Risk Management and Insurance Planning
The risk management process
Identify exposures → evaluate frequency and severity → select a technique (avoidance, reduction, retention, transfer, sharing) → implement → monitor. Retain high-frequency/low-severity losses; transfer low-frequency/high-severity losses.
Life insurance
Compare term, whole life, universal life, and variable life on cost, cash value, and guarantees. Need analysis uses either human life value or the needs approach. Death benefits are generally income-tax-free under IRC §101(a); cash value grows tax-deferred. A policy failing the 7-pay test becomes a modified endowment contract - loans and withdrawals are taxed LIFO and may incur a 10% penalty before age 59½.
Disability and health
Own-occupation definitions pay more generously than any-occupation. Watch elimination periods, benefit periods, residual benefits, and whether premiums were paid with pre-tax dollars (making benefits taxable). HSA contributions are deductible, grow tax-free, and pay qualified medical expenses tax-free.
Long-term care
Typical triggers: unable to perform 2 of 6 activities of daily living for at least 90 days, or severe cognitive impairment.
Traps
- Insurable interest must exist at policy inception, not at death.
- Group term coverage above $50,000 creates imputed income under IRC §79.
- The policy owner controls the contract and its taxation - not the insured or beneficiary.
- Coinsurance penalizes underinsurance: payment = (carried ÷ required) × loss, capped at the limit.
Worked example. A $250,000 building carries an 80% coinsurance clause (required $200,000); the owner insures for $150,000. A $100,000 loss pays (150,000 ÷ 200,000) × 100,000 = $75,000.