General Principles of Insurance and Risk Management
The risk management process
Risk management begins with identification, then measurement (frequency and severity), then treatment: avoid, reduce, retain, or transfer. Insurance is a transfer mechanism, and it is economically efficient only for low-frequency, high-severity events. High-frequency, low-severity exposures are usually better retained through an emergency fund or excess. Candidates should be able to classify a risk and justify the treatment.
Insurance principles
Know the insurable interest requirement, utmost good faith (duty of disclosure), indemnity (restoring the insured to their pre-loss financial position, subject to sum insured, excess and exclusions), subrogation, contribution between policies, and average (underinsurance proportional reduction). Distinguish agreed value from market value cover, and level from stepped premiums.
Life, disability and general insurance
For personal lines, understand life cover, total and permanent disability, trauma/critical illness, income protection (benefit periods, waiting periods, indemnity versus agreed value, offsets), and business succession or key person cover. For general insurance, know property, public liability, professional indemnity and home warranty exposures, and the role of exclusions, excesses and duty of disclosure in claims outcomes.
Traps
- Recommending insurance inside superannuation without checking whether the fund permits the cover, whether premiums erode retirement savings, and whether the definitions are weaker.
- Confusing trauma (lump sum on a defined event) with income protection (monthly benefit on incapacity).
- Ignoring underinsurance and the operation of averaging clauses.
- Overlooking the duty of disclosure at renewal, not just at inception.
Rule of thumb
Size cover as debts + income replacement + lump-sum needs − existing resources. For income protection, insure roughly 60–70% of gross income, subject to insurer limits.
Worked example. A client earning $120,000 has a $500,000 mortgage and two dependent children. Income protection at 70% of income provides about $84,000 annually (insurer caps and offsets may reduce this), while term life of $1m covers the mortgage plus ten years of family expenses. Trauma cover is added separately for a defined critical illness lump sum.