•A financial plan must take into account the possibility of risks such as disability and premature death may occur and aim to: –Eliminate them, or –Minimise their effect •A systematic approach should be taken to identify and manage these risks
Speculative risk •Arises where there is a chance of a loss or a gain •Examples: –Gambling; Once the bet is placed, there can only be a win or a loss –Setting up a business; The business will succeed or fail
Pure risk •Arises where there is only a
possibility of loss or no loss •Categories of pure risk –Personal –Property and (see next slide) –Liability •Common law – e.g. negligence •Statute law – e.g. faulty product •Contract – e.g. construction
Risk management process can be divided into 3 broad steps:
1. Identification and evaluation of potential risks –Identify possible losses and their costs
2. Management of identified risks –Seek to avoid and minimise risks 3. Program review –Regularly reassess to ensure ongoing protection
Slide 1 Chapter 10 Risk Management and Insurance PowerPoint presentation by Lindsay Cowling Holmesglen Institute ©2011 John Wiley & Sons Australia, Ltd Introduction A financial plan must take into account the possibility of risks such as disability and premature death may occur and aim to: Eliminate them, or Minimise their effect A systematic approach should be taken to identify and manage these risks Risk Speculative risk Arises where there is a chance of a loss or a gain Examples: Gambling; Once the bet is placed, there can only be a win or a loss Setting up a business; The business will succeed or fail Risk continued Pure risk Arises where there is only a possibility of loss or no loss Categories of pure risk Personal Property and (see next slide) Risk continued Liability Common law – e.g. negligence Statute law – e.g. faulty product Contract – e.g. construction Risk Management Risk management process can be divided into 3 broad steps: 1. Identification and evaluation of potential risks Identify possible losses and their costs Risk Management continued 2. Management of identified risks Seek to avoid and minimise risks 3. Program review Regularly reassess to ensure ongoing protection Personal Risk Management 1. Identification Premature death Prolonged illness or injury Medical costs Business risks Personal Risk Management continued 2. Evaluation of personal risks a. Lump sum costs in the event of premature death include: Burial and associated expenses Estate administration costs Final medical and associated care Debt clearing Adjustment expenses b. Provision for dependents The multiple approach - Relatively simple to calculate - Ignores individual resources and commitments - Assumes constant resources and inflation Personal Risk Management continued The needs approach - Requires relatively detailed dynamic budgeted information necessitating reassessment from time to time c. Disablement costs can include: Medical expenses Other costs associated with the disability Provision of an income to support any dependants Personal Risk Management continued 3. Control measures Lifestyle factors such as fitness, diet, smoking and alcohol. 4. Financing measures Retention: losses met from individual’s own resources or via insurance excess Transfer: financial responsibility passed to another party – typically via insurance Personal Risk Management continued House and Contents Risk Management 1. Identification e.g. fire, storm, water damage, burglary, impact by vehicles and earthquake 2. Evaluation Value only considered for building and contents as land will always remain 3. Control measures Smoke detectors, burglar alarms, deadlocks etc House and Contents Risk Management continued 4. Financing measures Adequate insurance Replacement value Indemnity value Consider value of contents Consider impacts of a ‘co-insurance or average clause’ which seeks to pass on some of the financial impacts of underinsurance to insured Example of underinsurance: the full value of a house is $300 000 but it is insured for only $160 000. The house sustains partial damage amounting to $150 000. The calculation is as follows: insurance company would only cover $100 000 of the $150 000 loss, leaving the owners of the house with an amount of $50 000 to cover from their own resources. Keep in mind that some insurers do not use this clause... House and Contents Risk Management continued Motor Vehicle Risk Management Identification and evaluation Damage to the vehicle itself Limited to amount of the repairs Loss or damage to third parties or their property May be extremely large in cases of serious bodily injury Motor Vehicle Risk Management continued Control and financing measures Control via car alarms, safety devices and improved driving skills Financing via insurance policies Liability Risk Management Identification and evaluation Liability at personal level is increasing. Rise in number of negligence actions Control and financing measures Take steps to minimise chance of loss in relation to potential identified situations e.g. Financial planning office: use a check list of procedures to help ensure nothing has been overlooked in gathering information in order to advise client AFSL holders must have adequate PI insurance cover Liability Risk Management continued The Insurance Marketplace Insurers Life, General and Health Intermediaries Financial Services Reform Act Clients Insurance Contracts Act 1984 General Insurance Codes of Practice The Insurance Marketplace continued Regulators APRA via prudential regulation ASIC via consumer-oriented matters Principle of Utmost Good Faith Principle underlies contractual relationship between insurer and the insured Highest degree of honesty imposed on both parties Duty of disclosure of all ‘material facts’ Principle of Utmost Good Faith continued Absence of disclosure of a material fact by applicant may result in contract becoming voidable at the option of the insurer, or Reduction in insurer liability upon a subsequent claim Principle of Utmost Good Faith continued Misrepresentation of information provided to insured may be categorised as being either Innocent, or Fraudulent Different contractual outcomes arise from the categorisation made Insurance Policies Insurance is a central part of risk financing measures Policies include: Life insurance policies Disability policies (TPD) Trauma policies Health insurance policies General insurance policies Life Policies Most common life policy is term life with whole-of-life policies much less frequently used today Term Policy features Sum insured payable on death Terminal illness benefit reducing subsequent sum insured Indexed sum insured Special sum insured increase Guaranteed renewable Multiple lives Policy duration - Stepped premiums - Level premiums Convertibility Optional benefits Life Policies continued Life Policies continued Term Policy exclusions Suicide Other War, terrorist attacks Pre-existing conditions Taxation of Term insurance policies If regular premium payments can be claimed as a tax deduction, policy proceeds are taxable Life Policies continued Other life company products Whole-of-life policies Endowment policies Life insurance cover in a superannuation fund Life Policies continued Policy ownership A life policy can be in the name of: The life insured A person or company on the life insured The life insured with a named beneficiary Disability Policies Total and permanent disablement insurance (TPD) - critical aspect relates to definition of total and permanent disablement - more restrictive definition typically provides for lower premiums but less chance of making a successful policy claim Disability Policies continued Trauma insurance - lump sum benefit - can be purchased separately or as an extension of another life policy Combined life, trauma and TPD policies - Linked policies - Combined policies Disability Policies continued Income protection insurance - benefit - waiting period - guaranteed renewal - total disablement lump sum benefit - partial disablement lump sum benefit - Additional benefits Business overheads insurance Health Insurance Policies Health insurance via Medicare provided to all Australian residents as a government service Medicare Available to all Australian residents. Medical benefits Hospital benefits Pays up to 85% of the scheduled fee Health Insurance Policies continued Public pay for Medicare by a levy assessed on taxable income Levy surcharge if resident does not have private health hospital cover and taxable income beyond a family threshold level Private health insurance Available to those who purchase it from a licensed health insurer at an additional cost to the Medicare levy Government supports private health cover by way of a subsidy Provides greater flexibility in where and by whom a person is treated Health Insurance Policies continued Arranging Insurance Through a Superannuation Fund Some personal risk policies such as term life insurance can be arranged via the individual’s superannuation fund Premiums will be substantially less within a superannuation fund as opposed to a retail environment Necessary to have a binding death nomination to overcome the issue of trustee discretion… Arranging Insurance Through a Superannuation Fund Potential problems arranging TPD within superannuation… If the TPD is ‘own occupation’ it is unlikely to be a deductible expense to the super fund and the fund will need to charge a higher premium to the superannuant If the individual suffers from a disability which qualifies from the insurer to the fund but it does not satisfy a condition of release of the fund, proceeds can be locked in the fund until preservation age… Arranging Insurance Through a Superannuation Fund Income protection Such policies must cover a period of temporary disability of at least two years. Then the contributions will be a deductible expense to the fund The individual must also satisfy the SIS ‘temporary conditions of release’ for benefits under the policy to pass to the individual Premium savings by taking income insurance through superannuation Group Underwriting Insurance policies can either be underwritten individually or as a group of employees Group policies are available for Term Life, TPD and Income Protection Group cover does not take into account higher risk individuals so it a good way for such individuals to obtain cover at a reasonable price – funds need to implement strategies to overcome the risk of adverse selection General Insurance House and contents Policies may cover all risks and damage or specify the list to be covered or loss or damage to valuables only Flood damage often not covered although some cover ‘flash flood’ Policies will generally have exclusions Public liability insurance usually included in policy Contents insurance normally provided on a replacement value basis (‘new for old’) May also cover credit card fraud, food spoilage, fusion of electric motors (to an age limit) General Insurance continued Motor Vehicles: Compulsory Third Party Insurance (CTP) Insurance covers legal liability personal injury arising from a motor vehicle accident and is required by law Nature of cover varies from state to state – e.g. Vic has a no fault scheme whereas NSW had a fault based scheme (i.e. the injured person is covered so long the accident is not their fault) General Insurance continued Motor vehicle insurance Comprehensive motor insurance - Covers all vehicle costs of insured and any other party to accident - Market value vs. agreed value - Common exclusions such as drink driving apply General Insurance continued Fire, theft and third party property damage Third party property cover only Uninsured motorists extension General Insurance continued General Insurance continued Sickness and accident insurance Restricted form of an income protection policy provided by life insurers Consumer credit insurance Provides protection for those who have entered into any type of consumer finance contract requiring regular payments General Insurance continued Travel insurance Includes luggage and personal effects, medical expenses and personal liability Implementation and Review Identification and evaluation of potential risks possible losses and their costs Management of identified risks avoidance and minimisation Program review to ensure ongoing protection Summary The risk management process is a systematic approach to the identification and management of risks faced by individuals Key stages in the process are: Identification Evaluation Control Financing Summary continued Insurance is the principal means of providing for serious losses Insurance contracts are based on the principle of ‘utmost good faith’ between the relevant parties Summary continued Insurance policies should be regularly reviewed to cater for changing circumstances, particularly those creating the potential for underinsurance or financial hardship