Transcript PPCh10ud

CHAPTER 10 – Background:
Introduction to Risk
Management and Insurance
by Del Spencer
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10-1
Most Americans have the
wrong type of insurance
coverage.
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10-2
Some types of risks cannot be
insured against.
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The economic loss from
automobile accidents exceeds
$100 billion annually.
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12 cents out of every dollar
consumers spend goes to pay for
insurance.
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10-5
Standard homeowners insurance policies
will not pay for flood damage.
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10-6
Importance of Risk in a Financial
Plan
• A sound financial plan requires an
analysis of major risks that can threaten
your financial security. If you fail to plan
for these risks, you may not attain your
financial goals.
• Our balance sheet will show the risks
we need to protect against.
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10-7
Meaning of Risk
• Risk is defined as uncertainty of loss.
• Pure risk is a situation in which there
are only the possibilities of loss or no
loss.
• Examples: premature death of a family
head, car accident, sickness or injury,
unemployment, destruction of a home
and personal property.
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10-8
Meaning of Risk (continued)
• Speculative risk is a situation in which
either profit or loss is possible.
• Examples: buying stock, betting on a
horse race, investing in real estate,
going into business for yourself.
• Knowing the difference between pure
and speculative risks is important
because speculative risks are usually
not insurable.
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10-9
Major Types of Risks
• Personal risks
– premature death
– insufficient income during retirement
– poor health
– unemployment
• Property risks
• Liability risks
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10-10
Personal Risks
• Risks of premature death of a
household head with unfulfilled financial
obligations. These could include
dependents to support, children to
educate, or a mortgage to be repaid.
• Four costs that can result from
premature death of a household head:
– Human life value - present value of the
future earnings of the head.
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10-11
Personal Risks (continued)
– Burial cost, uninsured medical bills,
probate costs, estate taxes.
– Replacement income may be inadequate
for basic needs.
– Non-economic costs - emotional grief of
spouse and loss of a role model for the
children.
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10-12
Personal Risks (continued)
• Risks of insufficient income during
retirement.
– This is the major risk associated with old
age.
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10-13
Personal Risks (continued)
• Risk of poor health. Includes both
catastrophic medical bills and the loss
of earned income.
– Cost of major surgery has increased
substantially in recent years.
– Inability to pay catastrophic medical bills is
a major cause of personal bankruptcy.
– Probability of being disabled before age 65
is higher than is commonly believed.
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10-14
Personal Risks (continued)
– A person age 25 has a 54% chance of
becoming totally disabled for at least 90
days before age 65.
• Risk of unemployment.
– Regardless of cause, unemployment can
cause financial insecurity in 3 ways.
• The worker loses his earned income.
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10-15
Personal Risks (continued)
• because of economic conditions, may only be
able to work part-time and part time pay may
not cover basic needs.
• Past savings may be exhausted.
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10-16
Property Risks
• Property owners are exposed to the risk
of having their property damaged or
destroyed from numerous causes.
• A direct loss is a financial loss that
results from the physical damage,
destruction, or theft of the property.
– Examples: destruction of personal property
in a fire or the theft of your automobile.
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10-17
Property Risks (continued)
• An indirect loss is a financial loss that
results indirectly from the occurrence of
a direct physical damage or theft loss.
– Examples: fire destroyed home, forced to
move to apartment during rebuilding.
Moving expenses and rent payments.
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10-18
Liability Risks
• You are legally liable if you injure
someone or damage someone’s
property.
• Liability risks are extremely important in
financial planning.
– There is no maximum upper limit on the
amount of loss. You can be sued for any
amount.
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Liability Risks (cont.)
– A lien can be placed on your income and
financial assets to satisfy a legal judgment.
– Legal defense costs can be enormous.
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10-20
Personal Risk Management
Refers to the identification and evaluation
of pure risks faced by an individual or
family, and to the selection of the most
appropriate technique for treating such
risks.
• Steps in Personal Risk Management
– Identify potential losses.
– Evaluate potential losses.
– Select the appropriate technique for treating such
risk.
– Review the program periodically.
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Identify Potential Losses
Catastrophic financial losses can result
from
• Personal risks
• Property risks
• Liability risks
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10-22
Evaluate Potential Losses
• Involves an estimate of the frequency
and severity of a potential loss so that
the most appropriate technique can be
used to deal with the risk.
• If loss frequency is small, but severity of
loss is catastrophic, these losses should
be insured.
• If loss frequency is high, but loss
severity is low, such losses should not
be insured.
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10-23
Select the Appropriate Technique
for Handling Losses
• Control.
• Avoidance.
• Retention.
• Transfer
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10-24
Control
• Loss control
consists of certain
activities that reduce
both the frequency
and severity of loss.
Reducing Risk
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• Control has 2 major
objectives: loss
prevention and loss
reduction.
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Avoidance
• Avoiding certain
situations in which
losses might occur.
– Examples: To not get
injured riding a
motorcycle, avoid
riding a motorcycle.
– To escape injury
from falling off a
mountain, avoid
mountain climbing.
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10-26
Retention
• Means that you
retain part or all of
the loss if it should
occur. Can be
aggressive or
passive.
• Aggressive or active
risk retention means
you are aware of the
risk and plan to
retain part or all of it.
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10-27
Retention (continued)
• Examples of aggressive: Collision
insurance with a deductible. The
amount of the deductible is that part of
the risk that you are retaining.
• Passive retention is because of
ignorance, indifference, or laziness.
– Example: Many worker are not insured against the
risk of long-term disability, which from a financial
stand point could be more severe than premature
death.
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10-28
Transfer
• This means you
transfer the risk by
purchasing
insurance.
• Most people rely
heavily on insurance
as the major method
for dealing with risk.
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10-29
Non-Insurance Transfers
• Methods other than insurance are used
to transfer to another party the risks of a
loss.
• Examples:
– Purchasing an extending-warranty
contract.
– Collecting a damage deposit from tenants
of rental property.
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10-30
Review the Program Periodically
• At least every 2 or 3 years, you should
determine if all major risks are
adequately covered.
• Also, review the program when a major
event happens in your life; marriage,
divorce, new job, new home.
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10-31
Chapter 10
Auto and
Homeowner’s
Insurance
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Chapter Objectives
• Explain the role of risk management
• Outline typical provisions of auto
insurance
• Describe financial coverage provided by
homeowner’s insurance
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10-33
Background on Insurance
• Insurance protects you against potential
financial losses or liability as a result of
unexpected events
• Its primary function is to maintain your
existing level of wealth
• Insurance is beneficial even when no
payments are received from the
insurance company
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10-34
Managing Risk
• Risk: exposure to events or perils that
can cause financial loss
• Risk management: decisions about
whether and how to protect against risk
• Control or Reduce risk
• Avoid risk
• Retain risk
• Transfer risk
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10-35
Managing Risk
• Accept risk
– Feasible when likelihood of financial loss is
low
• Insure against risk
– Premium: the cost of obtaining insurance
– Benefit is protection from financial loss
• Risk management decisions affected by
degree of risk tolerance
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10-36
Role of Insurance Companies
• Types of insurance
– Many types of insurance available
• Most popular forms are property and casualty
insurance, life insurance and health insurance
• Insurance company operations
– Relationship between insurance
companies and premiums
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10-37
Role of Insurance Companies
• Underwriters: from an insurance perspective,
are hired to calculate the risk of specific
insurance policies, decide what policies to offer,
and what premiums to charge
• Insurance company credit ratings and
service
– Select a company that is in good financial
condition
– Shop around for best coverage and price
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10-38
Role of Insurance Companies
• Role of insurance agents and brokers
– Insurance agent: recommends insurance
policies for customers
– Captive insurance agent: works for one
particular insurance company
– Independent insurance agent: represent
many different insurance companies
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10-39
Role of Insurance Companies
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10-40
Financial Planning Online:
Reviews of Insurance Companies
• Go to: http://www.gomez.com
• Click on: “Insurance Carriers: from the
“Scorecards” drop-down list
• This Web site provides reviews and
ratings of various insurance companies
and descriptions of services offered by
each insurance company.
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10-41
Auto Insurance
• Auto insurance protects you from financial
loss from damage or liability resulting from
automobile accidents
• Insurance policy: contract between an
insurance company and the policy holder
– Auto insurance policy: specifies the coverage
provided by the insurance company for a
particular individual and vehicle
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Auto Insurance
• Coverage A: Liability Coverage
– Bodily injury liability coverage: protects
against liability associated with injuries
caused by the policy holder
– Property damage liability coverage:
protects against losses that result when the
policy holder damages another person’s
property with their car
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10-43
Auto Insurance
• Auto insurance policy provisions
– Policy limits often described as 100/300/50
• $100,000 per person injured in an accident
• $300,000 for all people combined
• $50,000 for property damage
– Financial responsibility laws: laws that
require individuals who drive cars to
purchase a minimum amount of liability
insurance
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10-44
Auto Insurance
• Coverage B: Medical Payments
Coverage: insures against the cost of
medical care for you and other
passengers in your car when you are at
fault in an accident
– Applies only to insured car
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10-45
Auto Insurance
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10-46
Auto Insurance
• Coverage C: Uninsured or
Underinsured Motorist Coverage
– Uninsured motorist coverage: insures
against the cost of bodily injury when an
accident is caused by another driver who is
not insured
– Underinsured motorist coverage: insures
against bodily injury an divers who have
insufficient coverage
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Auto Insurance
• Coverage D: Collision and Comprehensive
Coverage
– Collision insurance: insures against costs of
damage to your car resulting from an accident in
which the policy holder is at fault
– Comprehensive coverage: insures you against
damage to your car that results from floods, theft,
fire, hail, explosions, riots and various other
events
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Auto Insurance
– Deductible: a set dollar amount that you
are responsible for paying before any
coverage is provided by your insurer
• Other provisions are available for an
additional premium
• Summary of auto insurance provisions
– Contained in standard insurance policy
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10-49
Financial Planning Online: How
Much Car Insurance Do You Need?
• Go to:
http://insurance.yahoo.com/auto.html
• Click on: Coverage Analyzer
• This Web site provides a
recommendation on the amount of car
insurance coverage that is appropriate
for you.
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10-50
Auto Insurance
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10-51
Factors That Affect Auto
Insurance Premiums
• Characteristics of your car
– Value of car
– Repair record of your car
• Your personal characteristics
– Your age
– Your mileage
– Your driving record
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10-52
Factors That Affect Auto
Insurance Premiums
– Your location
– Discounts
– Your school performance
• Comparing premiums among insurance
companies
– Always obtain several different quotes
– Several Web sites offer quotations
– Compare prices at renewal time
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10-53
Factors That Affect Auto
Insurance Premiums
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10-54
Factors That Affect Auto
Insurance Premiums
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10-55
Factors That Affect Auto
Insurance Premiums
• Focus on Ethics: Impact of Lawsuits
and Fraud on Premiums
– Fraudulent claims are unmerited claims
– Injuries are often exaggerated
– Insurance companies pass on increased
costs to policyholders
– No-fault insurance programs: do not hold
a specific driver liable for causing the
accident
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10-56
Homeowner’s Insurance
• Homeowner’s insurance: provides
insurance in the event of property
damage, theft, or personal liability
relating to your home
• Types of perils covered
– Homeowner’s insurance structured in sic
packages, each covering different perils in
different amounts
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10-57
Homeowner’s Insurance
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10-58
Homeowner’s Insurance
– Personal liability coverage provides protection
if someone is injured on your property
• Factors that affect homeowner’s insurance
premiums
– Value of insured home
– Deductible
– Location
– Degree of protection
– Discounts
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10-59
Homeowner’s Insurance Policy
Provisions
• Property damage covers damage to the
home
– Cash value policy: pays you for the value of
the damaged property after considering
depreciation
– Replacement cost policy: pays you for the
actual cost of replacing the damaged property
• Other structures on property also covered
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10-60
Homeowner’s Insurance Policy
Provisions
• Personal property is normally covered
– Includes furnishings and other personal
possessions
– Home inventory: contains detailed
information about your personal property
that can be used when filing a claim
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10-61
Homeowner’s Insurance Policy
Provisions
– Personal property replacement cost
coverage is available
– Personal property floater: an extension of
the homeowner’s insurance policy that
allows you to itemize your valuables
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Homeowner’s Insurance Policy
Provisions
• Liability insurance included to cover any
lawsuits resulting from an event
occurring in your home or on your
property
• Many other expenses can also be
included
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10-63
Homeowner’s Insurance
Premiums
• Factors that affect homeowner’s
insurance premiums
– Value of insured home
– Deductible
– Location
– Degree of protection
– discounts
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10-64
Homeowner’s Insurance
Premiums
• Reducing your homeowner’s insurance
premium
– Increase your deductible
– Improve protection
– Use one insurer for all types of insurance
– Stay with the same insurance company
– Shop around
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10-65
Financial Planning Online:
Purchasing Homeowner’s Insurance
• Go to:
http://moneycentral.msn.com/articles/
insure/home/contents.asp
• This Web site provides step-by-step
instructions for purchasing
homeowner’s insurance.
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10-66
Homeowner’s Insurance
Premiums
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10-67
Filing a Claim
• Contact insurance company
immediately if damage occurs
• Claims adjuster estimates damage
• Present your home inventory
• Get an independent estimate
• Appeal low estimates by insurance
company
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10-68
Renter’s Insurance
• Renter’s insurance: an insurance policy
that protects your possessions within a
house, condominium, or apartment that
you are renting
• Renter’s insurance policy provisions
– Specifies maximum coverage for personal
assets
– Also covers liability from damages to a
person on your property
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10-69
Financial Planning Online:
Renter’s Insurance Quotation
• Go to:
http://insurance.yahoo.com/r1.html
• This Web site provides a customized
renter’s insurance quotation based on
information about your personal
property.
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10-70
Umbrella Personal Liability Policy
• Umbrella personal liability policy: a
supplement to auto and homeowner’s
insurance that provides additional
personal liability coverage
– Especially important for wealthy people
– Must show proof of existing coverage
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10-71
How Insurance Fits within Your
Financial Plan
• Key decisions about car and
homeowner’s, insurance for your
financial plan are:
– Do you have adequate insurance to protect
your wealth?
– How much insurance should you plan to
have in the future?
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10-72
Integrating Key Concepts
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10-73
Integrating Key Concepts
• Part 1: Financial Planning Tools
• Part 2: Liquidity Management
• Part 3: Financing
• Part 4: Protecting Your Wealth
– In Chapter 10 we learned about auto and homeowner’s
insurance
– In Chapter 11 we will learn about health and disability
insurance
– In Chapter 12 we will learn about life insurance
• Part 5: Investing
• Part 6: Retirement and Estate Planning
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10-74