The Potential Losses - Case Study Example

Running header: Insurance Risk Management Insurance Risk Management Author’s Name Institutional Affiliation Introduction Insurance Risk Planning Part 1: 1. The potential losses the couple are exposed to have been identified as classified below; i) Property losses- These include Loss of family home, loss of the 2 cars, loss of house contents, loss of various shareholdings including Woolworths -1,000 shares, Incitec Pivot-15,000 shares, Westpac Bank -650 shares, loss of the savings with Westpac Bank and Superannuation- conservative funds. Potential loss exposures to the property would include such things as theft or damage to property thus leading to direct loss of property. This would also include indirect losses resulting from the loss of property such as the lost income arising from loss of property identified above. ii) Liability loss exposures –These include those associated with the assets mentioned above. For instance, the cars may cause accidents that hurts third parties while failure to adhere to certain rules regarding property may lead to liability losses. Other liability losses the couple is exposed to is falling to honor its various obligations regarding the various liabilities (Condamin and Maim, 2002). For instance, failure to pay housing mortgage may lead to loss of the house while failure to honor credit card terms may lead to associated liability losses such as penalties. iii) Personal losses – These are the events that would affect the couple’s normal life making the couple not to be able to meet their day to day obligations such as work, paying the mortgage, rates, utilities, putting food on the table, car running expenses , entertainment and annual holidays. The events would also deny them the ability to educate their children and thereafter provide them with allowances until they are 25 years old. Such personal losses exposures may include death or injury leading to disability or a disease that denies them (both or one of them) ability to work. Quantification of the losses i) Property losses property Loss exposure Family home $700,000 Cars (2 vehicles) $100,000 House contents $100,000 Shareholding Woolworths-1,000 shares Incitec-15,000 shares Westpac Bank-650 shares $34,000 $46,000 $20,000 Savings account with Westpac Bank $200,000 Superannuation-Conservative fund $250,000 Superannuation-Conservative fund $50,000 Total loss exposure $1,500,000 ii) Personal losses In computing the personal loss exposure, it is assumed that the annual expenses will be incurred in perpetuity while the expenditure on the children will be incurred as stated. Thus, personal losses are computed as shown below; Annual expenses Mortgage payment $28,700 Rates $2,000 Household $49,000 Utilities $7,000 Car running expenses 3,000 Entertainment $15,500 Annual holidays $10,000 Work related $3,000 Total $118,200 The present value of the living expenses will be; PMT/i = $118,200/0.075 = $1,576,000 The present value of the expenditures on children will be given by; Present value = PMT (1-(1+i)-n)/i = 10,000(1-(1+0.075)-12)/0.075 = $77,352.78 For the first child = $77,352.78/ (1.075) ^1 = $71,956.07 For the second child = $77,352.781/ (1.075) ^3 =$62,265.94 Total required for children education = $134,222.01 The allowances will be = 10,000(1-(1+0.075)-7)/0.075 = $52,966 For the first child = $52,966/ (1.075) ^13 = $20,686.51 For the second child = $53,966/ (1.075) ^16 = $16,651.83 Total allowance =$37,338.34 Total personal loss will be present value of annual expenses add present value of children school fess and allowances = $1,576,000+134,222.01+37,338.34 =$1,747,560.35 But assuming that in case one of the couple dying prematurely, the living expenses will go down by 25%, the living expenses will be; =$118,200*75% = 88,650 The associated loss will be PV =PMT/i = 88,650/0.075 = $1,182,000 Hence, the total personal loss exposure will be = $1,182,000+134,222.01+37,338.34 =$1,353,560.35 2. If Michael were to be disabled, the additional cost of maintaining him would be $20,000 pa, my evaluation of the personal loss exposure from question 1 would increase if I was to take disability rather than death into account. This is because death will result in reduction of living expenses as observed above while maintaining the disabled person will lead to increased cost of $20,000 per year as noted above. Thus, the new component of disability maintenance would have to be included in the total personal loss exposure as shown below; Present value = PMT (1-(1+i)-n)/i = 20,000(1-(1+0.075)-25)/0.075 = $ 222,938.92 Thus, the total personal loss exposure will be= $1,353,560.35+$222,938.92 = $1,576,499.27 3. A number of techniques are available to Michael and Mary that could be used to manage their risk exposure. These are explained below; i) Risk avoidance- this would involve the couple not performing the activities that would expose them to risk. For instance, they may choose not to travel in order to avoid the risk of accident and also avoid the liability associated with it. The method may have the advantage avoiding any loss associated with the occurrence of the risk. However, the couple would lose on the potential gain associated with accepting or retaining the risk. For instance, not travelling will mean they will not work and hence earn income to sustain their lives. ii) Loss reduction –this involves reduction of the severity of the loss or likelihood of the loss occurrence. This will involve a balance between risk and the benefit of the activity and between the loss and the effort applied. The technique is good in that the severity of loss is reduced while taking advantage of the benefits of the activity. However, in case of the loss occurring, the couple stands to lose the corresponding loss. iii) Loss prevention- this will involve taking steps that will prevent loss from occurring. For instance, they can avoid drunk driving to avoid car accident and hence loss of life or disability. This is helpful in preventing loss from occurring hence avoiding the associated costs. However, the technique does not guarantee that the loss will not occur and in case it occurs, the cost involved is enormous. iv) Risk retention- this would involve the couple assuming all or part of a risk as opposed to transferring the risk to a third party. This technique may be good for risks that are least likely to occur (Baranoff, 2005). For instance, the money in the bank account does not have a high risk of loss and hence they may not insure it. However, risk retention may be dangerous in case the risk is underestimated. In case the loss is to occur, they may not be able to meet the associated cost. v) Risk transference- this would involve transferring of risk to a third party for instance by taking an insurance cover against the risk. This is preferred since if the loss occurs, the couple would be compensated thus bringing them back to the original position so that they are able to continue with life. However, the disadvantage is that some cost is involved in insuring the risk whether or not the loss occurs. 4. A number of specific insurance products exist that could be used to manage the couple’s risk exposure. These are discussed below; i) Life insurance- Life insurance would involve taking insurance policies which would provide payment in case of death, trauma or continuous disability. This would be appropriate for the couple to ensure that in case of death or disability, the couple is assured of continuous flow of income thus ensuring that living expenses as well as their children’s expenses are continuously catered for even when they have no earning capability. In this case, they may opt for income protection insurance to ensure their children complete school even in case of death, trauma or disability of either all or one of them. ii) General insurance- this type of insurance would be ideal for the couple in order to protect their various properties against loss or damage to property or even losses that arise from legal liability. The products the couple should take could include fire insurance to protect their property against damage by fire, motor vehicle insurance for their car and associated third party insurance, multiple line insurance and liability insurance. iii) Health insurance- With this type of insurance, the couple would be protected against loss arising from accidental bodily injury or sickness (Mohammed and Sykes, 2016). This would include such things as doctors’ bills, hospital bills, cost of treatment and long-term care as well as the resultant loss of wages. 5. Managing risk exposures effectively is an essential element in the couple’s financial strategy. This is because if not properly managed, the occurrence of the losses will be a hindrance to their achieving their financial strategy. For instance, they would want to support their children until they are 25 years of age, however, if they were to die or get disabled, this might not be possible since their ability to earn income will have been put to an end. On the other hand, their ability to pay mortgages will be affected by their loss of income earning ability which will in turn lead to their losing the house. As such, effective management of the risk exposures identified above will be instrumental in their achieving their financial strategy. This is because they will take appropriate steps to transfer risks that are beyond their control while only assuming risks whose likelihood of occurrence is very low and whose likely losses are minimal. Managing risk exposures by for instance taking life insurance will ensure their desire to support their children until they are 25 is actualized even if unfortunately they lose their income earning ability. The same principle should be applied to all the other risk exposures to ensure that only minimal risks are assumed while the rest is transferred. This way, they are assured of achieving their financial strategy. It should be understood that though a certain risk may seem unlikely to eventuate, once it occurs, loss will have occurred hence greatly affecting their ability to achieve their financial strategy and hence the need to manage risk exposures. It is important for the couple to understand insurance premiums can be reduced without necessarily reducing the benefits. For instance, taking appropriate steps to reduce likelihood of occurrence or reduce losses if risks occur will most likely reduce losses. For instance, installing fire extinguishers or employing watchmen would greatly reduce risk. Such factors if included in the insurance contract could lead to reduction of premiums. In addition, changing the insurance contract so that premiums are paid in lump sum at the beginning of the period will also lead to significant reduction in insurance premiums for the couple. Part 2: 1. The opponents of the affordable care act believe that mandating insurance companies to insure people with pre-existing conditions on the same terms as people without pre-existing conditions will result in higher health insurance premiums, and in time will result in the collapse of the health insurance market. This is because people with pre-existing conditions are more risky in a number of ways. First, their likelihood of getting sick and hence making use of the insurance services is very high compared to those without pre-existing conditions. Secondly, their treatment costs would be higher compared to those without any pre-existing conditions. Thus, naturally the people with pre-existing conditions would pay high premiums while those with no pre-existing conditions would have to pay lower premiums. However, if uniform premiums are paid by all regardless of their health conditions, the insurance companies would have to charge a higher premium in order to cater for the higher costs associated with the more risky group with pre-existing health conditions (Jones and Oberlander, 2014). The higher premiums would discourage most people with no pre-existing conditions since they would not be assured of value for their money since in most cases they would not consume the insurance services since they rarely get sick. The result is massive withdrawal by people with no pre-existing conditions leading to the collapse of the health insurance market since they would not be able to collect enough premiums to cater for health needs of their clients, their maintenance and their profitability. Thus, firms would start closing down for operating on losses. 2. A key component of the affordable health care act is the imposition of a penalty on people who do not purchase a complying health insurance policy. The government believes that a penalty is necessary for the new systems to work since this will ensure that as many people as possible purchase insurance policies which would ensure that costs of health premiums come down so that they are affordable for everyone to ensure that the health insurance market continues in operation. As stated above, charging the same rate for everyone regardless of their health status would mean that people with no pre-existing conditions are over-charged so as to finance the health of those with pre-existing conditions. Thus, unless a penalty is imposed against those who do not purchase health insurance, most of them would opt out hence making the industry to collapse. However, if a penalty is imposed on those who do not purchase the premiums, almost everyone will purchase health insurance. This will see health insurance companies reduce premiums in a bid to attract as many clients as possible thus making the health insurance affordable to everyone regardless of their health conditions. This will eventually result in the success of the health care plan. It should however be noted that for it to have the desired effect, the penalty imposed should be set above the health insurance premiums. This will ensure that people prefer to pay the premiums as opposed to paying the penalties. Otherwise, people will view paying the penalty as better than paying high health insurance premiums thus rendering the penalties not to achieve their intended purpose and the eventual collapse of the health insurance market. References: Condamin, L&, Maim, P2002, Risk quantification: Management, diagnosis and hedging, Chichester, UK, John Wiley & Sons. Baranoff, E2005, Risk management and insurance during the decade of September 11, in the day that changed everything? An interdisciplinary series of edited volumes on the impact of 9/11, vol.2. Mohammed, A&, Sykes, R2016, Sharpening strategic risk management, Retrieved on 30th September 2016, from; http://www.pwc.com/gx/en/services/advisory/consulting/risk/resilience/publications/sharpening-strategic-risk-management.html Hull, J2015, Risk management and financial institutions, New York, John Willey & Sons. Jones, D&, Oberlander, J2014, Report on health reform implementation: Health insurance exchanges, Obamacare and the Republican dilemma, Journal of Health Politics, policy and Law, vol. 39, no. 1, pp. 23-56. Read More