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topic_8.ppt
Topic 8 – Risk Management & Insurance
BAFI 1016 Personal Wealth Management
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
Personal Risk Management continued
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
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
House and Contents Risk Management continued
- 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...
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
Liability Risk Management continued
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
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
Life Policies continued
Special sum insured increase
Guaranteed renewable
Multiple lives
Policy duration
- Stepped premiums
- Level premiums
Convertibility
Optional benefits
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
Health Insurance
Policies continued
- 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
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
General Insurance continued
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
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
