Risk Management

Everything in the world is certainly at risk, the risk is something that is beyond expectation happen. Financial and business as an integral part of human activity were also at risk. This time I am going to discuss about risk management which can be define as the process by which we identify risks and control them so that we are able to achieve individual goals. Why we use the word control instead of use the word eliminate? because we cannot eliminate risk entirely, we can only attempt to keep risk within acceptable ranges of impact. The risk management process have six steps to do, and that are :

1. Develop Objectives, determine the scope of risk management process, which is one are only or at all household risk?
2. Establish Exposures, each area of household assets has its own risks and separate in to financial and non financial assets.
3. Identify Available Risk Management Tools, there are many techniques available to you in managing the overall risk of the household, such as : Avoid Risk, under the avoid risk method we could seek to eliminate exposure to risk. Reduce Risk, when we reduce risk it's not eliminate, it's lessened. Diversify, assets are diversified so that the impact of an unfavorable outcome for any one asset is reduced. Transfer Risk, it happen when we take the possibility of loss and give it to someone else
4. Match Appropriate Risk Management Tools to Exposure, in determining the appropriate overall risk management tool, a number of factors should be taken into account. Among them are the cost of alternative risk management techniques, the amount and likelihood of loss, any convenience factors, and the risk tolerance of the person
5. Implementation is taking the action step, setting an implementation plan with specific dates to accomplish tasks can help
6. Review, because time by time the risk management exposure can be change

In this part, we must also understand about real assets, financial assets, financial liabilities, and intangible liabilities. Real assets are tangible assets that the household owns, such as the house they live in, cars, furniture, jewelry, etc. Financial assets is form of the ownership asset that are typified by pieces of paper and often marketable, e.g stocks and bonds. Financial liabilities are money owed to others or we called it debt. Intangible liabilities are less quantifiable current liabilities such as potential liabilities to the third parties

We also have to discuss about insurance as part of overall risk management. Insurance is a method of transferring risk, risk is shifted to the insurance company that assumes the risk for a fee. Let's see some reasons why insurance products are not fully efficient in a financial sense :

1. Overhead Costs, insurance companies have overhead costs to maintain and grow their business, pay out claims, and earn profit.
2. Incomplete Information, a healthy purchaser of an insurance policy will bear part of the operating cost of any less healthy people in their pool of policy-holders
3. Search Costs, these are costs that the person desiring to be insured undertakes to find out which policy is best, in finance this is called as an opportunity cost.
4. Behavioral Factors, some people prefer to insure against small losses that have high probabilities of occurring and not larger losses that have low probabilities of occurring.

There are three major types of provides of insurance to individuals. Government, Property, and Personal were further subdivided into government (unemployment and social security), property (property and casualty, also personal liabilities), and personal (life, disability, long-term care, and health).

Readers, don't forget to analyzed an insurance company. They must consider to criteria of financial strength, good operating sense, service, price, and other considerations.

Insurance is commonly regarded as an expense, an appropriate designation.

Life Insurance is traditionally used to provide money that compensate for the death of a household wage earner. The price we pay for the policy include mortality charge which can be defined as the probability of dying for any individual is relatively low, investment return helps pay the mortality costs and providing the policy with extra cash to be invested, and overhead expense include the costs to market the product and maintain the policy and company profits. Life insurance is taken out to cover a need, the death of an income earner, we can view the amount needed using three different approaches. Income replacement, the amount of insurance is intended to cover the loss of income in full. Life insurance needs perform by a second approach to how much insurance to purchase. Partial replacement, insurance is costly and funding can reduce cash flow availability for other purposes such as current cost of living.

Here is type of life insurance:

• term insurance, a life insurance providing fixed coverage for a stated period of time with policy-holders premium that vary based on the possibility of death of the insured during that time-frame
• whole life insurance, life insurance providing fixed coverage for the life cycle of the insured, the premium are made possible by higher than pure mortality and insurance company overhead payment in early years which bring about a cash value saving component
• universal life insurance, cheaper than whole life insurance but if the policy projections aren't met, the extra cost may be shifted to the policy-holders through additional insurance payment.
• variable life insurance, similar to whole life insurance except that it transfers the investment function from the insurance firm to the individual
• variable universal life insurance, combines the payment flexibility of universal life with the investment flexibility of variable life

 

 

reference :  financial planning textbook chapter 10, LJ Altfest

“Playing it safe is the riskiest choice we can ever make.” Sarah Ban Breathnach

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