Risk Management and Insurance
Risk handling methods
Know the four responses to risk: avoidance, reduction (mitigation), retention, and transfer. Insurance is a transfer mechanism. Candidates should identify pure risk (loss only) versus speculative risk (gain or loss); insurance addresses pure risk. The principle of indemnity restores the insured to the pre-loss financial position, no better.
Life and health insurance
Distinguish term from permanent life insurance. Term is pure death benefit for a defined period. Whole life includes cash value and level premiums; universal life separates the cost of insurance from a cash account and is interest-sensitive; variable life ties cash value to subaccounts with investment risk borne by the owner. Know that the death benefit is generally income-tax-free to beneficiaries, while cash value growth in permanent policies is tax-deferred.
Property, casualty, and liability
Key concepts: deductibles (retained loss), coinsurance (shared loss), and limits. Replacement cost versus actual cash value (which subtracts depreciation) is a frequent trap. Liability coverage protects against claims from third parties and is often the largest uninsured exposure for high-net-worth clients; umbrella policies sit above underlying limits.
Worked example
A home with replacement cost of 400,000 is insured for 300,000 under an 80% coinsurance clause. The required limit is 320,000; because the insured carries less, the claim is reduced proportionally - a 40,000 loss is paid at 300,000 divided by 320,000, about 37,500, less the deductible. This is why underinsurance is a classic exam trap.
Suitability
Coverage should match need, not be sold on tax advantages alone.