but doesn’t want the business to be broken up. So he or she takes out a life insurance policy to pay out a lump sum on his death to not prejudice the other two children. As such, insurance is achieving estate equalisation."

Tucker also notes that Asia is some way ahead of the rest in using insurance to manage and protect wealth. It is the most mature market and tops the tables in volume of premium insurance per annum, he said. “Whilst the use of insurance is much more prevalent and the solution is better known by Asian clients, it is still relevant all around the world."

The notion that insurance is a basic service that requires limited knowledge could not be further from the truth, Tucker said.

“International insurance is a highly sophisticated wealth planning tool requiring experienced and qualified individuals to both sell, market and provide ongoing maintenance for insurance products sold,” he countered.

Regulation and cross border rules can often create barriers to completing insurance business and staff sometimes aren’t well-versed in how to “unlock the potential value,” Tucker added.

But this lack of knowledge is not for lack of available training for wealth managers or private bankers. Training options are “widespread” across jurisdictions in Tucker's view. The problem for him lies more in senior management at private banks not identifying and supporting talent in this area.

For behavioural scientist Davies, getting across the value of insurance also depends on the regulatory environment and how much people are protected from large risks by the state. “There is certainly less need for it in strong welfare states, for example,” he said.

In terms of innovative products and services coming into the insurance market as a result of COVID-19, Davies sees the biggest gap to fill is decision support tools to help lead people through the complexity of insurance decisions in the context of their overall wealth.

“Too often insurance products are purchased in isolation from the larger picture. Therefore consumers may very easily be led to purchasing much more, or much less, than is appropriate for their unique needs.” At best, Davies says, “people follow rough rules of thumb that are roughly wrong for everyone." He gives the example: “You buy sufficient life insurance to cover your mortgage, which is a simple but very poor proxy for the amount of life insurance that is actually right for any individual.”

Regulation of the insurance sector has brought headaches but also "significant" innovation, according to Aon's Bird, largely stemming from the Solvency II regime introduced in 2016 that changed capital and reporting obligations for insurers. "It caused advisors and insurers to find new solutions to client problems," he said. While Bird has seen fairly rapid innovation, particularly in the reinsurance space, innovation needs to go a lot further if more employers want to secure their defined benefit schemes with insurers.

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