Over the next few weeks, we’ll revisit our multi-part series on risk management and the basics of different insurance plans!
Over the next few weeks, we’ll discuss the different ways to manage risk, introduce some insurance terms, and discuss various types of insurance such as auto, health, homeowner’s, disability, life, and long-term care insurance.
First, let’s discuss what sources of risk we face out in the world. We risk the loss or damage of some of our property, like to our vehicle, our home, and our valuables like our jewelry. We risk developing health problems or getting hurt, including the consequences of whether or not we’ll be able to continuing working as a result. We risk being liable for the unintentional harm to a person or their possessions. We risk passing away without leaving the resources needed for our spouse and/or our children. Lastly, we risk not being able to afford long-term care expenses after we retire.
Looking at these risks, there are two things we need to address to decide how to manage them: how frequent might these risks or losses occur, and how much is at stake – what is the severity. Depending on the frequency and severity, we can determine whether or not we want to avoid that risk, reduce it, retain it, insure it, or some mix of these four approaches.
For risks with both high frequency and high severity, we’ll want to avoid that risk altogether. As an example, think about the proposition of building a home on a plot of land that significantly floods multiple times a year. It’s probably better we avoid building a home there at all.
For risks with low severity, often some level of risk retention is recommended. Because of the low severity, it probably doesn’t make sense to insure against that risk, such as the risks of employees stealing office paper or pens.
For risks with high severity and low frequency, such as the risk of your home burning down, or a serious car accident, this is where insurance is recommended. With that said, all four risk management strategies can be used simultaneously. Let’s take driving as an example. To avoid certain risks, a driver can avoid driving drunk, and if they have vision impairments at night, not drive after it’s dark. They can reduce risk by wearing a seatbelt and abiding by the speed limit. They can insure against the risk that their car gets damaged or that they’re liable for being in a car accident by having insurance. But even with insurance, they can retain some of that risk by increasing their deductible and therefore lowering their premiums.
Once we’ve decided on an approach to managing our risk, we need to implement that plan, which may include purchasing insurance, adjusting deductibles, and/or adjusting certain lifestyles and approaches. These plans need to be regularly monitored and adjusted when necessary, as the risks people face in their lives changes continually.
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