Unexpected occurrences, such as death, disability, or other personal loss, are certainly not the types of events for which you can easily plan. However, the financial ramifications can be quite serious—not only for you, but your family as well. Therefore, it is important to include some type of risk management plan within the framework of your overall financial strategy.
Insurance, in all its varied forms, is quite simply a method for handling risk. In order to plan the most effective insurance program for your needs, you’ll want to consider what risks you and your family are exposed to and how financial loss would affect you. For each risk exposure, the key elements are the severity and frequency of loss.
All Risks are not Created Equal
Some risks may be so negligible that we often decide to accept full responsibility for any potential loss. In insurance language, we “self-insure” for risks we choose to accept. For example, it is rarely cost-effective to carry collision coverage on a ten-year-old automobile. Since collision coverage generally pays actual cash value, and a ten-year-old car may have little current fair market value, it is common to self-insure in such cases. In making this choice, we assume full responsibility for any accidental damage to the vehicle that we ourselves might cause.
On the Other Hand
In contrast, sometimes the risk is so large (or the cost of insurance so great) that the best strategy is to try to avoid the risk entirely. We practice risk avoidance in daily life when we invoke the phrase, “not worth the risk” to describe our decision not to participate in some events.
Sometimes, risk can be reduced. Installing an automobile anti-theft device is one example of a strategy employed to reduce the conditions that may create loss.
Risk Transferring and Risk Sharing
Buying insurance is the process of transferring risk you cannot afford, or choose not to accept. Since few of us could afford to rebuild our homes in the event of fire, we typically transfer that risk to an insurer by purchasing a homeowners policy. However, even in situations of risk transfer, it is quite common to share some of the risk. For example, the deductible on a health insurance, automobile, or homeowners policy is a form of risk sharing—we accept responsibility for a small portion of the risk while transferring the bulk of the risk to the insurer.
Taking a closer look at the different types of risks that are faced on a daily basis can help you answer questions such as: What should I insure? What type of insurance do I need? And, how much coverage should I purchase? The fundamental rationale behind all forms of insurance is to determine what risks can be transferred on a cost-effective basis. With the assistance of a qualified insurance professional, you can set up an insurance plan that meets your needs both today and in the future.