This month (September, 2016) my firm is focusing on Risk Management, with the idea to raise awareness and decrease the number of people who only consider what they are paying each month, rather than what they need to protect. I have no issue with people accepting risk, but I’m concerned too many of us don’t understand what we’re accepting responsibility for when we decrease coverage or increase deductibles.
Those who have served in the military have likely heard the term ORM (operational risk management). I picked the picture above because it shows most of what you can do with risks – which is what ORM explained (or used to, not sure if it’s still in use). This post will explain each of the five options – retention, avoidance, sharing, reduction and transferring – using real life comparisons.
First – retention. This means you accept all the risk, and associated consequences yourself. If your home has a fire or you’re in an accident, you pay for all repairs and replacements out of your pocket. This can get incredibly expensive, and should generally be weighed against the probability of an event and the potential cost. For example, not purchasing flood insurance because you live in the middle of Texas. Sure there is a potential a river or something similar could flood, but the probability is low. However, if you lived along the coast of Louisiana or Florida there is a much greater chance of flooding, and you should own flood insurance – in fact if you live along a flood plain you may be required to purchase it.
Avoidance is just what it sounds like, you avoid the risk all together. An example of this would be never owning/driving a car; so there is no risk of you being found liable in a car accident. This can be difficult, because many of us will have to face some risk as we progress through life – moving out of our parents’ house, buying/leasing a car, having children or pets, etc…
Sharing the risk means you’re lessening what you are responsible for. Car, renters and homeowners insurance are examples of this. You maintain a deductible, which is your share of the risk. Anything between the deductible and the max limits of your policy the insurance company pays for. When the policy’s limits are exceeded it either falls back on you, or is protected by an Umbrella Liability policy – until that limit is reached and then it’s back on you. This is where advisors and financial planners help people – by helping their clients identify how much of the risk they can not only accept, but afford as well.
Transferring the risk means somebody else assumes full responsibility. In the insurance world this would be life insurance. There is no “deductible”, you’re not paying a set amount and then the life insurance policy pays the rest. You are paying an insurance company to accept the risk of you dying, which is why term insurance is so much cheaper than permanent – by it’s very nature term insurance isn’t designed to protect you forever, the insurance company is not on the hook for your entire life. Most of the other types of insurance share the risk – you are required to pay a set amount of the cost or wait a certain number of days to be paid.
Reducing the risk is taking measures to lessen the probability of an event occurring. Staying or getting in shape reduces the risk of disease and obesity. Observing rules of the road and posted speed limits reduces the likelihood of an accident and/or ticket. These things are also rewarded by insurance companies. More and more health insurers are giving credits for quitting smoking and gym memberships; and auto insurers offer safe-driver discounts.
Pretty simple, right? None of the terms are super complicated, so why do people get into trouble? Because all too often they worry about how much something is going to cost, rather than what it really means. If we would take a moment to consider what the possible consequences of our actions are, I think many of us would make different decisions. Oh, we’re still going to think we’re invincible, but we’d acknowledge we have no control over everybody else – and if for no other reason that one is why we want to protect ourselves. Maybe we’re still not reading our policy declarations, but now we at least ask the agent we’re working with to give us an overview of what’s covered and what’s not – and we listen. Don’t let your risks be managed by what everyone else is, or isn’t doing. Take the time and do an inventory, what can you live without and what is important enough to protect.