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 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
Heart diseases (Heart attack & blocked arteries of the heart)
Dementia & Alzheimers Disease
Accidents (15-24 : 68%)
The average life expectancy will continue to rise with each generation
o Advisors need to plan for a longer time frame
Life insurance policies can be extended to include cover for disability and pay a lump sum amount in the event
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
o Any occupation
o Any business, occupation or profession for which you are reasonably suited by your education training
o Your own occupation
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 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
o Death of Income Earner
o Death of Homemaker
o Permanent Disablement
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 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.
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
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:
Types of Policies
Broadly there are three types of policies provided by life insurers:
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)
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.
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)
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
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
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 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
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
The premiums can be claimed as a deduction from income
Policy proceeds must be declared as 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