Risk Management Criteria

Risk Management Criteria

Risk Management is the process of protecting income and assets from financial loss.  This article addresses four types of risk management issues related directly to financial planning and money management; death, disability, long term care and health care.

In my estimation, risk management is a four-step process

1. Determine the risk.  Using life insurance as an example.  An individual with no debt or financial dependents and no plans for either would have minimal if any need for life insurance.  By comparison, a household in which the couple have a mortgage and two dependent children have a substantial need for life insurance.  In the event of the death of either parent, there is significant financial risk to the surviving household. 
2. Is the risk insurable?  In the situation of the household with two parents, a mortgage and two children, the risk of death of one or the other parents is insurable with life insurance.  So yes, the risk is insurable. 
3. What is the cost the insurance and is it affordable within a specific budget?  With life, disability and long-term care insurance, there are a number of factors in determining the cost of a specific policy including type of insurance, benefits, age, health history, smoking status to name a few.  Once a household has one or more quotes for the type of policy that best insured the identified risk, it is possible to decide the impact the premium will have on overall cash flow. 
4. Does the household wish to insure the risk.  This is the decision part of the process.  Insurance only works if the insurance is in force when a risk event happens.  This seems to be a silly statement, however, there are many individuals and households who did not insure a risk and then regret it later.  No individual or household wishes to spend money on any type of insurance.  They do so because they are concerned about the risk and its financial impact if it were to take place and wish to insure against this risk.  Once an individual or household has completed steps 1-4, there is not a lot of point in spending a considerable amount of time deciding to insure the risk or not. Either an individual decides to insure the risk or not insure the risk.  In short, make a decision. 

A final thought.  I would suggest when considering any of the above risk management issues, especially life insurance, it is best to work with a professional financial planner who has credentials and experience and is compensated by a fee paid by the client, not a commission paid by the insurance company to the agent.  A fee-based financial planner has no incentive to sell an individual or household a particular type of insurance while an agent paid a commission from the insurance company has an incentive to sell a policy with the highest commission. 

For example, again using life insurance, an insurance agent who sells a term life policy with a $200 annual premium may receive a commission between 50% to almost 100% of the first year’s premium.  A whole or universal life policy with the same death benefit will have a significantly higher premium which means the agent’s commission will be significantly higher.  This is a strong incentive to sell whole or universal life insurance when the vast majority of individuals or households with debt and/or financial dependents can buy a low cost term policy which will maximize their protection against the risk at the lowest cost.  A professional fee-based financial planner has access to national insurance brokerages which will provide one or more quotes for various types of insurance.     

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.