Week 10

Question 1

Managing risks

Answer 1

A financial plan will establish the pathway to a client accumulating wealth and obtaining financial security.
Need to consider the possibility of the risk of financial losses occurring which may prevent this from taking place.
Insurance is an essential part of a person’s financial plan and one way in which the risk of potential losses can be minimised.

Question 2

Basic categories of risk.

Answer 2

Pure risk:
a situation in which there is the possibility of loss or no loss
Speculative risk:
a situation in which either a profit or loss is possible
Fundamental risk:
a risk that affects the entire economy or a large group of people
Particular risk:
a risk that affects only individuals & businesses

Only a risk that is pure and particular can be transferred to
a professional insurer.

Question 3

Concept of Risk

Answer 3

Risk, peril and hazards
Risk: the uncertainty concerning the occurrence of a loss.
Peril: the cause of the loss, e.g. Fire, earthquake, burglary, malicious acts, etc
Hazard
Physical hazard: physical condition or activity that increase the chance of loss, e.g. Smoking, faulty brakes, defective electrical wiring.
Moral hazard: dishonesty or character defects, e.g. Making dishonest claims on insurance.
Morale hazard: carelessness or indifference to a loss as a result of having insurance.

Question 4

Rules

Answer 4

don’t risk more than you can afford
consider the odds
don’t risk a lot for a little

Question 5

Techniques

Answer 5

Risk Retention
Risk Avoidance
Risk Reduction / control
Risk Transfer

Question 6

Steps to Risk Management

Answer 6

Step 1. Determination of objectives.
to preserve the operating effectiveness of the individual, family or business.

Step 2. Identification of risks.
liability losses - negligent acts .
property losses - damage to house/content/car.
personal losses – e.g. financial loss as a result of death/disability.

Step 3. Evaluate the risks.
critical risks, important risks, unimportant risks.

Step 4. Select the most appropriate technique.
Only risk that has a low loss frequency and high in severity will be appropriate for transfer to professional insurers.

Step 5. Implement the plan.
decide on the types of insurance products or the
action necessary to handle the risk.
decide on the time frame to implement the plan.

Step 6. Periodic review and evaluation.

periodically review and evaluate to determine if the risk management objectives are being achieved.

Question 7

Advising on insurance matters

Answer 7

The process of giving advice on insurance is no
different to advising on any other financial product

identify the task
conduct a fact find
analyse the client’s needs and objectives
apply your specialist knowledge
make a recommendation (type and particular product)
document the above process (paper

Question 8

Insurance Defined

Answer 8

Insurance may be regarded as the pooling of fortuitous loss by transfer of such risk to insurers, who agree to indemnify the insured for such losses, to provide other pecuniary benefits on their occurrence, or to render services connected with such risk
Pooling of loss: the heart of insurance, i.e. spreading of losses incurred by a few over the entire group
Payment of fortuitous losses: a fortuitous loss is one that is unforeseen and unexpected and occurs as a result of chance, i.e. the loss must be accidental or occurs randomly
Risk transfer: the risk faced by the insured is transferred to the insurer
Indemnification: the restoration to the insured the approximate financial position prior to the occurrence of the loss

Question 9

The Nature of Insurance

Answer 9

Insurance is simply a means of transferring risks from individuals and businesses that cannot afford to retain the risks, to insurers who can:
The price for this is the premium
Insurers work under a “pool principle”
offer insurance to a large group of people and invest premiums to cover claims and profit
Insurance providers use mathematical and actuarial principles to predict insurable events and pool similar risk events into separate categories
Discriminatory pricing to cover different claim histories for different people

Question 10

The Insurance Marketplace

Answer 10

Regulators
ASIC (consumer matters)
APRA (licensing and financial matters)

Professional Bodies.
Insurance Council of Australia
Insurance Agents Association of Australia
National Insurance Brokers Association

Insurers
life (risk and investment products)
Life Insurance Act 1995, Insurance Contracts Act 1984
The Life Code of Practice
general (risk products)
Insurance Act 1973, Insurance Contracts Act 1984
health (hospital and medical)
National Health Act (1953)
Intermediaries
agent, broker
Insurance (Agents and Brokers) Act 1986
5.   Clients

Question 11

Legal Principles in Insurance Contract

Answer 11

Principle of indemnity
the insured cannot profit from loss but should be restored to the approximate financial position before the loss.
Principle of insurable interest
the insured must lose financially if loss occurs or must incur some kind of a harm if loss occurs.
Principle of subrogation
the substitution of the insurer in place of the insured for the purpose of claiming indemnity from third party for a loss covered by insurance.
Principle of utmost good faith
each party in the contract of insurance must have the highest degree of honesty to the other party.
Material Facts duty of disclosure.

Question 12

Generally, insurance can be divided into the following classes:

Answer 12

Insurance of person
Death: Dying too young (premature death)
Accident: Total permanent disability
Sickness: Disability and trauma
Retirement: Living too long
Insurance of property: damage, destruction or theft
Commercial
Domestic
Insurance of liability
liability under common law, legislation (eg. Trade Practices Act), and contract

Question 13

insurance purpose

Answer 13

slide 18

Question 14

Life Insurance

Answer 14

Types of Life Insurance Contracts
Term Life temporary insurance
Whole of life
Endowment permanent insurance

Additional extras
Permanent and total disablement .
Critical Illness (Trauma).
Guaranteed future insurability.

Question 15

Term Life Insurance

Answer 15

Characteristics
provides a cash lump sum in the event of insured dying during period of insurance
temporary insurance where the policy is renewed each year.
no savings component.
premium can be fixed (level) or adjusted over time (stepped).
premium can be expensive at older ages.
accounts for over 90% of new life policies written
taxation implications – can be held inside/outside super.
Applications:
Individual/family:
lump sum to cover medical bills, lost income, debts, provide for dependents
Business:
buy out partner upon death, cover business loans, key person

Question 16

Whole Life Insurance

Answer 16

Characteristics:
provides a death benefit and contains a savings component.
coverage extending for as long as the policyholder lives or to age 99 whichever comes sooner.
bonuses accumulate (savings) and paid together with sum assured upon death claim.
policy has a surrender value - refund of premiums.
premiums can be fixed over length of contract period
not popular now due to the returns (bonuses) being inadequate compared to other investments.
Applications
Constant premiums and Estate Equalisation/planning.

Question 17

Joint Life Insurance

Answer 17

These can be either first-to-die or second-to-die policies, also known as survivorship policies.
A first-to-die policy may be used in either a personal or a business situation and promises to pay the face amount on the death of the first of two or more covered persons

Question 18

Endowment Insurance

Answer 18

Characteristics
A combined Death and Savings policy.
Policy taken out for a set period of time (eg. 30 years).
Policy pays upon death or maturity date, whichever comes first.
Benefit is the sum insured plus bonuses. Returns low.
High percentage of premium goes into the savings.
Application?
Provides long-term death coverage
Provides for a systematic way of accumulating a certain sum at a future date eg. children’s education

Question 19

How much life insurance?

Answer 19

Three approaches
Human life value: how much a person will earn in the remaining of his/her productive life using present value estimation
Needs approach: estimate the various needs of a person’s dependents over the period of dependency, eg. last expenses, debt retirement, readjustment, education
Capital retention (multiple) approach: the amount of capital that is needed to generate the income necessary to maintain the surviving dependents
Usually use a combination of all three

Question 20

Needs approach

Answer 20

What are the needs?
1. Estimate capital required to pay out debts.
2. Estimate capital required to produce family
income (based on assumed rate of return).
3. Estimate all other expenses, including estate settlement costs.
4. Assess liquidity reserves.
5. Balance represents capital required.

Question 21

Disability Income Insurance

Answer 21

Life insurers, and some general insurers, offer a range of disability policies:

Total and Permanent Disability
Critical Illness
Income Protection

Question 22

Total and Permanent Disability (TPD)

Answer 22

normally an optional extra cover on a life policy
pays benefit in event of insured becoming totally and permanently disabled and insured prevented from working in chosen occupation / performing basic living activities.
need to be careful of restrictive definitions:
own occupation - you will be paid if by reason of accident or injury you are no longer able to perform your normal occupation. Chance of claim prior to 65 – 6%
any occupation - you will be paid if by reason or injury you are no longer able to perform any occupation suitable to your education, training and experience Chance of claim prior to 65 – 3%
claim paid as a lump sum.

Question 23

Critical Illness (Trauma)

Answer 23

Characteristics:-
lump sum paid upon the insured being diagnosed with any one of a number of major critical illness, eg. heart attack, malignant tumours, blindness, multiple sclerosis.
benefit paid upon diagnosis, not death.
provides lump sum when funds are needed most
can be acquired as a stand alone product or as an extension of a life policy. Stand Alone usually requires survival period of 7 or 14 days to qualify for a claim.
premiums can be level or stepped or a mixture of both
funds only paid for conditions specified.
Applications:-
Meets high costs of medical expenses associated with major illness, or pay down debt if required

Question 24

Income Protection

Answer 24

Characteristics:-
provides an income stream in the event of incapacitation as a result of an accident or sickness and unable to work for any medical reason:
typical coverage normally up to 75% of average pre tax income obtained from personal exertion
Benefit Period– 2,5, to age 65 or 70 years.
nominate waiting period (14, 30 or 90 days, 1 or 2 years)
How long can individuals support themselves for?
Suited to employed and self employed.
tax implications – can be paid by an individual or company and is usually fully deductible
Applications:-
Individuals earning an income, ages 20+ and working 15+ hours/week

Question 25

General Insurance

Answer 25

Provide cover for loss or damage arising from damage to almost any type of property:
Commercial
building, business overhead, key person, loss of profits, contents, personal property
Domestic
house and structural items (usually at replacement value)
contents
limits apply to valuables unless stated in policy or additional policy taken out
most house contents policies automatically provide personal liability insurance

Question 26

How much property insurance?

Answer 26

Indemnity policy: reimburses loss as defined in the terms of coverage, e.g. based on market value, original value minus depreciation or fixed amount
Replacement policy: full cost of replacing damaged or stolen items, e.g. if it’s a damaged building, the full cost of rebuilding or if it’s a stolen item, the full cost of a replacement with or without consideration to age of the lost item
Market policy: based on the market value of that item.

Question 27

Liability Insurance

Answer 27

Public liability
the Common Law protects the rights of individuals against negligent acts committed against them
Product liability
a manufacturer is liable to pay damages for defective goods supplied which cause injury to domestic consumers
Professional liability
Professionals, such as accountant, lawyers, doctors, & financial planners owe a duty of care to clients and are liable to pay damages for negligent acts which resulted in bodily injury or financial loss
How much insurance?:
get advice from insurer, professional bodies or trade associations

Question 28

Motor Insurance

Answer 28

Types of cover
Third party injury – compulsory (CTP). Covers claims made against insured if vehicle injures or kills someone – NO Property Cover
Third party property - covers damage caused by the insured’s vehicle to other people’s property
Third party fire and theft - similar to third party insurance but also extends coverage to loss or damage to the insured’s vehicle caused by fire or theft
Comprehensive - covers the insured for loss or damage to own vehicle as well as damage to third party’s property caused by the insured’s vehicle. Some will replace a written off car in first 1-2 years.
Most policies cover a total loss claim on market value

Question 29

Medical Health Insurance

Answer 29

Provided initially by Government through Medicare:
Treatment as a public patient in a public hospital and by a medical practitioner to a set level
Premium paid by taxpayer at 2% of taxable income (thresholds apply)
Private health cover
Medicare levy surcharge (incomes $90k +) and reducing rebate to discourage exiting from private health insurance
Covers hospital accommodation and related medical fees not covered by Medicare
Provides choice – both, doctors AND private hospital – can obtain non essential or elective treatment sooner
Option for ancillary benefits – dental, physiotherapy, chiropractory, acupuncture etc.

Question 30

Determining sums insured

Answer 30

Know your products
Know your client
Appropriate Cover
Ownership
Use appropriate combinations
 Pricing issues
Beneficiaries
Sum insured limits

Question 31

Insurance Planning

Answer 31

Select the most appropriate methods of managing the risk
Loss control, loss prevention and reduction, transfer.
Implement the plan - purchase insurance
Decide the amount to be insured.
The type of insurance products most suitable to meet the need, consider definitions & exclusions .
The time period for the insurance to be purchased.
Which insurer(s) that you like to do business with.
Choosing the Insurer / Intermediary
The financial strength of the insurer: get evaluation from magazines, rating agency etc.
Reputation of the insurer, range and price competitiveness of products, claim history, customer service.
Intermediary (Broker/Agent) can assist in both implementation and claims.