topic 8 – risk management & insurance bafi 1016 personal wealth management

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Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

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Page 1: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Topic 8 – Risk Management & Insurance

BAFI 1016 Personal Wealth Management

Page 2: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Introduction

• A financial plan must take into account the possibility of risks such as disability and premature death may occur and aim to:–Eliminate them, or

–Minimise their effect

• A systematic approach should be taken to identify and manage these risks

Page 3: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Risk

Speculative risk

• Arises where there is a chance of a loss or a gain

• Examples:–Gambling; Once the bet is placed, there can only be a win or a loss

–Setting up a business; The business will succeed or fail

Page 4: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Risk continued

Pure risk

• Arises where there is only a possibility of loss or no loss

• Categories of pure risk–Personal

–Property and (see next slide)

Page 5: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Risk continued

–Liability

–Common law – e.g. negligence

–Statute law – e.g. faulty product

–Contract – e.g. construction

Page 6: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Risk Management

Risk management process can be divided into 3 broad steps:

1. Identification and evaluation of potential risks–Identify possible losses and their costs

Page 7: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Risk Management continued

2. Management of identified risks–Seek to avoid and minimise risks

3. Program review–Regularly reassess to ensure ongoing protection

Page 8: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Personal Risk Management

1. Identification–Premature death

–Prolonged illness or injury

–Medical costs

–Business risks

Page 9: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Personal Risk Management continued

2. Evaluation of personal risks a. Lump sum costs in the event of premature death include:

–Burial and associated expenses

–Estate administration costs

–Final medical and associated care

–Debt clearing

–Adjustment expenses

Page 10: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Personal Risk Management continued

b. Provision for dependents

–The multiple approach

- Relatively simple to calculate

- Ignores individual resources and commitments

- Assumes constant resources and inflation

Page 11: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Personal Risk Management continued

• The needs approach

- Requires relatively detailed dynamic budgeted information necessitating reassessment from time to time

c. Disablement costs can include:

–Medical expenses

–Other costs associated with the disability

–Provision of an income to support any dependants

Page 12: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Personal Risk Management continued

3. Control measures–Lifestyle factors such as fitness, diet, smoking and alcohol.

4. Financing measures–Retention: losses met from individual’s own resources or via insurance excess

–Transfer: financial responsibility passed to another party – typically via insurance

Page 13: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

House and Contents Risk Management

1. Identification–e.g. fire, storm, water damage, burglary, impact by vehicles and earthquake

2. Evaluation–Value only considered for building and contents as land will always remain

3. Control measures–Smoke detectors, burglar alarms, deadlocks etc

Page 14: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

House and Contents Risk Management continued

4. Financing measures–Adequate insurance

–Replacement value

–Indemnity value

–Consider value of contents

–Consider impacts of a ‘co-insurance or average clause’ which seeks to pass on some of the financial impacts of underinsurance to insured

Page 15: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

House and Contents Risk Management continued

• Example of underinsurance:– the full value of a house is $300 000 but it is insured for only $160 000. The house sustains partial damage amounting to $150 000. The calculation is as follows:

– insurance company would only cover $100 000 of the $150 000 loss, leaving the owners of the house with an amount of $50 000 to cover from their own resources.

• Keep in mind that some insurers do not use this clause...

Page 16: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Motor Vehicle Risk Management

Identification and evaluation–Damage to the vehicle itself

–Limited to amount of the repairs–Loss or damage to third parties or their property

–May be extremely large in cases of serious bodily injury

Page 17: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Motor Vehicle Risk Management continued

Control and financing measures–Control via car alarms, safety devices and improved driving skills

–Financing via insurance policies

Page 18: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Liability Risk Management

Identification and evaluation–Liability at personal level is increasing.–Rise in number of negligence actions

Control and financing measures–Take steps to minimise chance of loss in relation to potential identified situations

Page 19: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Liability Risk Management continued

–e.g. Financial planning office: use a check list of procedures to help ensure nothing has been overlooked in gathering information in order to advise client

–AFSL holders must have adequate PI insurance cover

Page 20: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

The Insurance Marketplace

• Insurers–Life, General and Health

• Intermediaries–Financial Services Reform Act

• Clients–Insurance Contracts Act 1984–General Insurance Codes of Practice

Page 21: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

The Insurance Marketplace continued

• Regulators–APRA via prudential regulation

–ASIC via consumer-oriented matters

Page 22: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Principle of Utmost Good Faith

• Principle underlies contractual relationship between insurer and the insured

• Highest degree of honesty imposed on both parties

• Duty of disclosure of all ‘material facts’

Page 23: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Principle of Utmost Good Faith continued

–Absence of disclosure of a material fact by applicant may result in contract becoming voidable at the option of the insurer, or

–Reduction in insurer liability upon a subsequent claim

Page 24: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Principle of Utmost Good Faith continued

•Misrepresentation of information provided to insured may be categorised as being either–Innocent, or

–Fraudulent

–Different contractual outcomes arise from the categorisation made

Page 25: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Insurance Policies

• Insurance is a central part of risk financing measures

• Policies include:–Life insurance policies

–Disability policies (TPD)

–Trauma policies

–Health insurance policies

–General insurance policies

Page 26: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Life Policies

• Most common life policy is term life with whole-of-life policies much less frequently used today

• Term Policy features–Sum insured payable on death

–Terminal illness benefit reducing subsequent sum insured

–Indexed sum insured

Page 27: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Life Policies continued

–Special sum insured increase

–Guaranteed renewable

–Multiple lives

–Policy duration

- Stepped premiums

- Level premiums

–Convertibility

–Optional benefits

Page 28: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Life Policies continued

• Term Policy exclusions–Suicide–Other

–War, terrorist attacks–Pre-existing conditions

• Taxation of Term insurance policies–If regular premium payments can be claimed as a tax deduction, policy proceeds are taxable

Page 29: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Life Policies continued

• Other life company products

–Whole-of-life policies

–Endowment policies

–Life insurance cover in a superannuation fund

Page 30: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Life Policies continued

• Policy ownership–A life policy can be in the name of:

–The life insured

–A person or company on the life insured

–The life insured with a named beneficiary

Page 31: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Disability Policies

• Total and permanent disablement insurance (TPD)

- critical aspect relates to definition of total and permanent disablement

- more restrictive definition typically provides for lower premiums but less chance of making a successful policy claim

Page 32: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Disability Policies continued

• Trauma insurance

- lump sum benefit

- can be purchased separately or as an extension of another life policy

• Combined life, trauma and TPD policies

- Linked policies

- Combined policies

Page 33: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Disability Policies continued

• Income protection insurance

- benefit

- waiting period

- guaranteed renewal

- total disablement lump sum benefit

- partial disablement lump sum benefit

- Additional benefits

• Business overheads insurance

Page 34: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Health Insurance Policies

• Health insurance via Medicare provided to all Australian residents as a government service

• Medicare–Available to all Australian residents.

–Medical benefits

–Hospital benefits

–Pays up to 85% of the scheduled fee

Page 35: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Health Insurance Policies continued

–Public pay for Medicare by a levy assessed on taxable income

–Levy surcharge if resident does not have private health hospital cover and taxable income beyond a family threshold level

Page 36: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Health Insurance Policies continued

• Private health insurance–Available to those who purchase it from a licensed health insurer at an additional cost to the Medicare levy

–Government supports private health cover by way of a subsidy

–Provides greater flexibility in where and by whom a person is treated

Page 37: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Arranging Insurance Through a Superannuation Fund

• Some personal risk policies such as term life insurance can be arranged via the individual’s superannuation fund

• Premiums will be substantially less within a superannuation fund as opposed to a retail environment

• Necessary to have a binding death nomination to overcome the issue of trustee discretion…

Page 38: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Arranging Insurance Through a Superannuation Fund

• Potential problems arranging TPD within superannuation…–If the TPD is ‘own occupation’ it is unlikely to be a deductible expense to the super fund and the fund will need to charge a higher premium to the superannuant

–If the individual suffers from a disability which qualifies from the insurer to the fund but it does not satisfy a condition of release of the fund, proceeds can be locked in the fund until preservation age…

Page 39: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Arranging Insurance Through a Superannuation Fund

• Income protection–Such policies must cover a period of temporary disability of at least two years. Then the contributions will be a deductible expense to the fund

–The individual must also satisfy the SIS ‘temporary conditions of release’ for benefits under the policy to pass to the individual

–Premium savings by taking income insurance through superannuation

Page 40: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Group Underwriting

• Insurance policies can either be underwritten individually or as a group of employees

• Group policies are available for Term Life, TPD and Income Protection

• Group cover does not take into account higher risk individuals so it a good way for such individuals to obtain cover at a reasonable price – funds need to implement strategies to overcome the risk of adverse selection

Page 41: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

General Insurance

House and contents–Policies may cover all risks and damage or specify the list to be covered or loss or damage to valuables only

–Flood damage often not covered although some cover ‘flash flood’

–Policies will generally have exclusions

–Public liability insurance usually included in policy

Page 42: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

General Insurance continued

–Contents insurance normally provided on a replacement value basis (‘new for old’)

–May also cover credit card fraud, food spoilage, fusion of electric motors (to an age limit)

Page 43: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

General Insurance continued

Motor Vehicles:

•Compulsory Third Party Insurance (CTP)–Insurance covers legal liability personal injury arising from a motor vehicle accident and is required by law

–Nature of cover varies from state to state – e.g. Vic has a no fault scheme whereas NSW had a fault based scheme (i.e. the injured person is covered so long the accident is not their fault)

Page 44: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

General Insurance continued

Motor vehicle insurance

•Comprehensive motor insurance

- Covers all vehicle costs of insured and any other party to accident

- Market value vs. agreed value

- Common exclusions such as drink driving apply

Page 45: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

General Insurance continued

–Fire, theft and third party property damage

–Third party property cover only

–Uninsured motorists extension

Page 46: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

General Insurance continued

Sickness and accident insurance

–Restricted form of an income protection policy provided by life insurers

–Consumer credit insurance

–Provides protection for those who have entered into any type of consumer finance contract requiring regular payments

Page 47: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

General Insurance continued

–Travel insurance

–Includes luggage and personal effects, medical expenses and personal liability

Page 48: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Implementation and Review

• Identification and evaluation of potential risks–possible losses and their costs

• Management of identified risks–avoidance and minimisation

• Program review–to ensure ongoing protection

Page 49: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Summary

• The risk management process is a systematic approach to the identification and management of risks faced by individuals

• Key stages in the process are:–Identification–Evaluation–Control–Financing

Page 50: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Summary continued

• Insurance is the principal means of providing for serious losses

• Insurance contracts are based on the principle of ‘utmost good faith’ between the relevant parties

Page 51: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management

Summary continued

• Insurance policies should be regularly reviewed to cater for changing circumstances, particularly those creating the potential for underinsurance or financial hardship

Page 52: Topic 8 – Risk Management & Insurance BAFI 1016 Personal Wealth Management