Risk Management

1
Risk Management

• Personal Financial Planning
• Business 4099

2
Key Concepts

• five-stage personal risk management process
• identify, evaluate, control, finance and monitor
• speculative risk involves loss and gain, but in
  uncertain amounts.
• Pure risk involves the possibility of loss, only.
• hazard is a condition that can lead to a peril
  (for example some oily rags left in your basement
  is a hazard)
• a peril if it occurs can lead to an economic loss
  (for example fire is a peril that can damage your
  home.)
• Moral Hazard occurs when the loss is due to
  deliberate actions or choices of the insured.

3
Major Categories of Risk

• Personal (life and health)
• disability, death
• Property (residence, auto, aircraft)
• Liability (responsibility for your actions or the
  results of your decisions)

4
This Chapter

• It is short and straight forwardbut also very
  important.
• This is the core theory that underlies all of
  risk managementwhether applied to corporate
  finance or personal finance.

5
Problem 8 - 1

• a. Property and liability risks only. He must
  have accumulated most of this pension/retirement
  savings already. They must ensure that the
  pension conditions provide a sufficient
  survivors pension for Florimel.
• b. Disability of either one is the most serious
  risk, since neither has much money or income, and
  neither would be likely to be able to earn
  anything if disabled. Premature death is
  somewhat of a risk, because two can live more
  cheaply together than separately. However, it is
  not that serious, since there are no children.
  There is no property risk, since they have none.
  There is no liability risk, since they have
  nothing to lose!

6
Problem 8 - 1...

• c. It seems that Brian has been the breadwinner.
  The most serious risks are disability and
  premature death of Brian. He is old enough now
  that both are material risks. The disability or
  premature death of his wife are also significant
  risks, although she is somewhat younger. The
  loss would be the loss of her services in the
  household, which are especially important with
  three dependent children. Property and liability
  are also risks, since it is likely they have some
  property.

7
Problem 8 - 1...

• d. Failure to get his job back is the critical
  risk.
• Control is the only possibility - - this is an
  unisurable risk because of moral hazard. He is
  also at high risk of disability and premature
  death, due to his current state of health and
  lifestyle. The disability risk is probably
  uninsurable, and once again the best management
  is control. These risks are particularly serious
  because there is no other way for his child to
  receive support, it seems. In case (c), for
  example, it would be possible for the wife to
  start working if the husband died or became
  disabled. The children would grow up and leave
  home, becoming self-supporting.
• Property loss is also an insupportable risk,
  because he has no reserves. In this case, the
  main property is the house.

8
Problem 8 - 2

• There is hardly any material risk for him. His
  parents provide almost all his income, but they
  are rich and he will inherit. Since they are
  unwilling to provide a lot of money for him in
  one lump sum, there is some property risk to the
  bookds and other contents of his apartment, but
  it is not an insupportable risk. His current,
  unpublished manuscripts are at serious risk, but
  a simple control is to keep copies of them (or
  the diskettes, if they are on a computer) in
  another location, such as his parents home.
• You may argue that his cat has an insurable
  interest in his life and health!