Risk Management for Individuals Flashcards
How do we formulate a discount rate for calculating human capital?
Risk free rate plus some premium for occupational income volatility
What are the financial stages of life for an individual?
- Education - no focus on savings or risk management
- Early Career - family and housing expenses, human capital is our largest asset
- Career Development - income growth, begin saving for retirement - This is typically between 30-50
- Peak Accumulation - higher career risk but may be taking lower investment risk.
- Pre-retirement - reduce risk, tax plan
- Early retirement
- Late retirement
What are the basic risks that an individual faces with regards to their finances?
- Earnings Risk - anything that affects earning power
- Premature death risk - affects the ability to provide for family
- Longevity risk - how long will retirement last
- Property Risk - your property is destroyed
- Liability risk - you’re legally liable for destroying others
- Health risk - illness or injury
What are the three considerations for pricing life insurnace?
- Mortality expectations
- Discounts - net premium (pure cost of insurance)
- Loading - expenses and profit
What are the two ways of calculating life insurance needs?
- Human life method - replace human capital
2. Need analysis - just meet needs
What are the advantages & disadvantages of annunities?
- Low vol for fixed, vol for variable
- Flexibility - not a lot of flexibility once you invest, but variable and deferred annuities will allow withdrawal
- Market outlook - lock in rates today (shift reinvestment risk) for fixed. Variable combats this to a certain extent.
- Fees - variable are higher than fixed
- Inflation - would need to pay for a rider
- Tax deferred growth
- Mortality credits - other people subsidize
- Net negative benefits
- Can benefit with if you live longer
What are the general methods of loss control that don’t include insurance?
- Avoidance - dont do it
- Prevention - detect it
- Reduction
If the loss if going to be severe and it could be frequent, how should we deal with it?
You must use risk avoidance
If the loss is going to be severe but infrequent, how should we deal with it?
We should transfer the risk
If the loss is going to be non severe but happens a lot, how should we deal with it?
Risk reduction
If the loss is nonsevere and non frequent, how should we deal with it?
Retain it
What factors contribute to the riskiness of human capital?
- Lower performance in your occupation
- Lack of geographic mobility
- Single source of income
- Employer specific human capital
- Routine jobs
- Human capital with high decay rates - if your area of expertise is changing and you don’t change with it
How do you calculate the amount of insurance needed using the human life value?
This estimates the current value of earnings that need to be replaced.
This is the found by taking the annual income (after tax) and costs, and then turning it PV using the annuity due formula. You then subtract existing insurance
How do you calculate the amount of insurance needed using the needs analysis method?
- Determine the costs upon death to pay out expenses and liabilities
- Consider the PV of future need for the remaining family members
- Consider the survivor income discounted to today with no growth
- Deduct capital existing.
What constitutes personal assets?
Personal assets are assets than an individual consumes during their life. They are not expected to appreciate and are often worth more to the individual than in the market.
