FINANCIAL LIFE | SPRING 2010 EFFECT

Risk Management: The Forgotten Area of Financial Planning

by Lynn F. Clark

Too often people focus more on growing their portfolio—selecting stocks and other investments—than planning for the unexpected—in other words, risk management. If you were building a home, you wouldn’t build it on sand. But when you neglect to review your risk management plan, that is exactly what you are doing. So, how should you build a more solid financial foundation? You can start by reviewing the following components of your financial life.

Automobile insurance

In this country in 2008, there were 2,346,000 people injured as a result of traffic accidents. Each day we spend a significant amount of time in our cars, so the risk of an accident is very real. Auto insurance usually covers a number of risks in one package.

• Liability coverage protects the owner against losses from legal responsibility arising from bodily injury or property damage caused by an automobile accident. The coverage can be a single limit ($300,000 per accident) or split limits such as $50,000/$100,000 (per person/per accident) for bodily injury.
• Medical payments coverage pays medical or funeral expenses.
• Physical damage coverage is designed to cover physical damage to the insured automobile.
• Uninsured/underinsured motorist coverage pays for injuries or losses sustained in an accident with a driver who’s not insured.

Homeowner policies

A typical homeowner policy provides protection against a number of dangers. One package can cover the physical dwelling and structures attached to it, as well as other structures, such as a detached garage. Personal property such as furniture, valuables, or heirlooms are often itemized and protected, too. Adding a personal liability option protects you against legal liability if a third party is injured on your property. It may also cover medical payments and property damage.

Personal liability insurance

Personal liability insurance, often referred to as an umbrella policy, is designed to provide additional liability coverage for situations where potential liability could exceed the limits of the protection provided in a typical homeowner's or automobile policy.

Let’s say, for example, that you have a $1 million stock portfolio, and the liability coverage of your car insurance is $25,000 per person, $50,000 per occurrence, and you do not have an umbrella policy. Now imagine you cause a car accident, injure two people, and damage property. You are sued by the other parties and total damages are $500,000. How much of that will your insurance company pay? A total of $50,000. Where will the rest come from? If you have no other protection in place, you would have to turn to your stock portfolio. A $1 million umbrella policy would have provided additional coverage and protection for your stock portfolio.

Medical insurance

For most Americans, this is arguably the most important type of insurance protection and the type that causes the most anxiety if it is lost or unaffordable. When you are evaluating the medical insurance component of your financial plan, it is important to consider the financial impact of a serious illness or accident. There are three important factors to consider:

• The deductible is the amount the insured person must pay before the insurance company will pay any benefits. It can range from a couple hundred dollars to many thousands of dollars. ·
• The coinsurance percentage is the amount of the covered medical expenses your insurance company will pay after the deductible is met. Usually it is 80 percent. ·
• Maximum lifetime benefit is the maximum amount your insurance policy will pay out. Some policies have a maximum lifetime benefit of $l million or $2 million, but this can vary. With today’s high health care costs, a limit below $1 million may not provide adequate coverage.

Disability insurance

Disability insurance replaces income if you are unable to work because of sickness or an accident. Briefly, the most important elements of the policy to consider are monthly benefit, elimination period, duration of benefits, renewability provision, and own-occupation coverage.

• Monthly benefit—Most plans provide 50–70 percent of an employee’s gross income. In assessing your risk, you should consider what combination of your resources would allow you to live on that monthly benefit. ·
• Elimination period—This is how long you have to wait until the insurance company pays your benefit. It is usually 90 days. ·
• Duration of benefits—Benefits can be paid for two years, five years, to age 65, or a lifetime. ·
• Renewability provision—As long as you pay your premium, the insurance company agrees to keep your coverage in force. But if the policy is not non-cancelable and guaranteed renewable, the insurance company can increase the premiums by state, occupation class, or other categories. ·
• Own-occupation coverage—This coverage defines “totally disabled” (and therefore eligible for benefits) as being unable to perform the material and substantial duties of your occupation. This distinction is important for highly skilled professionals who have invested much in education and training. Having this coverage means if you cannot practice your skilled profession—even if you can work in another occupation—you are still eligible for benefits.

It is a difficult scenario to envision, but even relatively small accidents can prevent people from being able to work in a field they have spent their entire careers developing. If you don’t have some sort of disability protection, you must consider how you will provide for yourself if you are injured.

Life insurance

In more than 60 percent of married couple families today, both partners work outside the home at least part time. When evaluating the life insurance component of your financial plan, it is important to consider the financial impact of the death of either (and both) spouses. Two important factors are how much life insurance you need, and what kind is best for your situation. The first question depends on what you’d like to provide for your family if you die. Do you want them to be able to pay off the mortgage? Do you want to provide college educations for your children? What sort of financial buffer do you want to give them? The next question is what kind of insurance do you need? There are two basic types of life insurance: term and cash value, which includes whole life, universal life, and variable universal life.

• Term insurance is the simplest form and is written for a specific period of time (1, 10, or 20 years). This type of insurance is suitable for a short period of time, for instance, when children are young.
• Whole life insurance has a level premium, level coverage (death benefit), and cash values. The cash value usually increases based on the insurance company’s general assets account portfolio performance, and a portion of the increases are guaranteed. It is suitable for long-term obligations, such as a surviving spouse’s lifetime income needs, estate liquidity, death taxes, or funding retirement.
• Universal life insurance has a level or adjustable premium, level coverage, and cash values. Similar to whole life, the cash value usually increases based on the insurance company’s portfolio performance and works well to meet those same long-term obligations.
• Variable life or variable universal life has a level or adjustable premium, level coverage, and cash values, and is suitable for meeting long-term obligations. In addition, it is a good match for those who are more active investors.

Emergency savings

Having enough emergency cash during difficult times can alleviate stress as well as help pay the bills. Regardless of the amount of income you earn or the size of your investment portfolio, it is important to have 3–12 months’ cash available. The necessary amount is determined by many factors including debt obligations, employment stability, elimination period for insurance policies, and accessibility of other investments. Despite the often repeated mantra about having a rainy day fund, 22 percent of working Americans have no savings at all. While risk management planning may be less exciting than planning for your retirement or children’s education, solid risk management protects you, your family, and your assets.

 

 

One should not rely on this information for the primary basis of investment, tax or financial planning. General market information does not take into account such factors as an individual’s goals, objectives, risk tolerance, tax situation, age, or time frame. We believe the information obtained from third-party sources to be reliable, but neither LarsonAllen Financial, LLC nor its affiliates guarantee its accuracy, timeliness, or completeness. The views, opinions, and estimates herein are subject to change without notice at any time in reaction to shifting market conditions. Tax laws change and investments in the stock market entail risk and potential loss of principal. Past performance is no guarantee of future results. This material may not be republished in any format without prior consent.