Risk Management and Insurance Planning
This domain tests whether you can identify exposures, decide which to retain, reduce, avoid or transfer, and size the transfer correctly - sum insured, deductible and term.
Core principles
- Insurable risk is pure (loss or no loss), fortuitous, measurable, and spread across many similar units; speculative risk (market, business) is not insurable.
- Indemnity restores the insured to the pre-loss financial position - no profit from loss.
- Insurable interest must exist at inception, and for life cover at the life insured's death in most jurisdictions.
- Moral hazard and adverse selection are controlled by deductibles, exclusions, underwriting and waiting periods.
Life and health sizing
Use the needs approach (debts + income replacement + education + final costs − existing assets and cover) rather than a multiple of salary; the human life value method capitalises expected future earnings and typically over-insures single-earner households. Disability cover should be own-occupation, with a benefit period matched to the retirement horizon and a 60–70% income replacement target.
Worked example: coinsurance clause
A building must be insured for 80% of its 1,000,000 replacement value = 800,000. The client insures for 600,000. A 200,000 loss occurs. Payment = 200,000 × (600,000 / 800,000) = 150,000, less the deductible. The 50,000 shortfall is the client's own retention - the penalty for under-insuring, even though the loss was well below the sum insured.
Traps
- Replacement cost confused with actual cash value (replacement less depreciation).
- Liability limits set at the regulatory minimum while net worth and future earnings are exposed.
- Named-peril policies assumed to cover all risks.
- Duplicate cover across policies, which indemnity prevents from paying twice.