Week 10 Flashcards
Managing risks
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.
Basic categories of risk.
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.
Concept of Risk
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.
Rules
don’t risk more than you can afford
consider the odds
don’t risk a lot for a little
Techniques
Risk Retention
Risk Avoidance
Risk Reduction / control
Risk Transfer
Steps to Risk Management
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.
Advising on insurance matters
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
Insurance Defined
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
The Nature of Insurance
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
The Insurance Marketplace
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
Legal Principles in Insurance Contract
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.
Generally, insurance can be divided into the following classes:
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
insurance purpose
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Life Insurance
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.
Term Life Insurance
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
Whole Life Insurance
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.
Joint Life Insurance
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
Endowment Insurance
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
How much life insurance?
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
Needs approach
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.
Disability Income Insurance
Life insurers, and some general insurers, offer a range of disability policies:
Total and Permanent Disability
Critical Illness
Income Protection
Total and Permanent Disability (TPD)
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.
Critical Illness (Trauma)
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
Income Protection
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
General Insurance
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
How much property insurance?
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.
Liability Insurance
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
Motor Insurance
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
Medical Health Insurance
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.
Determining sums insured
Know your products Know your client Appropriate Cover Ownership Use appropriate combinations Pricing issues Beneficiaries Sum insured limits
Insurance Planning
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.
