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Insurance: Why worry?

During our lives all of us are exposed to the possibility of a variety of risk events such as:

• Work accidents
• Major illnesses
• Death
• House fire
• Motor accidents
• Theft

While death is of course inevitable at some time, some of the other risk events may never happen. Also the likelihood of some of these risks occurring may be greater at particular stages of our lives. For instance most major road accidents involve younger people while most major illnesses occur with advancing age.

Also at different times of our lives our financial plans and our dependents are more vulnerable to the financial effects of the risk events occurring. For example a family with young children, a large mortgage and only one breadwinner would experience tremendous pressure if the breadwinner became incapacitated for one reason or another.

The following chart illustrates how some risks and their insurance remedies may assume more importance at different stages of our lives:

HIGH IMPORTANCE *** 

MEDIUM IMPORTANCE ** 

LOW IMPORTANCE *

The chances of being able to accurately predict when a risk event will happen are very slight. Occasionally there will be symptoms of the onset of a disease but usually these things come out of the blue.

Therefore, if our finances would be vulnerable to the consequences of a risk event, it would be wise to protect ourselves and our dependents against those consequences. This can be done in a number of ways, from taking steps to ensure that we are not endangered through to purchasing insurance that would compensate for the financial consequences of the risk event occurring.

Here are five steps that can help to manage personal risk:

1. Identify the risks that you are exposed to now and in the future.

Another risk that some readers may need to consider is the risk that someone may decide to sue you for a loss that they consider you have caused them. This can particularly affect professionals and tradespeople. Often having adequate Professional Indemnity Insurance is a condition of operating in a particular field but if this affects you, you should ensure that your cover is adequate against likely successful claims.

2. Analysis of Risks. 

The answers to the following three questions will provide a good basis for your risk management program:

• What is the potential loss if the risk event occurred?
• Who will suffer the loss?
• How likely to occur is it?

The way they can work is illustrated in the following example:

Bill and Sue are in their early 30's and both have good jobs earning $50,000 and $40,000 respectively. They are paying $15,000 p.a. on the mortgage on their house and are saving $20,000 p.a., half in superannuation and half in other investments. Sue is about to leave the workforce to start a family and they need to consider what would be the impact of any reduction of Bill's earning capacity.

The answers to the three questions could be:

If Bill was completely incapacitated, the family income could reduce to zero, they could deplete their savings and in the worst case they could lose their house due to their inability to continue their mortgage payments. As well as their living expenses they need to consider the impact of medical bills which could make the situation worse. The situation could be eased if Sue were able to go back to work.

They would suffer these financial consequences directly. They could face extreme financial hardship which, of course, could drastically affect their child's future prospects. If Bill were to die he would not feel the financial effects himself but Sue would have to cope with the double whammy of financial disaster and grief at his loss.

In this instance, too much hangs on one person's health for it not to be vital to insure Bill against death and disability and to have good medical insurance for the whole family. However, his family medical history may give some pointer towards the need for particular protection.

Of course this is only one of the risks of death that this family is exposed to. They would also need to analyse the implications of any misfortune that could befall Sue. If she were to die or be disabled with a young family, the last thing Bill would need on top of his grief would be the extra financial costs of housekeeping and raising the children.

3. Reduction of Risks. 

This is the process of doing something that will reduce the likelihood of a risk event happening. Again a set of three questions can be asked:

• What precautions can be taken?
• Are the precautions reasonable? (remember you have to live and
  enjoy your life).
• What will be the benefits of taking the precautions? These could be
  reduced insurance premiums or other side benefits.

Often simple precautions like installing deadlocks or always locking the car can reduce the likelihood of loss quite considerably. And reducing weight, eating healthy food and giving up smoking can reduce the likelihood of early traumatic illness. You might even find that some of these actions (e.g. giving up smoking) can make your insurance cheaper too.

4. Consider Retaining Some Risk

It could be that the cost of obtaining protection might outweigh the benefits. Or the likelihood of the risk event occurring is very slight or its cost could be easily afforded. In these instances it may be prudent to retain the risk yourself, to self-insure.

Decisions on retention should not be taken until the previous three steps have been completed. It is also vital that we don't underestimate the consequences of the risk if we decide to self-insure. Remember we can't go back and tidy up once the event has happened. It is therefore prudent to get expert advice before taking this option.

However once a risk is identified, analysed and reduced as much as possible a rational decision to self insure may be considered. The questions to ask at this stage are:

• If the event does happen what will be its financial impact? (can
  you afford it?)
• Can you afford the insurance premiums?
• Can part of the loss be afforded?
• Do the premiums represent good value?

5. Buy Protection Against the Financial Consequences of the Risk Event

When you have decided it would not be prudent to carry the financial consequences of the risk yourself you need to purchase appropriate insurance protection. This transfers the financial consequences of the risk event to the insurer and to compensate them for taking on that risk you pay them a premium.

The act of buying insurance does not reduce the likelihood of the risk event occurring but it does mean that the financial consequence is removed or reduced. In our earlier example, insuring Bill's life for a large amount will not reduce the likelihood of his death but it does mean that if that unfortunate event was to occur Sue and the family could cope financially.

The range of insurance cover that can be purchased is extremely broad. Cover for just about every conceivable risk is available. Some policies cover a number of related risks while others are very specific covering only the financial consequences of a very particular risk event. Some risks are covered by the policies of a number of insurers while for other more specialised risks only one or two insurers provide cover.

Different insurance policies provide a wide variety of different benefits which may include:

• A specific lump sum of money.
• A lump sum of money plus bonuses related to the company's
  investment performance.
• Cost of replacement of or repairs to a damaged or stolen item.
• Provision of a stream of income
• Meeting all or part of defined medical expenses.

Sometimes your premium will just buy cover for a particular period of time, at the end of which you have to renew your policy. In other instances the premiums are regular and may even have a savings/investment component built in.

Because the range of insurance on offer is so wide, you should shop around before you purchase. First you should find the policies on offer that cover the risks you need covered. Then you should read the policy to make sure that there are no exclusions relating to a particular risk you might face.

Also check that the benefits are in a form that will be appropriate should the risk event occur. And lastly you should look for the most cost effective of the products that would cover your particular risk need.

This can be very complex, so most people find it is very useful to purchase their insurance from an expert with specialist knowledge in that.