Risk Management and Insurance Planning
Risk Management and Insurance Planning
This domain tests risk identification and treatment, the legal principles that make a policy enforceable, and the arithmetic of how much cover a client actually needs.
Principles
- Pure risk (loss or no loss) is insurable; speculative risk (gain or loss) is not.
- Insurable interest must exist at inception - you cannot insure what you do not stand to lose.
- Indemnity restores the insured to the pre-loss financial position, so no profit arises from a claim; life insurance is the exception, paying the stated sum.
- Utmost good faith: material facts must be disclosed; non-disclosure can void cover.
- Subrogation transfers the insured's recovery rights to the insurer after payment.
- Adverse selection and moral hazard explain exclusions, deductibles, and underwriting.
Treatment options
Avoid, reduce, retain (deductibles, self-insurance), transfer (insurance), and share (co-insurance, pools).
Measuring the need
The needs approach sums capital requirements - debts and mortgage, income replacement for dependants, education, final expenses, emergency reserve - then subtracts existing resources such as group life, savings, the surviving spouse's income, and government benefits. Human life value capitalises future earnings instead. Disability is often the larger exposure: check own-occupation versus any-occupation wording, elimination period, benefit period, and replacement ratio, typically 60–70% of gross income and tax-free when premiums are paid personally.
Worked example
Capital needs: mortgage $300,000 + education $100,000 + final expenses $20,000 + income replacement $400,000 = $820,000. Existing resources: group life $150,000 + investments $120,000 + spouse's continuing income $100,000 = $370,000. Net gap = $450,000, rounded to $500,000 of term cover to absorb inflation. A 20-year term matches the dependency period; permanent insurance is not indicated unless estate liquidity is also a goal.
Traps that cost marks
- Insuring the stay-at-home spouse for zero - childcare replacement is a real cost.
- Ignoring policy ownership and beneficiary designations, which override the will.
- Comparing premiums without comparing definitions, exclusions, and renewal guarantees.
- Selling permanent insurance to a client with a cash-flow deficit and no estate liquidity need.
- Forgetting that a claim payout itself can push the estate into a higher tax position.