In our last article, we introduced you to the first of six components of a successful investment plan. In the coming months, we will go into each component in detail, defining what each one means, and why it’s important to you.
Today, we’ll be talking about insurance and risk management.
“Insurance and risk management focuses on strategies designed to manage the client’s exposure to an unexpected financial loss due to death, health issues, property damage, business and other risks.” – Financial Planners Standards Council, Definitions, Standards & Competencies.
But what exactly does that mean? Let’s start by going back and look at its origins.
Although, the word might not have been used, “insurance” has been around since ancient times. For example, ancient Chinese traders were known to redistribute the goods they were selling (or had bought) across many different boats when they were travelling on dangerous rapids. That way, if one of the vessels capsized, they didn’t lose everything.
Consider also the community of ancient and medieval farmers who created granaries to protect them during years when the crops would fail and cause widespread famine.
In the first example, the traders were spreading their risk of disaster across many boats thus protecting themselves from total disaster. In the second example, each farmer is setting aside a portion of their annual crop to be kept in a safe place in case of a future crop failure (an all too common occurrence before modern irrigation systems and fertilizers).
These strategies seem like wise “risk management” strategies. Our risks today may be more modern, but have they really changed?
Today we need to protect ourselves from many things. Death, automobile accidents, fire, theft, injury, and illness, are all events in our lives that might happen, though we’d rather they didn’t. To protect ourselves from these events, we buy insurance.
Let’s consider life insurance as an example. Just, like the granary from our medieval farm community, an insurance company takes in money, called premiums, from each individual buying insurance and creates a pool to be stored like grain. Fortunately, not all the people paying for insurance will require a payout, but it’s this fact that allows insurance to work. If everyone died and had to be paid on their insurance policy then it wouldn’t work and the insurance companies would go out of business.
So, how do they come up with what to charge you in premiums? Considering the Life Insurance example above, insurance companies employ very sophisticated statisticians who can take into consideration things like your age, whether or not you smoke, your family history of illness, etc. to determine a fairly accurate estimate of your likelihood of passing away on any given year. Once they know that, and how many people are paying into the pool, they can estimate with confidence, the amount of premium they will need a person to pay.
Today, we’ve just scratched the surface in our discussion on insurance and risk management, but hopefully we’ve provided a useful introduction. In addition to risk management, it’s also important to consider the role that insurance plays in estate planning, but we’ll have to leave that discussion for a later article.
In the meantime, insurance is one of our specialties at LGK Wealth Management and we would welcome any questions you may have. A review of your overall strategy should be done from time to time, where we can help you answer such questions as, “How much insurance is enough?” “What are your risks?” “What type of insurance do you need?”, and “How much can you afford?”
Next month, our article will focus on the third component of an investment plan, Investment Planning. Stay tuned.
Gary M. Koss
Senior Mutual Fund Advisor
Manulife Securities Investment Services Inc.