Insurance is not the only way to manage risk. In the near future I will be an expert* on risk. In fact, I’m actively working on that goal now. My dissertation in Behavioral Economics and Financial Planning will be based entirely on an individual’s perceptions and measurement of risk. But what is risk? What does it actually mean? And what are the ways we can manage risk? Can we manage risk without insurance?
Risk management can become a dirty word in financial circles. Although planning for and understanding risk is fundamentally necessary in all aspects of life, many individual’s interaction with sellers of insurance and risk management products are less than savory. Insurance, and especially life insurance, is seen as an entry point into the risk management industry and fraught with many inherent conflicts of interest. The underlying assumption for many individuals is that risk is managed with insurance. Sure, insurance plays an important role, but risk management is much more than simply insurance.
Risk is a broad subject. It can be thought about in terms of physical risk (safety, war, etc), financial risk, business risk, health risk, or even environmental risk. For the scope of this article, I’ll focus on personal risk, which we have some capacity to control.
The biggest risk (and most important) that we have control over is our health. Before you get upset, I understand that some health risks are beyond our control; but we certainly have the ability to maximize our health given the heredity or environmental constraints that affect our daily lives. Our health is the most important thing we have, yet we often take very poor care of our bodies. Health insurance is expensive and as we move toward more high deductible type plans, we will be even further incentivized to keep our bodies as healthy as we can. There is certainly a monetary incentive to keeping our bodies healthy, but maintaining optimal health provides dividends well beyond our wallet. We have more energy, better sleep, greater wellness and overall life satisfaction when we take care of our health. Our health often loses priority as we develop in our careers, but should remain the fundamental baseline for minimizing risk and creating an efficient lifestyle.
Bottom Line: Eat as healthily as possible, develop consistent sleep and exercise habits, don’t smoke and keep a Body Mass Index (BMI) out of the overweight or obesity range.
Financial risk is a broad term that can be applied to investment, business decisions or even our savings and spending strategies. Margin. Margin is the key to managing risk in our financial worlds. Not the borrowing money to make money kind of margin, but the spend significantly less than we earn and plan for financial emergencies and contingencies type of margin.
Life is expensive when we run out of money. Having margin allows us to take greater risks in our investments, career opportunities, and time choices. We all spend a percentage of our income. It may be 105%, 85% or 50% .The closer we move to 100%, the less flexibility we have when in trouble. I love working with students just leaving college, most are non-indoctrinated in the ‘spend all you earn’ camp, and it is great to have someone start with the expectation of saving at least half their income. For individuals with large families and more established habits, the challenges are greater but certainly necessary to complete for long-term happiness.
We personally manage financial risk by minimizing debt, minimizing outflow, planning well in advance for annual expenses, and having plenty of money saved for unexpected emergencies. We have chosen to pay off our mortgage early to help minimize our outflow exposure and protect ourselves from unexpected job losses or interruptions in our expected income.
Bottom Line: Develop margin, minimize or eliminate debt payments, plan for future and annual expenses, build cash for emergencies, and be efficient with the money you currently earn.
Insurance is really any product or service that transfers risk from one party to another. Insurance is a tool that is used to bring stability to our financial situation and our financial future. I don’t really mind insurance, but I find that people are often under-insured in certain areas and over-insured in others. I personally understand the need for health insurance, home/auto insurance, and long-term disability insurance. The tricky part about insurance is that it is difficult to understand what we actually need, and to learn more about our options without being influenced by someone who has a conflict of interest about our insurance needs (traditional commission based insurance salesmen). Once we establish our true needs, shopping for appropriate and efficient policies should be done on a consistent basis (we get new quotes for all of our insurance needs every January 15).
Insurance is less expensive when we can self insure. If we have enough money we do not need products like life insurance or longevity insurance. We can further shoulder the low frequency risk by increasing our deductibles and paying out-of-pocket for minor potential claims.
Bottom Line: Buy only what you need. Get an unbiased option about your options. Save cash and maximize deductibles once you can cover the risk. Shop all of your policies at least once a year.
Managing risk is important. We can control a large portion of risk we face by taking care of our bodies and developing financial margin. For the few areas of life where we need to transfer risk, insurance products can be used to fill the gaps. Having money and maintaining healthy relationships also decrease our needs for risk products. Life is full of different risks but we can use strategies to limit our exposure and keep our financial lives protected. It is always wise to maintain our health, develop financial margin, and insure away the risks we cannot withstand.
*I am in the process of completing my dissertation on risk assessment, risk tolerance, and risk perceptions. The I’ll be the “expert”