Risk Management and Insurance Planning
Domain 4 tests risk identification and the selection of insurance as a risk-transfer tool. Questions often ask for the appropriate cover, the correct policy principle, or the amount of cover using a needs analysis.
Principles and tools
- Risk treatments: avoidance, reduction, retention, transfer, sharing.
- Insurable interest must exist at inception; indemnity restores the insured to the pre-loss position and prevents profit.
- Utmost good faith requires material facts to be disclosed. Subrogation lets the insurer pursue a third party after paying a claim. Contribution prevents double recovery across policies.
- Life cover: term for pure protection; whole life and universal life combine protection with cash value; endowment combines protection with savings.
- Disability and critical illness cover replace income or pay a lump sum on defined events. Liability cover protects against third-party claims; property cover is subject to deductibles, limits, and exclusions.
- Needs approach: add income replacement, debts, education, and final expenses; subtract existing assets and cover.
Worked example
A client needs 500,000 for income replacement, 200,000 to clear debts, 300,000 for children's education, and 50,000 for final expenses. Total needs are 1,050,000. Available resources are 300,000 in savings and 400,000 of existing life cover, total 700,000. The protection gap is 1,050,000 − 700,000 = 350,000. The planner should also check whether the existing policy is term or permanent and whether it remains suitable. If the client has a 20-year horizon and limited cash flow, term cover of 350,000 is the starting point; permanent cover may be considered only if estate liquidity or lifelong needs justify the higher premium.
Traps
- Buying insurance primarily as an investment without comparing costs and returns.
- Using a rule of thumb such as 10 times income instead of a needs analysis.
- Ignoring inflation when setting the income replacement figure.
- Forgetting liability limits; a low limit is a false economy.
- Replacing an existing policy without comparing premiums, exclusions, and new underwriting.
- Assuming all premiums are tax-deductible.