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Risk - The possibility of loss or uncertainty in achieving financial goals.
Approaches to managing risk:
Avoidance - Eliminating exposure to certain risks.
Reduction - Decreasing the likelihood or impact of risks.
Transfer - Shifting risk to another party, such as through insurance.
Acceptance - Acknowledging and tolerating certain risks.
Insurance - Financial protection against specified risks, typically provided by contractual agreements.
Cost/Benefit Analysis - Evaluation of potential gains versus sacrifices or costs associated with a decision or action.
(ChatGPT, 2024)
Risk is the potential for an event or outcome to deviate from what is expected or desired, involving uncertainty and the possibility of both positive and negative consequences.
In our daily lives, risk is an ever-present factor influencing the decisions we make. Whether it's deciding to invest in the stock market, launch a new business venture, or even cross the street, we constantly encounter situations where outcomes are uncertain. Risk encompasses the chance of events not going as planned, introducing the potential for both gains and losses.
It is a fundamental aspect of decision-making, requiring individuals, businesses, and organizations to assess, manage, and sometimes embrace uncertainty. From financial markets to personal health choices, the concept of risk underscores the dynamic nature of our world, prompting us to navigate the delicate balance between potential rewards and the inherent unpredictability of future events.
Risk management involves identifying, assessing, and prioritizing risks, followed by the application of resources to minimize or control the impact of those risks. There are various approaches to managing risks, and different sources may present different categorizations. However, a common framework includes four primary ways to manage risk:
Avoidance:
This strategy involves taking actions to eliminate or avoid the risk altogether.
You may choose not to engage in certain activities or projects that pose significant risks.
While effective, avoidance may also mean missing out on potential opportunities.
Example: Jane is concerned about the potential health risks associated with smoking. To avoid these risks, she decides not to start smoking and actively discourages her friends and family from smoking as well.
Reduction:
This involves taking steps to reduce the likelihood or impact of a risk.
This may include implementing safety measures, redundancies, or using protective technologies.
By reducing the severity or probability of an adverse event, you can minimize potential losses.
Example: Alex enjoys outdoor activities, including cycling. To reduce the risk of injury, he invests in high-quality safety gear, such as a well-fitted helmet, knee pads, and reflective clothing. These precautions help reduce the potential impact of accidents while cycling.
Transfer:
This strategy involves shifting the responsibility for the risk to another party.
Common methods of risk transfer include purchasing insurance.
While the risk is not eliminated, it is transferred to another entity that is often better equipped to handle it.
Example: Emily is planning a destination wedding in a tropical location. Concerned about the possibility of unexpected weather disruptions, she purchases wedding insurance that covers unforeseen events such as hurricanes or venue closures, transferring the financial risk to the insurance provider.
Acceptance:
Sometimes, you choose to accept certain risks without taking specific actions to reduce or transfer them.
This strategy is often employed when the cost or effort of managing the risk exceeds the potential impact.
It's essential to make informed decisions about which risks to accept, and monitoring is usually in place to identify any changes in the risk landscape.
Example: Mike is passionate about starting his own business. He understands the inherent risks of entrepreneurship, including financial uncertainties and market fluctuations. Despite these risks, he accepts the challenge and starts his business, embracing the potential rewards along with the acknowledged risks.
It's important to note that these strategies are not mutually exclusive, and a combination of them may be used to navigate risk. The specific approach depends on the nature of the risk, organizational goals, and the resources available. Additionally, continuous monitoring and reassessment are crucial to adapting risk management strategies as circumstances change.
(The Church of Jesus Christ of Latter-day Saints, 2017)
Preparation is a powerful gospel principle. The Lord promises that “if ye are prepared ye shall not fear” (D&C 38:30). After our obligation to pay the Lord first through tithing and other offerings, our second obligation is to work to protect our families from hardship. We can do this only if we develop a long-term perspective.
How would it impact you or your family financially if one of you became very ill or disabled, or perhaps even passed away? What would be the financial impact of something like a house fire or a serious car accident? These types of hardships happen, and if we are not prepared, they can cause major financial problems. A good source of protection against possible hardship is insurance. Insurance is an arrangement in which an organization (typically an insurance agency) guarantees to compensate an individual for specific hardships in exchange for a fixed payment.
President N. Eldon Tanner taught, “Nothing seems so certain as the unexpected in our lives. With rising medical costs, health insurance is the only way most families can meet serious accidents, illnesses, or maternity costs. … Life insurance provides income continuation when the provider prematurely dies. Every family should make provision for proper health and life insurance” (Tanner, 1979).
Insurance can help protect you from the financial devastation that accidents and other hardships can bring.
You do not need to insure all things—that is why you are building an emergency fund and other savings. However, it is critical that you protect yourself from hardship that could be financially devastating. President Marion G. Romney taught that “we have … been counseled [to] have a reserve of cash to meet emergencies and to carry adequate health, home, and life insurance” (Romney, 1981).
In today's world, insurance is readily available for a wide array of scenarios, offering protection against potential risks and uncertainties. From life and health insurance to coverage for homes, cars, and even specific events, the market provides a comprehensive array of policies. However, the decision to acquire insurance should be approached thoughtfully. While insurance offers a safety net and financial security, it's crucial to assess individual needs and circumstances.
Acquiring insurance for every possible scenario can lead to unnecessary expenses, as some risks may be negligible or easily manageable without coverage. Striking the right balance involves evaluating the likelihood and impact of potential risks, considering personal financial resilience, and making informed decisions about the necessity of specific insurance policies. In essence, while insurance is a valuable tool for mitigating risks, prudent judgment should guide individuals in determining the extent of coverage needed for their unique situations.
Here is a list of common types of insurance:
(Boies, n.d.)
Health insurance—helps pay your doctor’s visits and other health care expenses
Disability insurance—replaces some of your income if an injury or illness prevents you from working
Life insurance—helps pay bills and your family’s future financial needs after you die
Auto insurance—protects you against financial loss if you have a car accident
Homeowner’s insurance—pays you if there is damage to your home, or for loss of personal property due to damage or theft
Flood insurance—protects you against property loss from flooding
Renter’s insurance—pays claims for damage or loss of your personal property as a renter
Pet insurance—helps pay veterinary bills for your pet
Crop and livestock insurance—protect your farm from loss due to natural disasters or declining prices
Catastrophic health care insurance—covers certain types of expensive medical care, like hospitalizations
College tuition insurance—refunds college tuition if you must withdraw because of a serious injury or illness
Dental and vision insurance—helps pay your dental or vision care expenses
Identity theft insurance—reimburses you for the cost of restoring your identity and repairing credit reports if you’re a victim of identity theft. This insurance may be part of your homeowner’s insurance policy or a stand-alone policy.
International health care insurance—provides health coverage no matter where you are in the world. The policy term is flexible, so you can purchase it only for the time you will be out of the country.
Liability insurance—pays if you are sued for negligence or injury to another person
Host protection insurance—protects you if you rent your home out or use your car to drive others for a fee
Travel insurance—protects against losses during travel. There are four kinds of travel insurance: travel cancellation insurance, baggage or personal effects coverage, emergency medical coverage, and accidental death.
Umbrella insurance—supplements the insurance you already have for home, auto, and other personal property. Umbrella insurance can help cover costs that exceed the limits of other policies.
Before you buy insurance, do your homework. Research the insurance company to be sure that the company is financially sound and provides good service. Unfortunately, there are scams and fraudulent activities related to insurance so do your best to make sure you are not falling for a scam. Once you have found a good company to get insurance through, find out what factors matter so that you can get the coverage you need at the best price.
Find the Best Rates
Compare quotes from several companies to get the best deal.
Ask your insurance company representative about discounts. You may be able to get a lower premium if you have safety features in your home, such as deadbolt locks, smoke detectors, an alarm system, storm shutters, or fire-retardant roofing material. Similarly, you may save on car insurance based on your vehicle’s safety features, the number of miles you drive, your age, good grades if you’re a student, and your driving record. You might also be able to get discounts if you’re a member of civic or alumni associations, or have multiple policies with the same company.
Consider a higher deductible. Increasing your deductible by just a few hundred dollars can make a big difference in your premiums.
Now that we have a basic understanding of insurance and some of its potential benefits, let’s discuss some of the costs. The two primary types of costs or expenses associated with insurance are the premium and the deductible.
A premium represents the price of the insurance—or the money you pay directly (often monthly or annually) to the insurance company in exchange for the coverage.
A deductible represents the amount of money that you pay toward your expenses (such as medical expenses or automobile repair costs) before the insurance company will cover the remaining costs.
When comparing insurance plans, you are essentially trying to compare what the plan could potentially cost you versus what it could potentially provide in coverage. It may be helpful to compare best-case to worst-case scenarios.
Annual Minimum Cost (The Best-Case Scenario) - To calculate the annual minimum cost, simply multiply your monthly premium by 12 months (12 x the monthly premium), or look at the annual premium if you are billed just once a year. This scenario assumes that you do not have an insurable event in the year.
Annual Maximum Cost (The Worst-Case Scenario) - To calculate your annual maximum cost, add your annual minimum cost to the annual deductible ([12 x the monthly premium] + deductible). This scenario assumes that the expenses of the insurable event exceed your annual deductible.
Imagine that you are comparing two renters insurance plans: a plan with a high deductible of 2,000 which costs 10 each month, and a plan with a lower deductible of 500 that costs 40 each month. Calculating the Annual Minimum and Annual Maximum Costs would look like this:
Annual Minimum Cost
Annual Maximum Cost
High-deductible plan
10 x 12 = 120
120 + 2,000 = 2,120
Low-deductible plan
40 x 12 = 480
480 + 500 = 980
Notice that in the best-case scenario, the high-deductible plan will save you 360. This means that even if you have to cover up to 360 in rent property-related expenses out of your own pocket, it is still less expensive to go with the high-deductible plan, for this situation. However, this is not true in the worst-case scenario.
In the worst-case scenario, where you had to pay out the maximum annual cost, you would save almost twice as much (over 1,000) by choosing the lower-deductible plan. As you try to decide between insurance plans and options, consider your situation or that of your family in order to choose the plan that best fits your needs.
Determining if you have too much or too little insurance involves a careful evaluation of your specific circumstances and needs. Here are some general guidelines to help you assess your insurance coverage:
Signs you may have too much insurance:
Excessive Premiums: If you find yourself struggling to meet premium payments and your coverage exceeds your actual needs, you might have too much insurance.
Redundancy: If you have multiple policies that cover the same risks, you may be over insured. Reevaluate whether each policy provides unique and necessary coverage.
Low-Risk Tolerance: If you are risk-averse and have extensive coverage for unlikely events, you might be overestimating the potential risks. Consider whether the cost of the premiums justifies the level of protection.
Signs you may have may have too little insurance:
Limited Coverage for Essential Risks: If your insurance coverage doesn't adequately address essential risks such as health, property, or income protection, you may be underinsured.
Insufficient Coverage Limits: If the coverage limits on your policies are too low, you might not be adequately protected against potential financial losses. Ensure that your coverage aligns with the potential costs associated with various risks.
Life Changes: Significant life events, such as marriage, having children, or buying a home, can change your insurance needs. If you haven't adjusted your coverage to reflect these changes, you may be underinsured.
Inadequate Emergency Fund: If you lack a sufficient emergency fund to cover unexpected expenses, you might be relying too heavily on insurance to protect you from financial setbacks.
To find the right balance, regularly assess your insurance needs, considering changes in your life, financial situation, and risk tolerance. Consult with insurance professionals or financial advisors to get personalized advice based on your unique circumstances. Remember that the goal is to have enough coverage to provide financial security without paying for unnecessary protection.
Insurance is a cornerstone of a comprehensive financial plan as it directly addresses and manages various risks that you may encounter. By transferring the financial burden of certain risks to insurance providers, you can protect your assets and maintain financial stability in the face of unforeseen events.
Effectively integrating insurance into a financial plan requires thoughtful consideration of individual risk tolerance, current circumstances, and long-term financial goals. Regularly reassessing and adjusting insurance coverage is crucial to maintaining a resilient financial strategy that addresses evolving risks.
While there are many different options for insurance, you may not have all or any of them available where you live. Prayerfully consider how these principles can best be applied to your unique situation.
Boies, C. (n.d.). Personal Finance. Creative Commons Attribution. Retrieved January 23, 2024, from https://library.achievingthedream.org/lfccpersonalfinance/chapter/request-access/
ChatGPT (Version 3). (2024). [AI]. Open AI. https://chat.openai.com/auth/login
Romney, M. G. (1981). Principles of Temporal Salvation. Ensign.
Tanner, N. E. (1979). Constancy amid Change. Ensign.
The Church of Jesus Christ of Latter-day Saints. (2017). Learn—Maximum Time: 45 Minutes. In Personal Finances for Self-Reliance. https://www.churchofjesuschrist.org/manual/personal-finances-for-self-reliance/9-managing-financial-crises/learn-maximum-time-45-minutes?lang=eng