Family income benefit is often better value than level term assurance for many young families. Tom Baigrie argues why more should be done to promote this product
As IFAs, we are the only people who sell a portion of family income benefit (FIB), and we don't sell a lot. Those who think they know why that might be, often put it down to FIB's relative complexity and its reducing benefit over the policy term. Many also point to the fact that most recipients of FIB commute it to a lump sum to show that lump sum term is the better option.
Put like that, it seems that's that then, or is it? Like many other products once considered the best option for all by the market and consumers, lump sum term assurance simply isn't the best solution for everyone. In a few years' time, I firmly believe that everyone will agree.
The key reason FIB is not sold more is that family protection is only now being understood as an area where good advice is genuinely required if consumers are to get what they need and be treated fairly. Until now, it has been a profitable sideline for most IFAs and not something that many have spent much time thinking about.
The very few policies written in trust - when almost all should be - confirms this sad truth. Most of us think of it as a simple, quick sale. What is more, customers like the idea of a lump sum - it looks big and safe, and the first rule of making money in business is to give the customer what they want. The trouble is, consumers are often wrong and it really is the IFA's job to tell them so and do a better job than they could do themselves.
One of the problems facing IFAs is that the bear market turned us all into keen advocates of protection policies, and the numbers sold have grown extremely quickly in the last five years. But the intellect applied to the quality of the advice has not gone up equivalently - it is just beginning to follow on now.
Profitable sideline
The first impact of this has been the sharp decline in critical illness (CI) sales. Only recently, IP sales have risen from a tiny base and now here I am, rattling cages about FIB. Because, like endowments before it, lump sum term assurance dominates the market because clients want it and as advisers, we don't know much better.
I will try to explain why FIB should outsell lump-sum term. The nice thing about protection arguments is that they are largely mathematical and therefore provable. This is not a matter of opinion, it is one of fact. To prove that FIB is better than level term for many clients, there needs to be widespread agreement that the reason consumers buy cover, other than to clear debt, is to ensure that there is enough income to meet the relevant needs whether they become disabled or die.
Despite what has sometimes been said, people do not buy cover for the windfall benefits, even though sometimes they materialise. Thinking about this point for long enough, it is easy to see that the right way to assess someone's need for cover is to work out how much income they need and for how long, in the event of disaster, and look to either provide that income or a lump sum sufficient to cover it.
There are obviously unknown factors, the main one being how long will be long enough. My own view is that 20 years should be around the maximum length of any policy not covering a mortgage. Children grow a little less dependant every day and after 20 years need not be dependent at all. What is more, giving a grieving partner 20 years to sort their life out seems reasonable. One can argue the numbers, but the concept is sound.
Let's take a look at the maths. In the case of a 35-year old client earning £40,000 gross a year - taking into account all other benefits capital, debt and insurance - they felt that their dependents could get by with £15,000 per year cash in hand, if that salary was lost. After much discussion, and taking children's ages and such into account, it is agreed that 20 years at this level is enough time for the policy term.
Unknown factors
With all these details to hand, all that is needed is to find the policy to do the job. The first contender is FIB. It will provide that £15,000 indexed linked for those 20 years at a cost of £14.87 per month. The second contender is level term assurance. Firstly, a few assumptions must be made - which the Financial Ombudsman Service will say is the same as taking an unnecessary risk.
Regardless, let's start with a 6% average annual compound growth rate and 3% inflation still providing cover for 20 years. The lump sum needed is a cool £225,388.64, which if arranged for the 20 years costs £19.18. So in order to mirror the performance of FIB if there is a claim on day one, the client needs to pay an extra 30% per month and take on more risk. What a poor decision.
Of course from day two onwards, the amount FIB pays out drops, so perhaps a decreasing term is a fairer comparison as it costs almost exactly the same. But that drops in line with a repayment mortgage, which has nothing to do with children's reducing dependency, and so one really is stretching a point trying to use it just because it too decreases.
But the level policy is the most frequently sold and because it costs a lot, it is sold for far lower sums assured than are needed. So it does not do the job properly when it is needed and creates windfalls when it is not needed. After all, a claim on the last day leaves the grieving widow with no dependants, 20 years of accumulated pension AND a huge lump sum. So FIB provides a well matched solution to most young families' genuine life cover needs and it does this at low cost because it does not have the windfall element.
Mis-selling
The best solution is a small amount of term - a windfall will help any bereaved individual recover faster, and then the main work is done by FIB, with regular reviews to keep things on track as long as health allows.
But there is a clincher. Tax. The £15,000 paid out by the FIB policy on a monthly basis is tax-free. But even if you did your work pro bono and your client somehow got 6% per year growth from a risk free, charge free fund, you would still have to pay around 20% tax on the income element now that zeroes are no more.
Without doing the amortisation calculation to reflect the 20 years (it drops a bit each year), I can tell you that the lump sum has to be much larger than the £225,000 previously mentioned, which makes it even more expensive and knocks out the MPA argument entirely, because you are paying more for less after tax.
Mathematically - and properly allowing for tax, charges and investment risk - it can be said that, for families like the one already mentioned, FIB complies closest with a golden consumer rule: spend as little as you can on insurance while providing proper protection.
There is a sting in the tail though. There are IFAs who have advised a client to commute a FIB benefit and then invested it to produce an income. But they are mis-selling. Why? Because the above maths means that anyone commuting FIB into a lump sum and then investing it is simply wrong, unless they are rich enough not to need income, and fancy a flutter on equities. It is appalling that this commutation is common, and I hope the Ombudsman never gets to hear about it.
So the only reason FIB is not used is that it has a daft name that makes it sound like something the Department for Work and Pensions doles out, and it is not in fashion because clients do not understand the maths that prove it is better value than that impressive looking lump sum.
All FIB needs is a new name, a lot of proper PR and an adviser force that realises that you can mess up someone's life with an inadequate protection job, just as easily as you can by putting them in a precipice bond.
Tom Baigrie is managing director of LifeSearch
COVER notes
• Complexity and a reducing benefit are cited as the two reasons for FIB's lack of sales.
• While protection sales have rocketed, the intellect behind the advice given has not.
• It is an adviser's job to inform the customer what they need, despite any pre-conceptions the client may hold.
• The key reason FIB is not sold more is that family protection is only now being understood as an area where good advice is genuinely required if consumers are to get what they need and be treated fairly.
