Increasingly however, there’s a focus on physical and mental fitness — particularly for business owners and those in middle to upper management.

Typically, Australians are spending more hours at work, with less resources, yet are under more pressure to perform. Research shows that 95% of managers make sacrifices to work longer hours, with exercise the first thing to go. For men, that’s followed by time with their partners, hobbies or other leisure activities, time with their kids and personal development. Second to be ditched by female managers are hobbies or other leisure activities, then time with their partners, energy and that hoary chestnut, sleep.

Life is stressful. Work is stressful. There is just no getting around it.

In the words of Chris Tennant, professor of psychiatry at the University of Sydney, “You can’t lead a life without stress, so you have to learn to handle better the impact of stress on your body.”

Fair enough, how?

Invest in you

Firstly, by investing in yourself and your life.

You possibly know all these, but here they are again:

• exercise daily
• make healthy food choices
• drink in moderation and have at least two AFDs (alcohol-free days) a week
• don’t smoke
• get adequate, good quality sleep

…and here’s the clincher: have fun!

Look, I just don’t have time…

Okay, so how do you actually do all that when you don’t have time?

Before answering that, let’s look at this issue a different way.

Dr Lynn Scoles, a medical practitioner and executive coach with the Australian Institute of Project Management, says women have an average life expectancy at birth of 83 years — but statistics show that the last 11.2 of those years will be spent struggling with a physical or age-related disability, such as dementia, stroke, heart disease, breathing problems (emphysema’s a typical one), cancer, diabetes, poor vision, poor hearing and arthritis. For men, the figures are 78.1 years life expectancy, with the last decade coping with a disability.

Know anyone who seems too young at 68 to be nearly at the end of their physical and mental peak? Thought so….

We all know the preventable risk factors, but let’s review them with the above freshly in our minds:

• being obese or even overweight
• having inadequate physical activity
• smoking
• risk-level alcohol consumption
• poor diet and nutrition
• high blood pressure
• cholesterol

And how do you lessen those risk factors? Exercise daily, make healthy food choices … etc.

(and don’t forget to have fun).

Too fluffy? … or too costly?

Before you think “that’s all a bit fluffy”, think about this: too much stress robs you of profits.

Dr Lynn Scoles says pressure is the aggregate of all the demands placed on us. It can be physical, psychological and social. We need some pressure to be effective, but this is only effective if the pressure equals our perceived capacity to cope. Increasing pressure just leads to stress.

Stress can cause a loss of confidence, depression, anger, poor concentration, procrastination, working harder but less efficiently, self pressure (“I should…”), poor sleep, increased smoking and alcohol intake, aggression and loss of interest in work.

Stress is what happens when we perceive the demands made on us are bigger than our capacity to cope.

So what can we do? What are our resources?

Get connected, find your purpose

Dr Scoles outlines a model for stress management as having equal balance between:

• your identity (a compelling purpose in life that gives you direction)
• emotion (emotional awareness and management)
• energy (physical resilience based on health and wellbeing), and
• cognition (a positive attitude, focus and using the whole brain)

What’s your “why” to live? What’s your source of motivation, perseverance or direction? Get connected to your deeply held set of values beyond your own self interest.

Dr Scoles says, “purpose creates a destination, engagement creates energy”.

Manage your emotions

Managing your emotional response can reduce your stress. Pretty amazing fact, but also incredibly powerful.

Dr Scoles says recognise that when you feel stressed, you must remember that you have a choice. You are in control and you choose the response; your feelings don’t control you. That can be a hard one, but accepting responsibility for your own feelings really puts you in control.

To deal with stress positively, shift your thinking from blame, excuses and denial to ownership, accountability and responsibility.

Disempowering emotions (fear, frustration, anger, sadness, regret and resentment) make you stressed, which is costly and inefficient in business.

Why would you choose to be inefficient?

Conversely, empowering emotions (challenges, optimism, opportunity, laughter, friendship and gratitude) are energising and engaging.

Readers of Steven Covey’s work will be familiar with the term “emotional capital”.

Dr Scoles says work on your important relationships, smile more and laugh often, practice gratitude, manage your time well, enjoy some hobbies and social activities, improve your self talk, change your perceptions of situations, and practice good communication and appropriate assertiveness — try the power of “no”.

“You can do anything, but not necessarily everything.”

Rest your brain

In building your resilience to stress, you must concentrate on cognition too.

Develop a positive attitude, focus your attention, develop and use your whole brain.

Dr Scoles says thinking takes energy: the brain comprises 2% of body weight, but uses 25% of the oxygen. It also needs resting time.

Develop your mental agility by using both sides of your brain. Exercise, meditate or pray, play some music, do art, create something.

Plan your breaks. Where are you when you get your best ideas? Walk outside, breathe in and look up. Learn something new…

Dr Scoles says habits are the key.

She quotes Aristotle, “We are what we repeatedly do. Excellence then is not an act, it is a habit.”

So get practising! 

Sources: Dr Lynn Scoles, “Fit For Business… Achieving Peak Performance Dealing with Stress”, Australian Institute of Project Management; Dr Steven Covey, “The 7 Principles of Highly Effective People”.

Global economic gloom and doom has returned, descending upon share markets, commodity prices and commodity currencies, such as the Australian dollar (down 13% from its US$0.9351 peak). From April highs, US, European, Japanese and Asian shares have fallen between 10-14%, while Australian shares have fallen 16%.

There are 4 key factors behind these falls, says Colonial First State: a “3-speed” global economy; ongoing worries over sovereign debt levels in Europe; moves to banking and financial re-regulation; and then some Australian-specific concerns.

So why now — when everything was looking good again? Is the cyclical recovery in shares over? Should investors be concerned? If not, then what should you be looking out for?

Key drivers

Dr Shane Oliver, Head of Investment Strategy and the Chief Economist at AMP Capital Investors, explains the factors pushing this slump:

• Europe: despite the aggressive support package, investors are still concerned about the effect austerity measures will have on the economic growth of Spain, Greece and Portugal; whether the debt of stronger Euro-zone countries will be “tainted by association”; and long-term questions about the euro’s survival
• US banks: legal action for transactions in sub-prime mortgage debt, plus moves to tougher regulations and taxes has investors concerned
• European banks: the same concerns re the same moves towards a tougher regulations and taxes
• China: worries that the tightening to cool a property bubble and inflation will lead to the long-talked about “hard landing” for the Chinese economy

Australian share falls have been magnified by:

• the proposed “resource super profit tax” (RSPT) possibly making Australia less attractive for mining capital
• that same proposed tax signalling additional taxes on other industries making “super profits”

How you feel about the RSPT depends heavily upon whom you ask and what sector of the economy you come from, but, says Colonial First State, “there is a strong view that the proposed RSPT, the way in which the government went about announcing its arrival and the public nature of the debate over its merits or otherwise, has added to Australia’s country risk premium”.

Shane Oliver agrees the concerns have still had an impact, although says they are “arguably overblown”.

Australia is also seen as highly exposed to any downside risks in China.

All of these things, compounded by market expectations that the Reserve Bank of Australia (RBA) has interest rates “on hold”, have sharply dragged down the dollar.

The total effect has been to weigh down the Australian share market. This is because foreign investors are not willing to buy Australian shares when the currency is falling sharply.

While the markets were looking good after the strong run-up into April, bear-market memories are still fresh, so the timing of “those other issues” has left investors “pretty skittish”, in Dr Oliver’s words.

‘Three speed’ doesn’t help

The global economy recovered from the deep recession of 2008–09 with a “2-speed” global economy — expected strong growth in Asia and some larger developing countries (such as Brazil), but much slower growth in the developed world (the USA, UK, EU and Japan).

However, says Colonial First State, the recent trend has been to a “3-speed” global economy, and the uneven nature of this recovery has added to investor uncertainty.

They explain this “3-speed” global economy thus:

      I.    economic growth is still expected to be strongest across Asia and the other developing nations (and it’s important to note that it’s this group that remains most important to Australia)

     II.    economic data from the USA, Canada, NZ and Japan suggest their recoveries are becoming more firmly based

    III.    but ongoing worries over sovereign risk in both Europe and the UK will see only minimal economic growth in the years ahead

It’s a correction, not a bear

While AMP’s Dr Shane Oliver is not saying the markets have bottomed — “measures of investor fear are yet to fall to the levels that are normally seen at market bottoms” — he is very happy to say this slump is a correction. And not the start of a new global bear market.

Why? Four reasons:

1. “Leading indicators”

These are still pointing to the global economic recovery continuing. (This is the opposite to 2008.) These “leading indicators” are:

• Spain, Greece and Portugal: yes, aggressive tax increases and spending cuts will see them stay in recession for several years, but at 16% of the “Euro-zone”, these countries are not big enough to drag Europe back into recession.
• northern Europe benefit: while our focus is on the south, businesses in northern Europe are actually benefiting from the euro’s fall and easy monetary conditions — Germany particularly (only 6% of its exports go to Spain, Greece and Portugal, but 60% goes outside Europe).
• the rest of Europe is fine: despite the debt crisis in southern Europe late last year, key business conditions indicators in the rest have had no impact
• lack of “contagion” spreading: European authorities acted quickly to head off “contagion” regarding sovereign debt, and there’s no sign of any “disease” spread to public debt in the USA, UK, France and Japan

2. Strong profit reporting seasons

Another reason Dr Shane Oliver cites to back a correction, not a bear, is the strong recent profit reporting season in the USA, Europe and Asia. But it’s even better in Europe, where the proportion of results beating expectations is at its highest in at least 5 years. This, he says, augurs well for future profit growth.

3. Easy global monetary policy

Shane Oliver says global monetary policy is not consistent with the start of a bear market. Before the 2007-09 bear market, policy was tightened to deal with rising inflation. Now, it’s very easy, with near-zero interest rates in key countries and short-term rates running well below long-term bond yields.

Europe’s situation will ensure such easy global monetary policy for longer. This is being reinforced by still-falling underlying inflation rates in Europe and the USA. Inflation in the USA (excluding food and energy) has now fallen to just 0.9% — its lowest since the 1960s — further pushing out any US monetary tightening into 2011. Continuing low global interest rates are very positive for share markets.

4. Brake stays on for China

The final reason we’re seeing a correction, not a bear, say Dr Oliver, is the unlikelihood the Chinese will ease up on the brake. There are increasing signs the property market in key Chinese cities is coming off the boil (some Beijing house prices are down 25%) and the Chinese share market has fallen 28% from last year’s high. When this easing does occur, it will remove a big weight from Asian and Australian shares, commodity prices and resources stocks. On top of this, shares are now very cheap again.

A word on Europe

Government bond yields in Portugal, Spain, Ireland and Greece remain well below the peak levels seen in the weeks before the announcement of Greece’s finance rescue package in May.

This is positive, but questions are now around the pace of Europe’s economic growth in coming years. Lifting taxes to boost government revenue, and cutting government expenditure (by winding back generous pension systems and public sector wages) will help reduce budget deficits, it will also slow economic growth rates.

Colonial First State makes the point that while this may not be new to economists, it appears to only recently be being factored in by markets. So is probably behind the “skittishness” Shane Oliver refers to. 

It’s neither good nor bad, just something to note.

A quick word on US banks

Colonial First State says something else to note is that while the final look of a re-regulated US banking system remains unknown, the fact that more controls will be placed over their activities means less leverage in the banking system and slightly lower profitability and economic growth over the medium term. Hence investors’ hesitation.

Why the AUD fell

Much of the decline in the Aussie dollar has simply been driven by investors having less stomach for risk.

Colonial First State explains that where buying the AUD had been a popular trade over the past year, profits are now being taken. Our dollar is sometimes seen as a “risk” trade. As “risk appetite” falls and concerns over a slowdown in China grow, so the AUD has fallen.

On top of this are signs that the RBA’s policy tightening has begun to work (recent weakness in consumer confidence, housing finance and retail sales), pointing to the expectation interest rates will stay “on hold” for several months, as Shane Oliver has also pointed out.

History is a good guide

We can’t definitively say that because something happened in history, it will happen again, but history has proven a very good guide in financial markets (and many other areas of life).

Historical records show that after major bear markets end, there’s a distinct pattern of very strong gains in the first 12 months, followed by a “constrained and volatile ride” in the second 12 months, as the easy gains have happened and some of the stimulus starts to be unwound.

This, says Dr Shane Oliver, certainly seems to be the pattern now unfolding (so read into that the “easy gains” are behind us). As well, volatility is likely to be higher than normal, because of the problems left over from the global financial crisis (high public debt levels, poor household balance sheets in rich countries, and the eventual need to unwind very easy monetary conditions).

Colonial First State says the concerns outlined above and the reduced global desire for risk, are unfortunately unlikely to be unwound in the very near-term — meaning volatility could be hanging around for a while.

But (and here’s a good “but”), Shane Oliver says if global recovery remains on track, this current set back will provide good buying opportunities in share markets. The same for currencies, particularly the Aussie dollar: it is likely to rebound, helped by the still strong medium-term outlook for commodity prices and the reality that Australian interest rates will stay well above US, Japanese and European rates.

Sources: “Latest developments in global markets”, Colonial First State; Dr Shane Oliver, Head of Investment Strategy and Chief Economist, AMP Capital Investors, “Oliver’s Insights, The return of gloom”.

The high divorce rate (put at 46% by NationMaster) complicates matters. This can be both via ill-advised people leaving tax-ineffective allotments to offspring, or the increasingly common court fight of children from first marriages against the step-parent and “second family”.

Because any Will can be challenged today it’s important to draft it very thoroughly. Law changes mean more people are eligible to be provided for in an estate, so, therefore, can contest a Will. (This can include “partners in clandestine affairs” — as was splashed about the late Richard Pratt in newspapers in May.)

Indeed, a successful Will is all about passing your assets as tax effectively as possible to those you want. It also has to take into account “the complexity of modern relationships”.

Sounds simple, but — and there’s always a “but” — it takes a specialist, including tax and financial advisers.

If you think seeing a specialist is “a bit over the top”, read on for some implications.

1. Superannuation death benefit taxes

It’s not uncommon to bequeath the proceeds of a life insurance policy to offspring. However, such proceeds going to a non-dependent child from a superannuation fund are taxed at 31.5%.

Mike Fitzpatrick, principal at Clarendene Estate Planning, gave this example to The Australian: a man set up a life insurance policy for his adult son from his first marriage, thinking that son would be catered for, with the rest of his estate going to his second wife and their children.

But that son had to pay 31.5% of his inheritance. Fitzpatrick said, “That is basically leaving one-third of your estate to the government. That’s an example of how tax can intrude significantly to those who aren’t properly advised.”

2. Income tax

Generally, couples structure their finances so income is shared, which gives them 2 tax thresholds. However, when one dies and the survivor receives all the assets, there is only one tax threshold. Mostly, this means that the survivor pays more tax.

Fitzpatrick gave this example to The Australian: a couple owns income-producing investments earning $40,000, declaring $20,000 each when they lodge their tax returns. While the tax on that is minimal, it suddenly goes up when the surviving partner (who is usually the wife) must pay tax on the whole $40,000.

Fitzpatrick said, “Quite often the [tax] increase is in the order of 40-70%, and the greater increase happens at the lower end of the income spectrum.”

So those who perhaps need the income the most, may cop a tax they cannot afford.

3. Capital gains tax (CGT)

The Tax Office says “rollover provisions apply to some disposals, one of the most significant is transfers to beneficiaries on death, so that the CGT is not a quasi death duty”.

However, Mike Fitzpatrick told The Australian, while CGT was drafted on the basis that it shouldn’t be “a tax that visits on death”, in practical situations, it is.

He gave this example: a person left their BHP shares to their 2 children equally. If, when they died, one of those children has been living and working in the UK, the shares left to them will be treated differently, having been deemed as sold the day before the person died. (Technically, that trigger is called a “CGT event K3”.)

The shares left to the child who’s a resident in Australia do not incur CGT.

4. Combination of local and overseas taxes

Fitzpatrick told The Australian a combination of local and foreign taxes, such as stamp duty on transfers of property, land taxes and even actual inheritance tax, was the “fourth effective death tax”.

He gave this example of a couple with 2 or 3 investment properties.

Very similar to the income tax example, while they’re both alive, state land tax doesn’t cost them much, because they’re sharing the cost. When one dies however, the survivor is again left with a much bigger tax bill.

Then there’s the overseas example.

The UK, Fitzpatrick told The Australian, has “severe, almost draconian, inheritance tax laws”. Estates worth more than £320,000 (AUD 534,534) cop a 40% tax. So that’s 40% of that asset lost, he says, “not even to the Australian government, but to the [British] government”. 

How do you minimise these taxes?

After your death, it’s too late. All structures need to be in place before you die. It’s not morbid to plan these things, it’s smart.

Sometimes, a Will is straightforward, and things can be bequeathed directly. Mostly, however, there needs to be a more thought-out process — particularly if the family has hard-earned wealth it wants to protect (including from the threat of divorce), businesses and so on.

a) Testamentary trust

According to Find Law Australia, discretionary testamentary trusts have 2 significant advantages:

• taxation advantages in terms of income splitting; and
• protecting bequeathed assets from financial (or other) difficulties the beneficiaries may suffer

They are probably the best way to ensure a Will:

• is as tax-effective as possible, and
• ensures the assets go to the chosen beneficiaries

In a nutshell, they are safe from divorce, litigation and bankruptcy.

They can also be particularly useful for those concerned about spendthrift children and looking after handicapped children.

b) Self-managed super funds (SMSF)

SMSF are also a good way to hold money for estate planning.

Jan Prescott, MD of financial and estate planning firm Blueprint Financial Specialists, told The Australian, “You can build into your fund’s trust deed the provisions of what you want done with your assets, which is quite an interesting strategy because that then binds the trustee to deciding what happens to those assets.”

However, the same article also had a warning not to “push the envelope”. Clarendene Estate Planning’s Mike Fitzpatrick said, “Before the last significant reform of superannuation, which happened in 2007, the Treasury papers made it clear that the SMSF was not intended to be an estate planning vehicle. It was intended to be a vehicle for people who wanted to take control of their superannuation.” 

You can only gift what’s yours

Bartram Lawyers’ Principal, Leanne Bartram, has a final reminder that, surprisingly, some people overlook: you can only gift what’s yours.

Bartram told The Australian that “even in relatively straightforward family situations” people need to understand their Will “can only dispose of assets they own”. In other words, what’s personally in your name.

“For example, you can’t gift something in a Will that is an asset of  trust because it’s not yours. Everyone thinks if they set up a trust, its assets are personally theirs, but they’re not.”

Most Australian family businesses — including farms — are held in a trust structure, so cannot simply be bequeathed in a Will.

Bartram suggests that clearly understanding the asset’s ownership will allow it to be passed to the person you wish.

Mike Fitzpatrick said asset ownership structures, overlaid with the complex modern family relationships now recognised by law, are a “recipe for potential chaos” if people make a simple newsagent “kit Will” or just ignore having one.

It’s estimated that in the next 20 years, $2 trillion across Australia will be passed down through inheritances. Worth protecting really.

This article is an overview only to give broad information about the taxes that can affect inheritances, Wills and some areas to think about. To discuss the contents in detail, and the relevance to your situation, please contact your Summerhill adviser.

Sources: Australian Taxation Office; NationMaster.com/country/as-australia/peo-people; Find Law Australia; “Certainty of death and taxes: inheritance”, 10 March 2010, James Dunn, The Australian, Business Section

That figure of 52.4% may seem high, so it may surprise you to know that statistically, a trauma claim is more likely across most business owners’ age groups than a death claim.

Trauma benefits can play a significant role in business-risk management outcomes, but it can also seem easy to ignore because the trauma “what-ifs” aren’t clear-cut black and white.

By comparison, it’s easy to quantify a specific result for a business if an owner dies or is disabled — because they will no longer be physically present in the business. An owner’s potential to have a presence in the business, even after a trauma, is a challenge when planning. But plan you must.

Why consider trauma insurance?

Well, firstly, come claim time, where other products may not pay due to their structure and breadth of benefits, trauma well may be the only product that can pay and therefore fill a gap.

There are 3 main types of “living” insurance product:

• total and permanent disablement (TPD)
• trauma
• income protection

If one of those can’t do the job (either fully or partially) of securing the desired level of financial security, then ideally another will fill the gap (as much as is possible).

Secondly, as mentioned in the beginning, the statistical risk is just too high to ignore.

Both these reasons mean that, as a business owner, you should have trauma insurance.

In business succession planning, if you choose to leave out trauma insurance, and review your needs later, that’s your choice. But do so understanding what it is that trauma insurance offers you and where it fits in business succession planning.

So where does it sit with other business insurances?

Trauma benefits can:

• repay debt (inside or external to the business)
• pay to replace a key person
• reimburse the balance sheet for loss of goodwill
• fund the transfer of shares back to the remaining owners

If none of these financial needs arise after the illness or injury of an owner and/or key person, then a decision needs to be made regarding those claim benefits. That’s usually pre-determined within the underpinning legal agreements. We’ll look at this briefly later.

Trauma insurance should be part of an overall protection portfolio. It pays a benefit when:

• there has not been a death, so the term life cannot be claimed
• the illness or injury will not lead to a total and permanent disablement, so TPD cover won’t pay
• the illness or injury may lead to a TPD, but the long-term prognosis is not known so the 6-month wait must be borne before the TPD claim will be assessed

The problem here — particularly the latter point —  is that business needs may arise immediately and funds need to be available.

But there can be limitations on trauma sums insured.

What can typically be funded by a trauma payout?

The various needs emerging from business succession planning — buy/sell funding, debt protection, key-person revenue and possibly key-person capital — all need to be catered for in the event of a serious illness or injury and not just death.

Most crucial to consider will be the debt protection, where a third party can affect the business’s future overnight.

In the buy/sell situation at least, all parties can agree how to manage what is needed.

With a business loan with personal guarantees, it only takes the bank to call in the whole loan and the business is affected by an event that may not even result in share transfer in the end. (Anecdotally, banks calling in the whole loan is a common strategy of theirs.)

What’s the likelihood of trauma?

1. The more, the less merry 

Quite simply, the more partners in a business, the greater the risk — as evinced by the 52% figure at the start.

It’s probably easy to accept that for anyone (of either gender) between ages 35-55, the risk of suffering a serious event and dying is far lower than the risk of suffering a serious event and surviving — even recovering.

Taking the effect of compounding into account, mathematically, across 4 business partners say, the chances of a trauma with survival increases exponentially.

That means any business with more than a sole proprietor has to address these risks — or be negligent of its owners’ collective needs.

Taking our 4 male partners from the opening example, who are aged 35, 45, 50 and 55, according to actuarial research commissioned by Aviva Australia:

• the likelihood of reaching age 64 unscathed by trauma events (including death), is only 23%
• the group’s risks of cancer, or a heart attack alone, are 12% and 13.2% respectively

Given that the effects of just the “big 4” trauma events — cancer, heart attack, stroke and coronary bypass — let alone all the others, are so variable, the level to which the sufferer subsequently can or cannot work is what presents everyone (including lawyers) with a challenge.

It needs careful consideration.

If what ensues is a serious and ongoing illness, then an exit from the business is likely and the outcomes are as straightforward as for death and TPD — with the additional safeguard built in that the owners have given themselves a window within which to make that decision.

But what if there could be a return to work? What if the sufferer’s goal is to return to work, but the other owners believe he/she isn’t well enough to maintain the same contribution level to the business? What if the sufferer is well enough to work but chooses to opt out, having received a severe “health warning”?

2. Everyone should consider all scenarios

Depending on who is deemed the most likely owner to suffer the fictional trauma, the others’ view on where the policy benefits should land will always cause dissention and, at worst, conflict.

It is likely in the early discussions that the younger owner(s) will automatically assume that the older owner(s) is/are the candidates to trigger a trauma claim.

While understandable, it’s not necessarily true.

Voluntary versus involuntary business changes

Businesses can suffer from various types of interruptions and changes to ownership and/or normal flow of day-to-day operating.

Most of these fall under “voluntary” — say retirement, sale, resignation, bankruptcy or divorce.

“Involuntary” interruptions to business viability include:

• death
• serious illness
• serious injury

…where the latter 2 may or may not see the sufferer out of the business. And it’s this uncertainty for which you need to plan. Ideally now.

Case study:

Jack and Bill own a business and, with good advice, agree to set up a portfolio of term life, TPD and trauma.

Scenario 1, “the ideal world”: Having assessed the business structure and liabilities, Jack and Bill determined that when one died or became totally and permanently disabled, the other would need/want to:

• ensure that the remaining owner had the funds to pay the sufferer’s estate fair and agreed value for their share of the business. The remaining owner would then retain total control remove the business loan over which both owners have given personal guarantees. The estate/sufferer would then be released from that guarantee and the balance sheet would be adjusted accordingly.
• pay to find and secure a replacement for the sufferer’s contribution to the running of the business
• secure a lump sum that would help plug the revenue gap the business would endure after the loss of the sufferer, and before the replacement person could be effective.

The non-variable in the above example was the sufferer’s departure from the scene.

Scenario 2: “alive and able to claim trauma”: Take the same needs as above, but in the case where Jack has suffered — and survived — a heart attack.

Jack qualifies for a claim, and lump sum benefits are paid out. The funds are designed to fulfil the same aims as above.

But while it’s not yet known whether Jack is coming back to work, what happens to those funds? Here are some likely scenarios:

• The estate accepting the funds, in return for the equity transfer, is delayed until a reasonable time has passed so everyone can work out if Jack will return to work or not. The mechanism that allows and dictates this is called a “sunset clause” and will have been incorporated in the buy/sell agreement. Commonly, it’s 6 months, but the owners can dictate this at the outset.
• The loan is paid out regardless, as this transaction can be discrete and independent of any other business transactions arising. The business has then benefited from this event by being relieved of debt repayment from cash flow. The owners have been advantaged also, having a business with reduced or no debt. This means the business is worth more and personal guarantees have been released.
• Any decision to replace Jack is similarly postponed, unless the key-person revenue funds are used for temporary replacement, which, in some cases, may be practical and possible, and in other cases not.
• Cash flow can be shored up if required from the funds set down from the key-person revenue cover.

In the above example the owners will be looked to for decisions about what happens to the funds after payment and before being used — if their use is postponed.

Also, the trauma fund distribution may not be used if Jack decides, in agreement with Bill, that he will stay in the business.

There are a few feasible options here that your financial adviser may instruct your lawyers to build into the agreements (after you’ve discussed them and agreed to them). The most common are:

• unused funds are kept by the recipient in lieu of or part-payment towards a subsequent exit from the business
• unused funds are split equally between the owners and regarded as a windfall
• unused funds are spilt equally between the owners and lent into the business to provide working capital (this creates directors’ loan liabilities, which all parties must agree is acceptable)

Naturally, each has tax implications.

Scenario 3: “alive and unable to claim trauma”: Assume, however, that only death and TPD have been bought and these are designed to fund all the same needs as listed above.

(Bear in mind that the TPD will have a waiting period of 3 or 6 months before assessment can be made and a claim admitted, if eligible. Also, TPD can take a very long time to be assessed due to the level of disability needed to be proved.)

Jack has suffered and survived a heart attack. His prognosis is unknown, because it is too early in his recovery.

The following is likely:

• no lump sum benefits are payable from any source yet
• it is reasonable that the estate will wait until Jack’s future in the business is determined — unless he decides he has had a scare and it is time to exit — if he does, no funds are available to pay him out yet
• the lender is nervous and will probably call in the loan, for the full amount, but no funds are yet available for this and negotiations are attempted with the lender
• the pressure is on to support cash flow as the loan is still being repaid, costs continue in the business, but revenue is suffering
• this doesn’t leave sufficient buffer to recruit a replacement and no additional funds are forthcoming from the insurance policies

The above could easily be the foreseeable scenario if the business has no trauma insurance.

The secret to succession planning sums insured

If, as a business owner, you accept the concepts of trauma insurance, then you should be able to work out relevant sums to insure for your business’s circumstances.

Thankfully, the methodology for this in the business scenario is rather more straightforward than personally.

Discuss with your adviser your liabilities and equity share, identify key people and decide what it would cost to lose/replace them. That will populate your business-needs analysis.

Ideally, the sums insured will be the same across term life, TPD and trauma.

But in the real world, the limits the market imposes on trauma sums insured (particularly taking into account the personal cover the owner might also need on his or her life) may have an impact.

However, as discussed, statistically, a trauma claim is more likely across most business owners’ age groups, than a death claim. So approach trauma insurance with an open mind — it might just plug the gap to keep your business in business.

Source: “Trauma – a business insurance necessity” by Kaplan Education Pty Limited, December 2009; Actuarial research commissioned by Aviva Australia.

A report by the University of Melbourne’s Centre for Corporate Law and Securities Regulation, analysed Australia’s bankruptcy cases for the past decade.

It pinpoints bankruptcy as a “middle-class phenomenon”, with professionals and high-income earners declaring bankruptcy like never before.

Professor Ian Ramsay, co-author of “Personal Insolvency in Australia: An Increasingly Middle-Class Phenomenon”, said personal bankruptcy filings rose steadily for 4 years, then jumped 6% in 2008-09. (The report was co-authored by Cameron Sim.)

While the 2008-09 bankruptcy total was a record 27,520 — a 34% jump on 2004-05 (20,501 cases) — last year saw a new record of 36,487 personal insolvency cases. (Personal insolvencies latter mainly involve bankruptcy, but also include debt agreements.)

Descent hastening since 1990

But it’s not a new trend. An earlier study, also by Prof Ramsay and Cameron Sim, found a 300% increase in personal insolvencies in Australia since 1990. This increase far exceeds population growth, hence, the pair says, indicates a strong middle-class presence.

Yet the news gets worse. The report did not include bankruptcy data from 2010, but Prof Ramsay said in the 9 months to 31 March this year, numbers were up slightly on the same period last year.

Prof Ramsay told ABC News, “We find things such as our excessive use of credit, particularly a challenge with home loans and skyrocketing mortgages.

“Unsurprisingly,” he added, “given economic times and economic trends, unemployment — of course — can be a major factor.”

No single factor for pain

Prof Ramsay described the phenomenon as “a social problem that has escaped notice”.

He told The Age that because the phenomenon of the middle-class bankrupt was so unheard of, Australians were largely unaware of the social costs to those affected — including tarnished credit ratings, workforce difficulties, personal relationship costs and the still-prevailing stigma attached to becoming bankrupt.

Going bankrupt … with more

Prof Ramsay described these “new” insolvents as being older, increasingly with dependants (adding financial pressure for families), being from higher-status occupations, with higher levels of personal and household income — and having rising asset and property ownership levels.

The fact that personal insolvencies rose during both good and bad economic times (good being economic expansion and low interest rates; bad being the global financial crisis), suggests the jump is not just due to economic conditions at the time.

But while there was no single factor responsible, Prof Ramsay cited unsustainable home loans as a major cause of increased middle-class bankruptcy.

Melbourne Law School figures from recent Australian Bureau of Statistics data to 2008 puts the amount of debt owed by Australian households at $1.1 trillion, a rise of almost 6-fold since 1990. Owner-occupied housing was the highest component of all household debt during this time, comprising 56-67% of total debt.

What to watch for

Many people use their home equity — whether it’s to consolidate debt or to fund their lifestyle. But using this money to spoil yourself with a “special” holiday or dream car, or splashing out on a 3D telly (no matter how much you watch it) is not a good choice.

That in no way means that you must life a life of austerity, never going anywhere special, still driving the car you bought as a student and watching a tiny colour “box”. If these things are your goals, great, go for them. But plan for them without using the equity you’ve saved in your home. While your home loan may be money at a lower interest rate, it is still debt with accumulating interest.

Another mistake people make is to buy a home that is really unaffordable. It may be “the best you can buy”, but, if you do your sums properly, is actually out of your reach. Buying something that stretches you — even a bit — is not a wise investment decision.

One of the first things you must do to avoid the slippery slope of bankruptcy pain is to know how much you earn versus how much you spend. And be accurate. Many people who slide under have no idea of these figures. You can only control what you measure, so start measuring accurately. And plan.

If you need help measuring your incomings and outgoings, call us for guidance. Summerhill also specialises in financial coaching; this is training and guiding people in dealing with and managing their finances. It’s not just about “teaching you to save”, it ensures you retain the discipline to maintain your financial strategy — and teaches you how to do it. 

Sources: University of Melbourne’s Centre for Corporate Law and Securities Regulation; “Middle class hit by bankruptcies”, Daniella Miletic, The Age, 23 May 2010; Surge in middle class bankruptcy, ABC News, 24 May 2010; “Soaring middle class bankruptcy blamed on unsustainable home loans” Lending Central 30 May, 2010

It can be one of the harsher sides of life that someone who’s fit and well today, may need to live in an aged care facility in the future. Indeed, as Baby Boomers in particular grow older, aged care is a “growth industry” that’s only likely to get bigger.

But in the past decade, aged care has become increasingly complex. Numerous changes to government policy regarding aged care means seeking specialist financial advice could be helpful in understanding the legislative issues.

Seeking an adviser familiar with the area will also help in understanding the types of facilities available, resident costs and financial-planning considerations such as the impact on a Centrelink or Department of Veterans’ Affairs pension, retaining the family home and estate planning.

Placing a parent in aged care is fraught with emotion, and will probably be distressing for everyone. Seeking specialist advice early removes the added stress of last-minute, hasty decisions, which may not be the right ones for your parents, or you.

How to work with your adviser

Whether for you or your parents, your adviser will need specific information so they can work out the best plan — for example, the level of care required and whether or not you want to keep the family home. This isn’t always just a financial decision; if someone has lived in the home or area for a while, the memories and feelings associated with it might weigh more heavily as a factor.

Your adviser will also need to know if person going into aged care has a legal representative, and they’ll probably also want to understand some of the family dynamics and relationships. As always, the more information, the more tailored the advice.

Generally, advice for aged care clients includes some alternatives for the person and/or their family to consider. The advice will often centre around generating income to meet ongoing aged care costs and estate planning issues.

How does the process begin?

The trigger for moving to an aged care facility is usually either a gradual health deterioration or sudden health-related issue (such as a mobility-limiting fall). 

A GP then identifies the need for “supported living”, requesting an Aged Care Assessment Team (ACAT) to determine the level of care needed — either low care (hostel) or high care (nursing home).

How are costs calculated?

For a new resident, costs are calculated using the assessment rules and rates current at the time of entry to aged care.

However, for existing residents, ongoing costs can vary, depending on the date they entered the aged care facility. For instance, it’s important to determine whether an “accommodation bond” or “accommodation charge” was paid, and what ongoing costs are applicable.

Some existing aged care residents are paying fees based on assessments before 20 March 2008, when the Federal Government implemented major reforms. Following announcements in the May 2009 Federal Budget, more changes began on 20 September 2009, which will be discussed below. 

(For more information on aged care issues, you may also wish to check the Department of Health and Ageing http://www.health.gov.au/internet/main/publishing.nsf/Content/ageing-whatnew.htm)

Types of aged care facilities

There are 2 types of aged care facilities: hostels (low care) and nursing homes (high care). Both are government subsidised, although residents may also have to contribute.

1. Hostels

The upfront payment is an “accommodation bond”, which is negotiable between the resident and the facility.

There’s no limit on the bond amount, which is generally determined by the resident’s assets at the time they enter the facility, but the resident must be left with no less than $36,000 in assets.

The bond can be paid as a lump sum, via periodic (fortnightly or monthly) payments, or as a combination. Where it’s paid partially as a periodic payment, an interest charge can be applied at a statutory rate (currently 7.3%).

Post-reform residents can pay an income-tested fee according to pensioner status:

• full pensioners are exempt
• the maximum amount of the income-tested fee is equal to 5/12 of the resident’s total assessable income above a threshold level

2. Nursing home

The upfront payment is an “accommodation charge”, which again is negotiable between the resident and the facility, but doesn’t apply if assets are less than $36,000. By agreement, payment can be deferred (but interest is charged) or paid from the resident’s estate.

For post-reform residents, the accommodation charge is based on their pensioner status and assets at entry. From 20 September 2009, both pensioner (supported) and non-pensioner (non-supported) rates are the same:

• supported and non-supported, with assets of $91,910.40 or higher = $26.88 per day
• partially supported, with assets equal to or less than $91,910.40 = $25.02 per day.

Residents who move from a hostel where they have paid an accommodation bond may be able to transfer it when they move to a nursing home, instead of also paying the accommodation charge. (The nursing home would need to be approve this.)

Extra service facilities may mean an accommodation bond is paid instead of an accommodation charge.

Rent won’t be assessed under the income test for residents renting their home while paying or deferring the accommodation charge. Neither will the home’s value be assessable under the assets test while this situation continues.

If the accommodation charge is not payable, the rent will be assessable under the income test (under the normal provisions) and the former home will only be an exempt asset for two years.

Post-reform residents pay a basic daily fee at a rate of 84% (from 20 September 2009) of the single age pension. They can pay an income-tested fee according to their pensioner status:

• full pensioners are exempt
• the maximum amount of the income tested fee is equal to 5/12 of the resident’s total assessable income above a threshold level

While the government sets the minimum charges that will apply — depending on the care level — many aged care providers who offer “extra service facilities” may charge an accommodation bond for a high-care resident instead of the accommodation charge. The aged care provider usually bases this bond on a commercial value, however, there are no set limits or formulae for calculating it.

Other ongoing fees

As well as the accommodation bond or charge, other ongoing fees can also apply, depending on the resident’s means-tested income and type of aged care facility services provided.

1. Basic daily fee

All residents in an aged care facility pay this, which contributes to the costs of meals, laundry and “comfort”, including general areas of daily care. For residents who entered care before 20 March 2009, a higher basic daily fee can apply than for those residents who entered after this date when the fee was capped at 85% of the full single pension. From 20 September 2009, this cap has been reduced to 84% of the full pension, which is subject to change (see details below).

2. Income-tested fee

This is similar to a co-contribution by the resident, and covers care costs where the resident is income means tested. Centrelink or the Department of Veteran Affairs (depending on the pension source) does this assessment when a resident enters an aged care facility permanently. The threshold for this fee from 20 September 2009 is $783.70 a fortnight (or $20,376.20pa) for a single person, or $765.70 per fortnight for a member of a couple.

Income earned above this threshold is calculated at 5/12th of the total assessable income. Income-tested fees are capped, based on whether or not the resident is a pensioner and cannot exceed the cost of their care.

3. Extra service fee

Some aged care facilities provide extra services, such as improved in-room services, and/or services across the whole facility. This fee is generally an extra daily charge; it varies from facility to facility. (For more information on charges as of 1 January 2010, visit http://www.health.gov.au/internet/main/publishing.nsf/Content/ageing-finance-resfees.htm)

May 2009 Budget changes 

Changes to pensions in the 2009/10 Federal Budget will also affect payments regarding aged care facilities.

In that Budget, the government announced it would increase the maximum single age pension by $32.49 per week from 20 September 2009, on top of the normal indexation increases; while the single basic age pension was increased $30 a week to $305.15 (indexed).

A new supplement was created by rolling the GST supplement, the pharmaceutical allowance and the utilities and telephone allowances into a single pension supplement. This also increased on 20 September 2009 by $2.49 per week (on top of normal indexation), to $27.88 (indexed).

As a result of all this, the new single pensioner rate (including supplement) is $335.95 a week.

The government also lowered the maximum rate of the basic daily aged care fee to 84% of the new higher single age pension. From 20 September 2009, the maximum basic daily fee is $36.94 a day, or $258.58 a week (indexed).

New ‘grandfathering’ arrangements

Special arrangements have been put in place for self-funded retirees who do not benefit from the pension rise and for part-pensioners whose increase is less than $22.40 a week (the rise in the basic daily fee). 

1. For those in care before 19 Sept 2009:

This doesn’t include all part-pensioners, because self-funded retirees and part-pensioners who receive an increase worth less than $22.40 a week on 20 September 2009, and who were in care on 19 September, had their basic daily fee set at the pre-20 September level of $33.41 a day or $233.87 per week (indexed). This is equivalent to 77% of the new single basic age pension. For these residents, the level of their basic daily fee remained at this level (indexed), while they remain in care.

2. For those in care after 19 Sept 2009:

Self-funded retirees and part-pensioners who received a pension increase worth less than $22.40 a week on 20 September 2009, and who entered care after 19 September 2009, will have the level of their basic daily fee increased 1% every 6 months from 20 September 2009 to 20 March 2013.

Entering care in the transition period

The government paid a new supplement to aged care providers for residents who entered care after 19 September 2009, and whose maximum basic daily fee is less than 84% of the single basic age pension. This means providers will receive the same income for these residents as they do for those who pay the full basic daily fee.

The value of the supplement was equal to the difference between the total daily fee (basic daily fee and income-tested fee) that the resident would have paid if the transition arrangements hadn’t been in place, and the total daily fee that the resident will pay.

Let’s work through an example.

Calculating the basic daily fee from 20 September 2009: 

Post-20 Sept 2009 fortnightly single pension = $671.90

Less pension supplement of $55.76*

Giving a net pension for calculation of $616.14 

Multiply this by 84% = $517.56

So the basic daily fee (divide by 14) = $36.94 

(* this comprises GST $19.50 + utilities allowance $19.96 + telephone allowance $5.32 = pharmaceutical allowance $6 + Budget allowance $4.98)

It is also important to note that following the Budget announcements, residents entering care from 1 January 2010  will no longer enjoy a 28-day grace period before income-tested fees apply. This will align the residential income-tested fee with other aged care fees payable from the date of entry into the facility.

What will not change is that a resident who is a homeowner has a two-year exemption period from the date of entry into aged care before their previous home is counted for the purposes of a means-tested Centrelink or Department of Veterans’ Affairs pension.

Aged care strategies

Aged care is an increasingly complex area financially. In many cases, an aged care resident has to decide whether or not to sell the family home and this may not be a simple financial decision. For an elderly person who has lived in the same home or area for many years, there may be a psychological attachment and a belief that one day they will resume living in the home.

Some people may prefer to pay a part-accommodation bond and retain the family home, even though they may need to rent it for some time to retain the means-test exemption.

If the resident-to-be holds financial assets that will not be exempt, they may need to consider strategies to reduce deemed or other income. By reducing these assets, and therefore income, it may be possible to maintain the level of government pension they are receiving and reduce any income-tested fee payable, should income be in excess of the threshold.

Many prospective residents and their families believe that they must accept the aged care cost arrangements in the terms outlined by the aged care facility. This is not always so, as you can often negotiate the method and timing of payment with the aged care facility. But, where an accommodation bond applies, a penalty interest charge is usually payable at the rate of 7.30% a year (effective 20 September 2009) over a 5-year period.

Bear in mind, aged care is a growth industry with demand outstripping supply in many areas.

It’s important to understand that after a resident has entered aged care, it may be too late to undo any financial decisions made by them, or on behalf of them, before entry.

As per above, for more information on aged care issues, you may also wish to check the Department of Health and Ageing http://www.health.gov.au/internet/main/publishing.nsf/Content/ageing-whatnew.htm and for charges as of 1 January 2010, visit http://www.health.gov.au/internet/main/publishing.nsf/Content/ageing-finance-resfees.htm

Source: “Aged care advice” by Kaplan Education Pty Limited, November 2009.

Accidents only account for 23% of deaths for 50-year-old males, yet many people choose them because of the lower premium. But while they are somewhat cheaper, they are not 77% cheaper (if you look at the face value of that statistic). And curiously, older males — who have less chance of dying accidentally than young males — get to pay the same premium for the same amount of cover.

Hmmm.

On top of that, there’s this: if you replace an accidental death policy with a standard policy, you can end up paying a premium loading for certain conditions (such as asthma). 

Then consider this: a male over 45 years of age who dies has only a 1 in 4 chance that their beneficiaries will collect on an accidental death policy. That’s a pretty grim statistic.

All those facts make the initially cheaper-looking accidental death policy actually more expensive.

There are financial and emotional penalties to consider here: right when your family may need the financial help of a payout from the policy, it may not materialise. Plus, it’s added stress they certainly do not need at that time.

The fine print

As always, you must read the fine print.

Usually, accidental death policies have:

• exclusions for deaths related directly or indirectly to drugs and/or alcohol (think car accidents)
• defined times in which death must occur from the accident to qualify for a payout (such as time on life support — and you do not want to be forced to include the policy’s requirements in any of your thinking here)
• exclusions to pay claims for death from suicide

These conditions are not in standard policies that cover “death from all causes”.

So before you think “hey that’s cheap, I can save here” when you read a brochure sent by your bank, you need to think it through entirely.

Sometimes, having an accidental death policy is a bit like having some boxes stapled together to look like a computer — they just won’t do the same job.

If you would like to discuss your insurances, and whether they fit your lifestyle and financial needs, contact us — even if it’s outside of your scheduled planning meeting.

Source: The Risk Store

The alarm over sovereign risk and technical malfunctions has certainly sparked renewed volatility in markets. But amid all the learned analysis and soul searching, it’s worth reflecting for a moment on the long-term view.

It is now only a year and half since the collapse of Lehman Brothers had markets staring into the abyss. After several years of extraordinarily low volatility when nearly all the focus was on return, investors were reawakened rather rudely to the notion of risk.

The sudden spike in volatility—and the preceding long lull – can be seen in this chart, which records the performance of the Chicago Board Options Exchange Volatility index, a yardstick of investor anxiety.

This volatility was also reflected in ordinary stock prices. The US share market in 2008 suffered its second worst performance in eight decades. For the Australian market, it was its worst year on record; in Canada, the worst since the Great Depression and in Europe the worst since records began.[1]

The turnaround in sentiment from March 2009 was just as stunning, with major indices registering their best performances in years. In Europe, the broad market registered its biggest annual gain in a decade, in Australia in 16 years and, in the US in 20 years and in Canada in 30 years.[2]

So the performance of markets in the past two years has been extreme by historical standards. But the important point for investors is to note that over time, the positive return years from equities have outnumbered the negative and that investors who can bear the risk of stocks and stay committed through these various periods are rewarded for their discipline.

This chart shows the historical distribution of US equity market returns since 1926. The performance years are stacked in order of return range, with the down years in red and the up years in blue. The past two polar opposite years are in black. As you can see, the positive years over this eight-decade period outnumber the negative by a factor of almost three to one.

So investors may feel legitimately worried about the current sovereign debt strains in Greece or sudden computer-driven volatility in US stock exchanges. But it’s important to understand that markets have a way of working through these things and rewarding those who over the long term risk their capital.

Saying markets work doesn’t mean they don’t make mistakes from time to time and are perfectly efficient. But these mistakes make less difference the longer your horizon. What matters ultimately is that markets are extremely competitive, and absorb new information almost instantly.

Trying to second-guess how markets might move in the next day or month or year tends to be counter-productive, because no-one knows the future.

We can deal with this volatility through diversification and by taking only those risks we feel comfortable with, while noting that risk and return are opposite sides of the same coin.

Whether ancient Greek or modern geek, the language of long-term investment remains the same.

[2] Reuters data

The Australian Financial Review, in February 2009, caught the mood in a report headlined ‘Faint Optimism amid Gloom’. The article noted that signs of a turnaround in the small cap sector were scarce. Risk appetites were “anaemic” and earnings downgrades were outstripping upgrades by 5 to 1.

And why wouldn’t investors be frightened of small, unknown, unfamiliar companies? After all, small caps had been – after listed property – the second worst performing asset class for Australian investors the prior year.

The index was near a six-year low, reflecting the view that this sector finds it harder to adjust to an economic downturn, is more cyclical in nature and lacks the market power and balance sheet strength of large companies.

This was all perfectly logical. Small cap stocks looked riskier and the larger fall in their share prices relative to the wider market reflected those risks. Put another way, the expected returns from the small cap sector were higher.

The knee-jerk response to the gloom in the media and markets a year ago about small cap prospects might understandably have been to decide “this is too risky for me; I’m selling out and going back to a large cap fund”.

But bailing out of an asset class in the doldrums often means just realising what was, until then, a paper loss and missing the opportunity to ride the rebound when it comes.

And so it was that the extraordinary recovery in risk assets last year was led by the very sector that suffered most in the prior downturn: Small caps.

In fact, the Small Ordinaries Accumulation Index rose by nearly 77% over the 10 months to December, easily beating the wider market’s 51.5% gain. Dimensional’s Australian Small Company strategy did even better, rising by nearly 91% in that period.

A similar pattern emerges in the performance of low-priced “value” stocks relative to the market. Value, as measured by the S&P BMI Value Index, gained 60.5% in the 10 months to December, beating the market by nearly 10 percentage points. Again, the equivalent Dimensional strategy did even better, putting on 76% during this period.

Economists have shown that over the long-term value and small-cap stocks tend to outperform the broad market, but that these superior returns can be particularly evident around turning points in the economic cycle.

This makes sense intuitively as we tend to see investors swing from extreme risk aversion back toward a hunger for risk as they anticipate economies emerging from a recession or period of weak growth.

And we have seen that the sectors that lead these turnarounds are often those that were the most beaten down during the prior downward cycle.

The problem is there is very little evidence, if any, that investors can accurately time these changes in any consistent way. The premiums come and go and, often when they do kick in, they do so dramatically.

The consequence of that is that the only way of securing these long-term excess returns reliably is to maintain one’s exposure to these riskier assets in good times and bad. Jumping in and out may help you avoid the worst of the downturn, but it also opens up the threat of missing the best of the rebound.

It’s another vivid demonstration of why it pays to stay in your seat.

Data sources: Returns program.
Periods: More than 1 year are annualised, less than 1 year are actual
Dimensional strategies: Live returns, gross of fees & expenses
S&P/ASX data reproduced with the permission of S&P Index Services Australia.

Source: Returns program