While there are some that dismiss the concept of capacity for loss, I think those that do probably still carry out some sort of assessment of capacity for loss, even if unconsciously.
Capacity for loss is in its simplest sense is an assessment of how much a client might have to rely on invested assets in the event of a crisis.
When it comes to pensions, clients who are 10 years or more away from being able to access their pension savings means capacity for loss is irrelevant, given the inability to access that money.
What's probably more relevant in this context is discussions around affordability.
But there are two clear life stages where capacity for loss is relevant.
The first is in retirement, where a a sensibly sized cash reserve is likely to meet the needs of most retirees, and thus prevents the client from having to rely on invested assets in times of crisis.
The second is clients in the building wealth stage who are wanting to invest money outside of a pension. So how should we assess their capacity for loss?
Where protection fits in
Typically we examine a client's income and outgoings and make a judgement as to how much a loss of income might impact that individual. We also consider whether a client would need to access invested assets in the event of a crisis.
Yet there's an easier way to address capacity for loss - identify the client's protection needs.
The protection gap is real and I often wonder why this is the case.
Life can and will deliver the occasional problem or challenge. The frequency and impact of that problem will determine whether or not you self-insure or insure against it.
Having a robust wealth protection strategy is just as important, if not more so, than a wealth creation strategy.
The protection industry has innovated through the years and is becoming more of an online sale.
But clients still need your guidance through what can be a very daunting area, especially when thinking about the role that trusts can play when putting protection in place.
Clearly, the state will intervene to an extent but many overestimate what the state will provide.
For example, state support helps with interest on mortgage payments up to the value of £200,000, but only after a deferment period of 39 weeks.
So what can the client do?
- Protect their income, using income protection
- Protect their family in the event of their death by buying life assurance
- Protect their family in the event of them getting critically or terminally ill
All of these policies not only give the client peace of mind that either they or their family can continue to live their lives should the worse happen, but also means they don't have to rely on invested assets in the event of a crisis.
Of course, many employers offer different types of protection, which is why it's so important to conduct a full fact-find when taking on a new client.
Someone who you think may need to rely on invested assets in a downturn could well have a protection policy that you didn’t know about.
In turn, this gives them the ability to take on investment risk and not have to worry about the impact in a worse case scenario.
Protection can play a key part in the risk profiling process. More often than not, a client's protection needs can be identified and addressed through a comprehensive employee benefits fact-find.