Topic 8

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Topic 8 Risk Management Insurance

• BAFI 1016 Personal Wealth Management

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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

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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

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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)

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Risk continued

• Liability
• Common law e.g. negligence
• Statute law e.g. faulty product
• Contract e.g. construction

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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

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Risk Management continued

• 2. Management of identified risks
• Seek to avoid and minimise risks
• 3. Program review
• Regularly reassess to ensure ongoing protection

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Personal Risk Management

• 1. Identification
• Premature death
• Prolonged illness or injury
• Medical costs
• Business risks

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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

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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

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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

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Personal Risk Management continued

• 3. Control measures
• Lifestyle factors such as fitness, diet, smoking
  and alcohol.
• 4. Financing measures
• Retention losses met from individuals own
  resources or via insurance excess
• Transfer financial responsibility passed to
  another party typically via insurance

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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

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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

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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...

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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

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Motor Vehicle Risk Management continued

• Control and financing measures
• Control via car alarms, safety devices and
  improved driving skills
• Financing via insurance policies

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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

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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

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The Insurance Marketplace

• Insurers
• Life, General and Health
• Intermediaries
• Financial Services Reform Act
• Clients
• Insurance Contracts Act 1984
• General Insurance Codes of Practice

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The Insurance Marketplace continued

• Regulators
• APRA via prudential regulation
• ASIC via consumer-oriented matters

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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

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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

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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

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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

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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

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Life Policies continued

• Special sum insured increase
• Guaranteed renewable
• Multiple lives
• Policy duration
• - Stepped premiums
• - Level premiums
• Convertibility
• Optional benefits

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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

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Life Policies continued

• Other life company products
• Whole-of-life policies
• Endowment policies
• Life insurance cover in a superannuation fund

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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

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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

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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

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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

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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

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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

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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

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Arranging Insurance Through a Superannuation Fund

• Some personal risk policies such as term life
  insurance can be arranged via the individuals
  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

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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

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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

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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

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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

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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)

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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)

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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

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General Insurance continued

• Fire, theft and third party property damage
• Third party property cover only
• Uninsured motorists extension

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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

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General Insurance continued

• Travel insurance
• Includes luggage and personal effects, medical
  expenses and personal liability

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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

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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

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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

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Summary continued

• Insurance policies should be regularly reviewed
  to cater for changing circumstances, particularly
  those creating the potential for underinsurance
  or financial hardship

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