Chapter 2 - Serving The Retail Consumer Flashcards
Budgeting & Fact Find
Clients who know how they spend their money will have better control of their finances.
A budgeting exercise (fact find) will help determine if the client is living beyond their means or if there is surplus income available for financial planning purposes. Budgets can also be important for people living of investment income, as dipping into this will reduce its ability to produce required level of income.
Fact find - the advisor will discover the level of monthly needs through income details and main outgoings.
The difference between income and expenditure gives the clients disposable income - resulting figure is likely to be approximate and may lead to exaggerated expectations on what they can afford to save regularly. The budgeting assessment will allow you to if a proportion of income can be directed away from one expenditure to a more important one e.g. eating out to insurance.
Income & expenditure analysis is very important and will play a significant role in obtaining clients agreement to proceed. It should be carried out as an integral part of the advice process
Fact Find - Advisers Full Understanding
Some will seek to only determine surplus income and capital available for future financial planning.
For advice to be sustainable, you need to fully understand clients income and expenditure and then formulate recommendations that strike a balance between identified needs and budget available.
If assumptions are made instead, client may find they cannot continue with an important financial commitment leading to policy collapsing and loss of value for both you and client. It is better to fully analyse situation and recommend partial solution they can sustain rather than offer perfect solution they cannot sustain.
Managing Debt - 3 categories + what they can do
Working out money in and out is essential to managing debt. Income includes earnings from employment, state or private benefits, pensions, savings, investments, maintenance or any other (rental etc.).
Expenditure considered under 3 headings
- Essential Spending - housing costs, insurance, council tax etc.
- Everyday Spending - food, cleaning, travel etc.
- Occasional or Non-Essential Spending - clothing, entertainment etc.
Client should list of all debt and priorities. Priority debts include mortgage, utilities and council tax. Lesser importance include credit cards, overdrafts and personal borrowing.
If client struggling, then best to get in touch with those that they owe as soon as possible as they may be able to work out a payment arrangement until they get their finances sorted.
Check their income and see if there are any further benefits or tax-credits they are entitled to - always make sure they pay their priority debts.
Tips to reduce spending
Consider making small cut backs on non-essential items.
Check APR on their credit cards and loans. This shows cost of borrowing and they may be able to shop around for a better deal.
Switching services - better deal by switching phone or utilities suppliers.
Debt Management Plan (DMP)
If client has a surplus each month and number of secured debts, this can be used to help pay those off.
Can be established by client or debt management company negotiating acceptable repayment plans with with creditors. If company is used, it will consolidate debt into one monthly affordable payment and will then distribute to creditors.
Private companies charge a fee for this but free services are available. Advisers must be licensed under the Consumer Credit Acts 1974/2006 and authorised by the FCA.
Debt Consilidation - meaning & considerations when recommending
Negotiating a new loan to repay an existing loan(s) often with lower interest rate and monthly repayments. Ensure client has considered all their options before using debt management company.
Advisers should be cautious when recommending this due to;
- Companies charge high fees.
- Monthly repayment amount might be lower but client could end up paying much more over the length of the loan.
- Client with history of multiple loans may continue to do this and be in a more serious position down the line.
- If client cannot afford to repay the loan, could lead to higher costs and penalties which could make their financial position worse.
- If loan secured against property, they could lose their home.
Debt Counselling & Bankruptcy
Debt counselling available if clients situation is out of control and they’re panicking. Organisations offer free service such as Citizens Advice, National Debtline, Payplan and the Stepchange Debt Charity. They help tackle debt by setting up a budget, prioritising their debts and working out how clients can live within their means.
Final option for the client would be to file for bankruptcy or individual voluntary arrangement. Not to be considered lightly and should be last resort.
Borrowing
Clients can raise extra funds through unsecured loans from banks or borrow money secured on their home. Must be wary of borrowing against home as they may lose their house if they miss payments.
Some clients may have mortgages on other properties e.g. buy to lets.
Clients with mortgages who hold significant amounts of cash or other investments should consider whether to use these to reduce their borrowings.
Mortgages & Loans - Basic Terms
Mortgage is a security offered in exchange for loan.
Assignment - when the security is signed over to the lender in exchange for the mortgage. A temporary assignment for the term of the loan.
In the case of a loan on the property, security typically offered is the deeds to the property. Few lenders now take actual deeds due to cost and storage risk, they register charge on the property with Land Registry.
Mortgages & Loans - Methods of interest repayment, why they are popular & MMR
Two main ways
- Capital and Interest Repayment - monthly repayments include a sum to cover repayment of capital plus a sum to cover interest. Over the term, mortgage is gradually repaid interest payable reduces. Repayments only change if interest rates change and they do not have a fixed rate deal.
Interest only - Only interest accrued is paid and outstanding capital remains the same. Mortgage is repaid at the end of the term using another cash source or by selling the property.
Interest only became popular due to low-cost endowments and rising house prices. People could not afford capital and interest mortgages due to the higher monthly payments amount. Interest only affordable option.
Interest only can appear attractive but it not suitable long term as there is no method of repaying capital on maturity. Capital & interest revived after the financial crisis due to mis-selling endowments and need to guarantee mortgage repayments.
Mortgage Market Review (MMR) - April 2014, significantly reduced number of interest only mortgages as lenders now have to check that borrowers have a credible lending strategy.
Mortgage types
Capped - lender guarantees that the interest rate will not rise above certain level for certain period of time.
Cap and Collar - interest rate will not raise above a given level however minimum rate the below interest will not fall. Guaranteed to be an upper and lower limit for a given time period.
Discount - interest rate charged for initial period is reduced below set percentage.
Foreign currency - designated in euros or foreign currency to take advantage of lower interest rates. Can result in gains or losses depending on exchange rate but useful for those paid in overseas currency.
Equity-linked, shared appreciation mortgages (SAMs) - Lender takes a stake in equity of property and on sale, this is paid back. Possible for borrow to slowly accrue the lenders equity stake over time.
Fixed interest - remains fixed for a given period. Risk that interest rates will fall below rate charged but have a known payment amount. Redemption penalties.
Flexible - repayments can vary and lump-sums can be paid at any time. As capital repaid, creates reserve from which borrower can withdraw cashfrom at anytime - can be used to meet future repayments.
Offset - mortgage and bank account are linked. Interest is charged net balance of the two accounts - money in bank account = mort reduced. Monthly salary can have an effect on interest repayment amount.
Tracker - Variable rate with automatic link built in so tracks an index (usually BoE base rate or LIBOR. Designed to move as the index moves.
Equity release - characteristics & types
Only qualified advisers can give advise on these, only available to older clients >60, allows them to release equity tied up to home, no fixed term and allowed to stay for rest of life or until move to long term care, can be expensive and inflexible if circumstances change and may effect current or future entitlement to state or local benefits.
Two types - lifetime mortgages or home reversion plans.
Lifetime Mortgages - types
Loan secured against home and may be;
- Roll up mortgage - client gets regular income or lump sum and charged monthly or yearly interest rate that is added to the loan. Original amount + rolled up interest is repaid when the home is sold.
- Fixed repayment lifetime mort - lump sum and doesn’t have to pay interest. Pay the lender a higher amount than borrowed when home is sold and this is agreed in advance. They then use this sum to pay the mortgage when the home is sold.
- Interest-only mort - Lump sum and pay monthly interest on the loan (fixed or variable). Amount originally borrowed is repaid when home is sold.
- Home income plan - money borrowed is used to buy a regular fixed income for life (annuity). Income is used to pay the interest and amount borrowed is repaid when the home is sold.
Lifetime mortgages add - shared appreciation, drawdown facility, general overview no negative equity guarantee.
Shared Appreciation - Applicable to some lifetime mortgages and means the lender has a share in the value of the home.
Clients can choose to borrow lump sum or go for a drawdown facility or even combination. Drawdown suitable if they want to take small amounts and cheaper as only pay interest on money they actually need.
Works like normal mortgage and apart from roll-up and fixed repayment lifetime morts, interest is paid every month. Mortgage is paid back when they die or move into long term care - anything left goes to client or beneficiaries.
No negative equity guarantees guard against not being able to pay off loan after sale. This guarantee means the lender promises that the client will never have to pay back more than the value of the home.
Home Reversion plans - characteristics
Clients sells all or part of home in return for lump sum, reg income or both, belongs to provider, client still lives there until death or LTC, receive 20-60% market value, older they are the higher this will be and pay nominal fee or higher rent for more money.
Home purchase plans - Sharia Law
Two types of sharia compliant home purchase plans available;
- Ijara - monthly repayments towards buying property are held by the firm and used to buy home at end of term.
- Diminishing Musharaka - each payment buys a slice in the companies share of the house - as shares increase, firms shares get smaller and rent paid to firm also shrinks.
Sale & rent back arrangements.
Some companies offer to help clients with financial difficulties by buying their home and renting it back to them - also known as flash sales, mortgage rescue, rent back and sell-to-let schemes.
Allows to clear debt but means they no longer own the property - points to watch out for;
- paid less than market value of home.
- Check term on rental agreement.
- could be evicted if breach rental agreement terms.
- if firm buying the home gets into financial difficulties, property could be repossessed.
Buy to let mortgages - why and consumer and business.
Aims to generate income from rent and capital gain from selling.
Consumer - Regulated by FCA, consists of borrowers that are accidental landlords in need of consumer protection (e.g. borrowers moving elsewhere but don’t want to sell their property.
Business - Not regulated by FCA, professional landlords engaging in enterprise, characteristics of business rather than consumer activity.
Two types of loan
Unstructured - Mortgages and loans of commercial property, increase loan repayments to reduce capital and interest payments, loans can be repaid at any time, overdrafts and personal loans can fall into this category, rate of interest varies depending on risk of default.
Structured - tend to be for smaller purchases (sofa or car), fixed interest rate and fixed repayment structure, budgeting easier due to no base rate changes, falls into higher risk and often no collateral to back up loan therefore costs can be higher than unstructured loan, penalty for early repayment.
Protection & protection products overview
Another basic requirement for financial planning with life assurance and health cover top priorities for most.
Clients need to consider protection when managing debt due to financial consequences of death, critical and long-term illness and accidents and redundancy.
Influences on protection needs - list
Age, dependants, income, financial liabilities, employment status, existing cover. These interact so should be considered in relation to each other when making recommendations.
Influences on protection - age ranges
18- mid 20s - protection needs to start as they gain independence.
Mid 20s to early 40s - largest protection needs due to dependants, mortgages, death/ill health, accident and redundancy etc.
Mid 40s - investments and pension needs increase as children become dependent.
Mid 50s - investment for retirement income is now priority, protection is still required in case of death.
Retirement - maximise income without risk, protection focuses on health care and inheritance tax planning.
Influences on protection - dependants - adults, children’s needs and change
Number and age of dependants most important factor when considering protection.
Adult dependants - elderly or disabled protection is needed for the rest of their life. Spouse - period of dependence will vary on desire or need to work and ability to obtain employment.
Child dependants - reviewed on birth, adoption or stepchild and premature death of child. Difficult to estimate when they will become financially dependent but estimate should be made at early age and remain flexible to change.
Change - changes in dependencies will change the need for protection.
Influence on protection - Level of income & ill health cover, inflation and affordability.
Level of income will determine amount of protection required.
Level of death cover - estimated by taking a multiple of income - state benefits, pension scheme benefits and cost savings arising from death. A factor of ten is used for this. More complex and appropriate method of calculation is examination of lifetime cash flow.
Level of ill-health cover - % of current earnings less benefits and other sources, most limited to 50-75% to allow for the fact that insurance benefits are not subject to tax and NI - avoids client getting more income than they would from working.
Allowance needs to be made for inflation by taking index-linked cover or specifying increase options. More important if inflation starts to increase from low levels.
Income determines if client can afford to pay for the protection required;
- might be a need but not enough spare income to pay for it.
- desirability of paying for protection against current expenditure.
- if not enough spare income, client must prioritise choices accordingly.
Financial Liabilities in relation to protection.
Existing and future financial liabilities need to be taken into account e.g. mortgages, taxes, loans etc. Regular expenses need to be deducted from overall income to work out spare income for protection.
Inheritance Tax
Deducted from the estate by legal personal representatives (LPRs) before money is passed onto beneficiaries. May be necessary to sell assets to pay the tax - whole of life last survivor policy written in trust for beneficiaries can be used to pay the tax and allow property to be kept.
HMRC has first call on assets. Income tax deducted from estate if any repayable. If individual has large tax liability they are planing to pay off, they should get protection in case they die before they are able to pay it off. Could save heirs from reduction in inheritance.
Influences on protection - Employment status
- Employees of companies are more likely to have protection benefits such as ongoing pay if ill health occurs or lump-sum on death.
- Unemployed or retired only entitled to benefits from state or funded by themselves.
Business owners have a variety of protection issues;
- Own employer so need to provide life assurance and income protection for themselves.
- Private medical insurance for quick treatment so they can return to work quicker.
- Business protection issues such as key person protection.
Influences on protection - Existing Cover
Existing cover might be provided by existing insurances, lump-sum benefits from private pensions, employer and the state.
People should claim state benefits if they can as they have paid their taxes and NI towards them.
Life cycles
Way of illustrating the interaction of factors that impact have an impact on the level of protection required. Described as vulnerable, relaxed and anxious years. Fewer families conform to this structure.
Vulnerable years - factors effecting protection and advice
Early years of marriage and start of family.
- might be dependant on one income and have high expenses.
- low incomes and high protection needs.
- death or illness will mean large amounts of money needed to preserve family’s standard of living.
- little spare income to pay for cover.
Low-cost temporary products that meet immediate protection needs are most appropriate.
Relaxed years
Entering 40s with increased income and children becoming financially independent.
- Protection needs for dependants decrease and need for pension and savings take priority.
- Disposable income has increased.
- Increased protection against death and ill health may be needed to cover higher standard of living and earnings.
- health care and long term care needs become more priority.
Anxious years - characteristics and negative factors
50s and beyond
- earnings peaking
- mortgage nearly paid off
- children financially independent
- more disposable income
However;
- concerns over illness and death
- little time to make up pension shortfalls
- inheritance tax planning comes to the fore
- health and long term care become priority.
- divorce - may result in reduced pension, fewer resources and potential for remarriage
Term Assurance
Pays a lump sum to the family on death but if they survive until the end of the contract it simply comes to an end with no survival value or maturity payment. Premium decided primarily on age, level of cover and term. Offers life assurance only without any savings and no surrender value if cancelled early, usually cheapest way to purchase life assurance.
Types of term assurance
Level - offers level sum assured with a level premium throughout the term.
Decreasing - Designed for those with decreasing liability on death. Those with capital and interest mortgage use a variation of this whereby profile matches the way in which the outstanding liability reduces (mortgage protection insurance).
Lower premium but constant throughout term as sum assured reduces throughout term.
Family income benefit policies - special form of decreasing whereby on death life office will issue regular monthly or annual payments.
Increasing - Sum assured increased regularly over term or offers policy holder to increase premiums. More expensive but ensures life assurance maintains its value against inflation.
Convertible - allows holder to change into an endowment or whole of life policy. Good for those who need additional savings (endowment) or longer-term protection (whole of life).
Renewable - policy holder has a guaranteed right to effect similar policy without giving any evidence that they are good health. Premiums are very low at start but increase with age each time new policy taken out.
Endowment policies
Pay a lump sum on death but primarily a savings vehicle, some offer same level of critical illness cover, not suitable for significant level of life cover because bulk of premium is directed towards savings element, surrender value non-existent or low in first 1-2 years and there are low-cost endowment products designed for home purchase that have a higher amount of life cover but lower savings element.
Whole of life policies
Most geared towards sustainable level of life cover but some do have some investment (balance will depend on options selected), provide cover for lifetime, most pay regular fixed premium, can be used to allow heirs to pay inheritance tax without receding overall estate.
Non-profit & With-profit whole of life policies
Non profit - guarantees to pay a fixed amount of life cover on death whether one day after or 30 years. Can accumulate surrender value but likely to be low.
With-profit - guarantees a minimum amount on death and increases annually through annual bonuses (not guaranteed). Once added they increase sum assured. Final bonus is paid out on death which can significantly increase payout. Will accumulate a surrender value which is higher than NP (low early on in the policy) but premiums are significantly higher.
Flexible whole of life policies
Choose between minimum and maximum level of cover and cover selected can be changed at any time. Offers greatest level of flexibility to match changes in circumstance.
Premiums buy units in a fund and monthly charge is deducted by cancelling units. This way, policy grows as number of units accumulate and potentially the value of the unit increases - value increases in the early days of policy but decreases as assurance cost increase as they age.
If high levels of cover are selected, it is possible that there may be insufficient units to sustain cover. To address this, life office will offer client to increase regular premium or decrease level of cover.
Can offer the opportunity to get high level cover at low cost or have more emphasis on savings or even a balance of the two.
Sickness and health insurance
Provide income or lump sum in the case of being sick or injured. Each different contract is designed to answer specific needs and budgets and therefore should not be looked upon as competitors but complementary to each other.
Income protection (IP)
Replaces lost income due to illness or accident, only able to get benefits if they are unable to work for more than the deferred period, longer the deferred period the lower the premiums, benefits are exempt from income tax, typically offer 50-60% of earnings (up to 75% for lower earners), restrictions imposed so client has incentive to return to work (moral hazard), contract cant be cancelled as long as premiums are being paid, underwriting based on morbidity instead of mortality & gender differences no longer allowed.
Personal accident and sickness insurance - role & differences to income protection
Pay regular benefit while insured person is unable to work due to illness or accident but some differences compared to income protection;
- may also pay a one off lump sum
- max 1-2 years only compared to retirement age for income policies.
- deferred period very shorter c.1-14 days
- reduced number of health and occupation questions and greater range of occupations accepted.
- Cost usually much lower than income protection and app process much simpler.
ASU
Similar features to accident and sickness insurance (lump sum & pays income on illness or accident) but also pays out on unemployment through not fault of their own.
Max payout period of 1-2 years and a bit more expensive than PASI due to unemployment cover but still less than income.
Critical illness cover (CI) - differences to IP, what it covers, why its needed & renewable CI
Differ from income protection in three ways;
- pay lump sum
- payment is made on diagnosis of specified illness only as opposed to being out of work as a result of said illness.
- can be standalone or incorporated into whole life, term or endowment policies.
- However, they are complimentary to each other.
CI policy will pay a lump sum on diagnosis or permanent total disability - every provider typically includes heart attack, stroke, cancer, coronary artery disease, organ transplant and kidney failure.
CI cover might be needed for the following reasons;
- provision for private health care (sum can be used for additional treatment).
- Alterations to the insured’s home
- Purchasing special medical equipment
- Income replacement (limited)
- Repayment of mortgage or loans.
Usually pure protection contract with no investment element and linked with life cover.
Renewable CI - based on advances in medical science rather than clients health. Premiums are cheaper than guaranteed.
Private Medical Insurance (PMI) - moratorium and what they don’t cover
Health insurance allows choice of level of care, full medical underwriting undertaken or moratorium basis - will not be asked questions about health but if they have suffered from any health conditions in the last five years they will be excluded from cover.
Policies will not cover;
- treatments clients know they are already going to need at application stage
- pre-existing conditions - these must be disclosed or risk policy be invalidated
- treatments for chronic medical conditions
- some exclude certain treatments e.g. dental or outpatient
- most exclude routine pregnancy, AIDS, fertility, mental and cosmetic surgery.
Long Term Care Insurance (LTCI) - Two types
Immediate care LTCI - bought when care is actually needed, at any age, care plan bought with a lump sum, pays out a regular income for rest of life used to pay for the care. Cost varies on amount of income needed and whether it needs to increase in line with inflation, age or state of health. May need to be medically assessed and highly available.
Pre-funded LTCI - bought in advance, bought at any age, regular or single premium, regular sum paid out, tax-free money, few on the market, pays out if cant carry out if cant live without help or mentally incapacitated.
State might help towards cost depending on individual circumstances and other ways to finance it is through savings and investments. Firms and products are subject to strict regulatory regime and advisers need advanced qualifications.
