CHAPTER 5: RISK MANAGEMENT

PERSONAL RISK MANAGEMENT

PROCESS

1. Determine the objectives

2. Identify the risk exposures
3. Evaluate probability of occurrence and severity
4. Determine alternatives
5. Select alternatives
6. Implement
7. Evaluate and Review

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PERSONAL RISK MANAGEMENT
PROCESS

A general approach to ensuring individual risks is

as follows:
• Life insurance
• Disability
• Healthcare
• Property
• Liability

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RISK MANAGEMENT ALTERNATIVES
High Severity, Low Frequency:
• For risks that have a high financial impact but are unlikely to occur, like long-term
disability, the best strategy is to transfer or share the risk.
• This is usually done through insurance, which protects you from catastrophic losses.
High Severity, High Frequency:
• When a risk is both severe and likely to happen, the best course of action is to
avoid the risk entirely.
• This might mean changing behaviors or circumstances to prevent the risk from
occurring in the first place.
Low Severity, Low Frequency:
• If the risk is minor and doesn’t happen often, it’s often best to simply retain the risk.
• For example, if your car gets a small dent in a parking lot, it’s not catastrophic, and
it’s something you can handle out of pocket.
Low Severity, High Frequency:
• When the financial impact is low, but the risk happens often, the strategy is to
retain or reduce the risk.
• For instance, parking farther away from heavily traffi cked areas might reduce the
chance of your car getting dented.

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PERIODIC EVALUATION AND REVIEW

Purpose:
•Risk exposures can change over time:
• The risks you face aren’t static—they can evolve.
• Errors in judgment regarding the selected
alternatives may occur
• Even with the best planning, mistakes can happen.

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PERILS
A peril is the actual cause of a loss. It’s the specific event
that results in financial damage, such as fire, theft, or a
natural disaster.
Open-Perils Policy:
This type of insurance policy covers all risks except those
explicitly excluded. It’s a broad coverage option, meaning it will
cover anything not specifically listed as an exclusion.
Named-Perils Policy:
This policy only covers risks that are explicitly listed. If a peril
isn’t named in the policy, it won’t be covered.

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HAZARDS
•A hazard is any condition that either creates a risk or makes a potential loss
more likely. It’s diff erent from a peril, which is the actual cause of the loss.
•Physical Hazard:
• This type of hazard is related to the physical environment or situation.
• For example, having faulty wiring in your house or driving on icy roads increases the
likelihood of an accident or fire.
•Moral Hazard:
• This involves the behavior of people who may act dishonestly because they know
they’re insured.
• For instance, someone might exaggerate a claim or intentionally cause damage,
knowing that insurance will cover it.
•Morale Hazard:
• This is related to carelessness or a lack of concern. People may be less careful if they
feel like they are protected by insurance.
• For example, leaving your car unlocked because you know your insurance will cover
theft is a morale hazard.

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CONDITIONS FOR INSURABILITY
•Large Number of Homogeneous Exposures
• Insurers need a large pool of similar risks (like homes or cars) to spread out
their potential losses. This helps them predict losses more accurately and
ensure that premiums stay reasonable.
•Accidental
• The event being insured must be unexpected or unintended. Insurance is meant
to cover unforeseen losses, not those that are planned or intentional. For
example, if someone intentionally damages their property, it’s not insurable.
•Measurable and Determinable
• The loss must be measurable in terms of financial cost and time of occurrence.
This means that both the insurer and the insured can quantify the loss, like in
cases of theft or fire.
•Must Not Pose a Catastrophic Risk for the Insurer
• If the risk is too large (like a natural disaster affecting an entire region), the
insurer could face catastrophic losses. To avoid this, insurers spread their risks
geographically and sometimes exclude certain high-risk events from coverage.
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INSURANCE AS A LEGAL CONTRACT
• Off er and Acceptance

• In insurance, the applicant makes an off er by submitting an application, and the

insurance company accepts the off er by issuing a policy.
• Legal Competency

• Both parties involved in the contract (the insurer and the insured) must be legally
competent. This means they are of legal age and sound mind to enter into a
contract.
• Consideration

• This refers to the value that each party brings to the contract. For the insured, it’s
the payment of premiums. For the insurer, it’s the promise to pay out claims under
the conditions of the policy.
• Lawful Purpose

• The purpose of the insurance contract must be legal. For example, you can’t insure
something illegal, like insuring illegal activity.

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INSURANCE AS A LEGAL CONTRACT
•Unilateral

• Insurance contracts are unilateral, meaning that only one party (the insurer)
makes a legally enforceable promise. The insured is not required to pay
premiums but risks losing coverage if they don’t.
•Aleatory

• These contracts are based on an uncertain event, like accidents or disasters.

The amount paid by the insurer could be much larger than the premiums paid
by the insured or vice versa.
•Adhesive

• Insurance contracts are "take it or leave it" agreements, meaning the insured
must accept the terms as set by the insurer, with little room for negotiation.
•Utmost Good Faith

• Both parties must act in good faith, meaning the insured must provide accurate
information, and the insurer must be honest about the coverage provided.

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INSURANCE AS A LEGAL CONTRACT
•Principle of Indemnity

• This principle states that insurance should restore the insured to the financial
position they were in before the loss, but not more. It prevents the insured from
profiting from a loss.
•Insurable Interest

• The insured must have a legitimate interest in the item or person being
insured. For example, you can’t take out life insurance on someone unless their
death would have a financial impact on you.
•Conditioned upon the Payment of Premiums

• The insurance company is only obligated to pay claims if the insured continues
to pay their premiums on time.

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INSURANCE ON THE PERSON (LIFE
INSURANCE)
Life Insurance:
• Life insurance is often referred to as income replacement insurance because its main purpose is
to provide financial support to dependents if the insured person passes away.
• Dependency is a key consideration when determining life insurance needs.
• If someone relies on your income—such as children, a spouse, or even aging parents—life insurance
helps replace that lost income in case of death.
Methods for Determining Life Insurance Needs:
Human Life Value Method:
• This method calculates the economic value of a person's life based on their expected future
earnings.
Financial Needs Method:
• This method focuses on the specific financial obligations your family will face if you pass away. It
looks at things like mortgage payments, debts, education costs, and living expenses, ensuring
your family has enough to cover these needs after you're gone.
Capitalization of Earnings Method:
• This method assumes that the life insurance payout will be invested to generate ongoing
income. The calculation determines how much insurance is needed to generate enough
investment
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HUMAN LIFE VALUE METHOD

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FINANCIAL NEEDS METHOD FOR LIFE
INSURANCE

Introduction:
The financial needs method helps evaluate the income replacement and lump-sum
needs of survivors in the event of an income producer's untimely death.
It estimates the amount of insurance coverage required to cover financial
obligations and provide necessary support for the survivors.
Common financial needs are as follows:
• Lump-sum (cash) needs
• Final expenses and debt repayment needs
• Mortgage liquidation or payment fund needs
• Education expense needs
• Emergency expense needs
• Income (cash flow) needs
• Readjustment period needs
• Dependency period needs
• Spousal life income (pre- and post-retirement) needs
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CAPITALIZATION OF EARNINGS METHOD

The capitalization of earnings method is a way to determine

life insurance needs by assessing the income that needs to
be replaced for survivors and capitalizing it based on a risk-
free rate of return.

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TYPES OF LIFE INSURANCE
There are two general types of life insurance:
• Term insurance
• Permanent insurance
• Savings and investment component

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HEALTH INSURANCE
Health insurance is essential for covering the costs of medical care
and protecting individuals from financial hardship due to illness or
injury.
There are different types of health insurance plans, including
Indemnity Coverage and High Deductible Health Plans (HDHPs).
Indemnity Coverage:
• Indemnity coverage allows the insured to choose their
healthcare providers (e.g., doctors, specialists, hospitals) without
being limited to a specific network.
• The reimbursement is based on the services provided, meaning
the insurance company reimburses the insured or the healthcare
provider after the services are rendered.
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HIGH DEDUCTIBLE HEALTH PLANS (HDHP)
Definition: An HDHP is a health insurance plan with relatively low premiums but
a high deductible that must be met before insurance coverage kicks in.
Key Features:
• Low Premiums
• High Deductible
• Coverage After Deductible
• Suitable for healthy individuals or families
For 2024 (IRS guidelines for HDHPs):
• For individual coverage: The minimum deductible is $1,600.
• For family coverage: The minimum deductible is $3,200
For 2024 (IRS guidelines for HDHPs):
• For individual coverage: The maximum out-of-pocket limit is $8,050.
• For family coverage:
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| James Dalton | Joseph maximum
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HEALTH INSURANCE TYPES
Health Maintenance Organization (HMO):HMOs offer healthcare coverage that
typically requires members to use healthcare providers within a specific network.
Key Features:
Requires the insured to choose a primary care physician (PCP) who acts as the
gatekeeper for referrals to specialists.
Lower premiums and out-of-pocket costs if the insured stays within the network.
Out-of-network care is generally not covered, except in emergencies.
Preferred Provider Organization (PPO):PPOs allow more flexibility than HMOs in
choosing healthcare providers.
Key Features:
The insured is encouraged to use in-network healthcare providers to keep costs
lower, but they also have the option to go out-of-network for care.
Out-of-network providers are covered, but typically at a higher cost to the insured
(higher deductibles, coinsurance, etc.).
No requirement for a primary care physician or referrals to see specialists.

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 DISABILITY INSURANCE
 Disability insurance provides replacement income to the insured while
the insured is unable to work because of sickness (illness) or injury
(accident).
The critical issues or provisions related to disability insurance include:
Definition of disability
• Own Occupation
• Any Occupation
• Hybrid
• Partial disability
Coverage for both sickness and accidents
Amount of benefits per month / year
Term of benefits
Elimination period (waiting period of self-insurance)
Whether or not the policy is noncancelable or guaranteed renewable

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 LONG-TERM CARE INSURANCE
 Long-term care insurance pays benefits when the
insured is unable to perform at least two of the
activities of daily living (ADL) which include:
• Eating
• Bathing
• Dressing
• Toileting
• Transferring (bed to chair)
• Continence

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 HOMEOWNERS AND RENTERS INSURANCE
 The frequency of a loss of a home is small, but the severity, if
it happens, is potentially financially catastrophic.
 Homeowners insurance coverage is a package policy covering
dwelling, dwelling extensions (garage), personal property,
loss of use, medical payments for others, and liability.
 Most homeowners and renters should purchase open-perils
and replacement value for all property in a homeowner's
policy.
 Actual cash value is the depreciated value of property.
 Replacement cost is the current cost to replace the property.

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 AUTOMOBILE INSURANCE
 The Personal Automobile Policy (PAP) is
organized into six parts:
• Part A: Liability coverage for bodily injury and property
damage to others
• Part B: Medical payments coverage
• Part C: Uninsured motorist coverage
• Part D: Coverage for damage to the insured automobile
• Part E: Duties of the insured
• Part F: General Provisions.

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 PERSONAL LIABILITY INSURANCE
 Personal Liability Insurance:
 Liability policies provide protection not only by paying
claims if you’re found liable for an injury or property
damage, but also by covering your legal defense costs
 Personal Liability Umbrella Policy (PLUP):
 A Personal Liability Umbrella Policy (PLUP) provides extra
liability coverage beyond the limits of your homeowners
and auto insurance policies.
 It covers a wide range of potential incidents, from car
accidents to lawsuits related to accidents that happen on
your property.

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