Risk Management and Insurance Planning
Risk Management and Insurance Planning
This domain tests how a planner identifies, measures, and treats personal and business risks. Insurance is one treatment-transfer-not the goal. Expect questions on insurable interest, indemnity, policy limits, deductibles, coinsurance, life and disability needs analysis, and liability exposure.
Core rules
- Risk treatment options: avoid, reduce, retain, transfer (insurance), and share. Retain risks that are small and predictable; transfer risks that are low-probability but severe.
- Insurable risk is typically pure, measurable, accidental, and not catastrophic to the insurer. Speculative risk (market risk) is generally not insurable.
- Indemnity restores the insured to the pre-loss financial position, subject to limits, deductibles, and exclusions. Replacement-cost property coverage pays more than actual cash value.
- Life insurance needs analysis compares resources with obligations: income replacement, debts, education, final expenses, and emergency reserves, less existing assets and survivor income. Human life value is an alternative income-based method.
- Term insurance buys pure death benefit for a defined period. Permanent insurance combines death benefit with cash value; it is not automatically superior.
- Disability: own-occupation definitions are broader than any-occupation; check waiting period, benefit period, benefit percentage, and offset provisions.
- Liability: personal umbrella policies sit above auto and homeowners limits. Business owners need professional liability and key-person coverage.
Worked example
A client earns $50,000 and wants 20 years of income replacement. At a 4% discount rate, PV = 50,000 × [1 − (1.04)^−20]/0.04 = 50,000 × 13.5903 = $679,515. Add debts $150,000, education $100,000, and final expenses $20,000 = $949,515. Subtract existing assets $250,000 = $699,515 of coverage need. The reasoning: the discount rate converts a future income stream into a capital sum; existing resources offset the need.
Traps
Using insurance to fund speculative risk; ignoring inflation or taxes in needs analysis; treating cash value as a free benefit; confusing own-occupation with any-occupation; and underinsuring liability because premiums feel high.