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Lecture 6

Lecture 6 - Risk Management and Insurance

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Queensland University of Technology

LECTURE 6 – RISK MANAGEMENT AND INSURANCE Risk Management Process  Identification of risks o Identify risks with economic consequences  Unidentified risks can ruin a plan and thus, goals o A good advisor assumes unexpected events will happen  Quantification of risks o Establish the likely financial consequences of each risk  Allows you to work out best way to handle it  Helps establish a priority  Strategies for handling the risks 1. Eliminate the risk 2. Control or reduce the risk 3. Retain the risk 4. Transfer the risk  Implement the program  Review the program o Check to ensure the cover remains relevant & appropriate Life Insurance  Life insurance provides cover against the risks of premature death.  Emotions aside, establish if anyone would be financially disadvantaged upon the premature death of a client Principal Causes of Death  Cancer  Heart diseases (Heart attack & blocked arteries of the heart)  Stroke  Dementia & Alzheimers Disease  Accidents (15-24 : 68%) Life Expectancy  The average life expectancy will continue to rise with each generation o Advisors need to plan for a longer time frame Disablement  Life insurance policies can be extended to include cover for disability and pay a lump sum amount in the event of: o Total and permanent disablement (TPD); and  The TPD extension provides for a lump sum amount to be paid in the event of a situation where the insured will never work again. o The consequences of significant illnesses (trauma)  There are two broad categories of expenses: o medical and other costs associated with the disablement; o ongoing support of the client and their dependants Total and Permanent Disablement (TPD)  Pays a lump sum  Specific losses or unable to work again  Generally an extension of life policy  Can be added to/part of trauma policy  Own occupation & any occupation Can occur in one of two ways: 1.You suffer the permanent loss of use of:  Two limbs (whole hand or whole foot) or  The sight in both eyes or  One limb and one eye 2. Where you are engaged in any business, profession or occupation, whether as an employee or otherwise:  You have been absent as a result of illness or injury for 6 consecutive months and  At the end of 6 months, you are disabled to such an extent as to render you unlikely never again to be engaged in o Any occupation o Any business, occupation or profession for which you are reasonably suited by your education training or experience o Your own occupation Trauma  AKA: trauma, critical illness, crisis insurance;  Provides a lump sum on the occurrence of one of a number of specified events;  Can be added as extension to a life policy or stand alone;  Main conditions covered (92% of claims) - o Heart attack; o Coronary artery bypass o Stroke; o Malignant cancer Consequences of Death and Disability on Dependents  To provide for the consequences of premature death and disability it is necessary to establish: o who will be affected by the premature death or disability and o the degree of dependency  Young Adult o Death o Disablement o Trauma  Young Family o Death of Income Earner o Death of Homemaker o Permanent Disablement o Trauma  Mature Family o Children self supporting o Health, disability considerations The Multiple Approach  An investment interest rate at an achievable level if selected by multiplied by salary  The interest rate is divided by 100 and rounded up  The tax that would b incurred on this amount would be similar to the taxation paid pre-death Shortcomings of the Multiple Approach:  Other resources that may exist  What amount of income the dependents actually need  No capital to dismiss immediate debts  inflation The Needs Approach The needs approach uses three steps  Calculate the amount needed for the dependants to maintain their standard of living  Calculate the resources the dependants have to meet those needs  The difference between those two sums is the amount for which life insurance needs to be effected The Dependants  The immediate dependants would be the partner and children. o The partner needs to be provided for for life or, if there was a superannuation plan, until the superannuation benefits commence. o The children would need to be provided for throughout the period of their dependency.  It would be necessary to establish their age and the length of their dependency. The Living Expenses  The amount required for living expenses would be derived from amounts currently incurred.  In ascertaining costs the full amount of the family’s expenditure needs to be brought into account.  When considering living expenses in relation to children, consider costs at different stages of their lives. o As they get older, the costs will increase. Current Resources  After calculating the amount needed by the dependants, ascertain what funds will be available to meet the calculated amount apart from any sum insured by a life policy. This could come from: o The income of surviving family members. o Any available government benefits. o Where death or disability arises from a motor vehicle or workplace accident, a benefit may be payable under the state scheme providing benefits for those situations. o Proceeds from life insurance cover under a superannuation plan. o Life insurance cover currently in force would also be brought into account. o Any investment that can be converted into income producing assets. Need for Life Insurances  If the amount calculated is not adequate then it is the client’s family that will suffer the consequences  The sums produced can be high and may result in the client being inclined to dismiss the amount as being excessive Duty of Disclosure  At law the insured has a duty to disclose any information that can be regarded as material. Material information refers to any matter that the client could be reasonably expected to know is relevant to the insurer’s decision.  If the information given in the application form is incorrect in a material way the insurer may be able to reduce the amount payable or deny any cover under the policy. Types of Premiums There are two ways in which the premium may be applied:  Stepped  Level Types of Policies Broadly there are three types of policies provided by life insurers:  Term  Whole of life  Endowment Premium Rates  Premium rates — vary according to the situation of the insured as well as cost structures of the insurers and type of cover sought o Full cover vs accidental cover (be wary of credit card deals) o Smoker / Non-smoker o Age (accident hump) o Loadings Policy Exclusions  Suicide – 13 months  War or any act of war – declared or not Life Insurance and TPD under Superannuation  Superannuation funds often provide life insurance cover for their members. The nature and extent of cover will vary between funds. Some will also include permanent and partial disability cover. Advantages  lower effective tax rate producing a lower premium;  By using super balance to pay the premium, it offers some people the ability to access insurance they otherwise may not be able to afford  Using its bulk buying power a superannuation fund may be able to achieve premium concessions from an insurer (group rates) and sometimes the requirements to submit to a medical examination tend to be less stringent or waived (auto cover) Disadvantages  If using super balance, then note that depleting super savings  Legislation not consistent, so benefit may get paid but get stuck inside super fund INCOME PROTECT, HEALTH AND GENERAL INSURANCE Risk Identification  In many cases, people are diagnosed with a severe condition that won’t necessarily stop them from working now, but it will have a profound influence on how they will approach the remainder of their life.  Due to the advancement in the medical field, many life threatening events or illnesses can now be managed o Money remains an important issue  The period of disablement arising from these events can vary considerably, in some cases it is permanent and others for a short period of time.  Regardless of the period, the costs arising can be considerable. Broadly, these costs comprise: o medical expenses; o equipment and aids to assist in coping with disability, eg motorised wheelchairs, house alterations which may include ramps for wheelchairs, support rails, widening doorways, lifts; o nursing assistance; o loss of income o work & lifestyle adjustments Funding Sources  Having established how incapacity can arise, the next step is to establish how the costs associated with the disability can be met. o Bear in mind that the incapacity means that the person will not be able to continue working so an income will not be produced.  The possible sources of funds are: o sick leave entitlements; o workers’ compensation benefits; o compulsory third party benefits; o invalid pension o holiday & long service leave o family members Various Insurance Policies  There are a number of insurance policies that would provide for the costs of living during a period of disablement. These are: o total and permanent disablement (TPD) o trauma policies; o income protection insurance; o business overheads insurance; o Medicare; o private health insurance TPD and Trauma Policies  TPD and trauma policies will pay a lump sum amount in the event of total and permanent disablement or on the occurrence of a specified event (trauma) o These events will result in medical expenses where Medicare and private health insurance would provide some coverage  There are different levels of cover that can be effected, the higher the level greater the range and amount of costs covered  Where an event results in total and permanent disablement, the TPD cover would be invoked Income Protection Policy  Providing protection for loss of income is a major and essential item and can be protected under an income protection policy.  The income protection policy is designed to replace, in part, the insured’s income while the insured is totally or partially disabled (not necessarily permanently). The payment of the benefit commences following a waiting period and continues until the insured is no longer totally disabled or the benefit period expires Taxation  The premiums can be claimed as a deduction from income  Policy proceeds must be declared as income Income  Policy defines what includes income – varies between employed and self-employed persons o For employed this includes total remuneration including salary, feeds, commissions, regular bonuses, regular overtime, superannuation and fringe benefits.  Some policies make a qualification in regards to super – it is only included when
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