Risk and InsuranceThe first nine months of your life were perfect. Floating all day in your personal indoor pool. Food service available 24/7. No underwear to change. You thought the good life would go on forever.
But then it happened. Eviction day.
Shoved out into the real world. The easy life was gone. Now you faced problems and threats to your security.
But as you grew up, your parents gave you advice to help keep you safe. "Look both ways before crossing the street". "Don't talk to strangers". And if you lived in Las Vegas, "Don't draw to an inside straight."
You didn't know it at the time, but your parents were giving you some rules for risk management. Where there's uncertainty, there's risk. And their advice was designed to protect you from harm by either avoiding dangerous situations or taking certain precautions.
How Risk Management Deals with RiskRisk management is a way to reduce the financial risks a business or an individual faces. Part of a risk management plan involves insurance. But insurance is not the only way, and often not the best way, to handle risk. In fact, there are four ways you can deal with risks:
- Avoid the risk. Not talking to strangers eliminates a source of potential trouble.
- Reduce the possible risk. Looking both ways before crossing the street cuts down on accidents.
- Assume the risk. If the stakes are small, you may ignore your parents' poker advice and draw to an inside straight.
- Transfer the risk to someone else. This is the role of insurance. If a loss occurs, your insurance provider compensates you for it.
What are Your Risks?Since you're no longer a child, it's up to you to see the risks you face and decide who and what you want to protect. The three areas of risk you want to consider are:
- Personal Risk. You or your family members may be injured or become ill. In addition to medical costs, would a disability or death result in lost income?
- Property Risk. Possessions such as your car or house need protection as well as other assets or personal property.
- Liability Risk. We live in a lawsuit-crazy society. You don't have to be wealthy to need to guard against a financially-draining lawsuit.
When You Do and Don't Need InsuranceAlthough your parents gave you basic risk management tips, unless they were actuaries (insurance math geeks), they probably didn't explain how a risk decision is made. This diagram shows what action to take depending on how often a risk occurs and its severity.
|How Often Risk Occurs|
Reduce the Risk
|Transfer the Risk|
Assume the Risk
|Assume the Risk|
As the table shows, choosing insurance (Transfer the Risk) makes sense only if the risk seldom happens and has a high potential loss. If the occurrence is frequent, insuring against the risk would be too expensive. Likewise if the financial cost for a risk occurrence is small, look for non-insurance solutions.
Whenever you consider buying insurance, ask yourself what are the likely losses and could you handle the financial results if they occurred The easiest way to save money on insurance is to avoid it when there are better alternatives. So for every risk you look at, first think of ways to either avoid or reduce it's impact without insurance.
Types of InsuranceInsurance has two major categories of protection:
- Property and Liability Insurance. Homeowners insurance and auto insurance are the two main types of coverage which pay for damage to your property. The liability part of this insurance covers situations in which you're found legally responsible for injuries caused by or on your property. The insurance pays for the injured person's medical bills and your legal costs.
- Personal Insurance. This area of insurance covers the major costs related to your well-being. Health insurance pays for various medical expenses and life insurance provides a source of cash to your family or whoever you choose, upon your death.
Also included in the field of personal protection is long-term care insurance and disability insurance. Long-term care coverage insures you for on-going health problems. Disability insurance helps replace your income if you're incapacitated.
In addition to insuring people and property, specialty types of insurance cover such things as pet health care, travel-related mishaps, and even marriage ceremony problems.
What to Consider Before Buying Insurance
- Get insurance only if it's the best way to handle a risk. Whether it's your health or finances, preventing a problem is almost always cheaper than insurance.
- Apply the "pain test" to any risk you're thinking about insuring. Ask yourself, "Which would be more painful, paying for the insurance or paying for the loss?"
- When you do buy insurance, get the most for your money. Sometimes paying a little more for insurance offers a lot more protection. At the same time, always comparison shop to avoid overpaying.