How perceptions of risk can influence protection decisions

Financial decisions are not always made purely on the basis of probability or financial consequence.

Behavioural finance has long demonstrated that people respond differently to gains, losses and uncertain future events. As a result, some risks can receive considerable attention while others are underestimated or deferred.

This can be particularly relevant to protection planning.

High-net-worth and ultra-high-net-worth clients may devote significant time to investment performance, tax efficiency and estate planning while giving less consideration to the financial consequences of death, serious illness or incapacity.

The issue is not necessarily a lack of awareness. It is often the way different risks are perceived.

Several well-established behavioural biases can influence these decisions.

Present bias

People naturally place greater weight on immediate costs than on uncertain future events.

In protection planning, this can mean focusing on the cost of premiums today rather than the potential financial consequences the policy is intended to address.

Where the event being insured against may never happen, deferring the decision can feel rational even where the potential exposure is significant.

Status quo bias

There is also a tendency to leave existing arrangements unchanged.

For protection, this can mean policies arranged many years ago continuing without review even though the client’s circumstances have moved on.

Asset values may have increased, family circumstances may have changed or the purpose for which the policy was originally established may no longer be the same.

The policy itself may not have changed, but the risk surrounding it often will have.

The proposed inclusion of most unused pensions within estates for inheritance tax purposes from April 2027 is a good example. Existing protection may remain exactly as it was while the potential inheritance tax exposure changes materially.

Optimism bias

Death, illness and incapacity are recognised risks, but individuals can still underestimate the likelihood of those events affecting them personally.

For wealthier clients, there may also be an assumption that existing assets provide sufficient financial protection.

That may be true in terms of overall net worth, but it does not necessarily address liquidity.

A substantial estate can still have insufficient readily available cash at the point a liability arises.

Availability bias

Our assessment of risk can also be influenced by examples that are easy to recall.

A highly publicised declined insurance claim may therefore carry disproportionate weight compared with the very large number of claims that are routinely paid without attracting attention.

This can affect the way clients perceive the reliability or relevance of protection.

Moving the conversation towards consequences

For advisers, recognising these biases can help shape a more useful discussion.

Rather than beginning with a particular insurance product, it can be more effective to consider the financial consequences of different scenarios.

For example:

• What liquidity would the estate require if death occurred today?
• Which assets would otherwise need to be sold?
• What would happen to the business if a key individual were unable to work?
• Are existing policies still sufficient for the purpose for which they were established?

This moves the conversation away from attempting to predict whether an event will occur and towards considering whether the financial consequences would be acceptable if it did.

Protection can then be considered as one part of a wider risk-management strategy, alongside investment, tax, estate and succession planning.

Regular review is essential

Protection arrangements should also be reviewed as circumstances change.

Significant movements in wealth, business ownership, family circumstances and legislation can all alter the underlying exposure.

Regular review allows advisers and clients to assess whether existing arrangements remain appropriate rather than relying on decisions made many years earlier.

Ultimately, good protection planning is not about eliminating uncertainty. It is about understanding the financial consequences of uncertainty and deciding which risks should be retained and which should be transferred.

Get in touch

At John Lamb Hill Oldridge, we advise high-net-worth and ultra-high-net-worth clients and their professional advisers on complex protection arrangements.

If you would like to discuss how we can support you or your clients, please contact us at mail@jlho.co.uk or on 020 7633 2222.

Please note

This article is for general information only and does not constitute advice.

All information is correct at the time of writing and is subject to change.

The Financial Conduct Authority does not regulate estate planning, trusts or tax planning.

Financial protection plans typically have no cash-in value at any time and cover will cease at the end of the term. If premiums stop, cover will lapse.

Cover is subject to terms and conditions and may include exclusions. Definitions of illnesses vary between providers and will be set out in the relevant policy documentation.