AFN 221 Personal Finance Insurance and Risk Management PDF

AFN 221 Personal Finance Lecture Topic: Insurance and Risk Management Andreas Milidonis Department of Accounting & Finance University of Cyprus...

AFN 221 Personal Finance Lecture Topic: Insurance and Risk Management Andreas Milidonis Department of Accounting & Finance University of Cyprus Email: [email protected] 1 1 “Concept Map” for the Course Introduction Interest Rates Inflation & Time Money Management Savings Consumer Borrowing (Credit) Review & Midterm Exam Mortgage Insurance & Risk Investing Management Retirement Risk & Return Biases Review & Final Exam 2 2  Risk, Insurance and Risk Management 3 What is risk? Risk describes a condition where the individual is aware of the potential outcomes and the associated probabilities of those outcomes. Example: based on historical data, the probability that my house will: Be struck by lightning is 1%. If this happens I will suffer a loss of 20,000 euros. Not be struck by lightning is 99%. 4  What is insurance? Insurance is protection against possible financial loss; it gives you peace of mind. An insurance company, or insurer, is a risk-sharing firm that assumes financial responsibility for losses from an insured risk. People purchase a policy; the firm assumes the risk for a fee called the premium, which the insured policyholder pays periodically. 5 Why buy insurance? Risk is everywhere. Even if we think we ignore it, it will not go away. If you do not buy insurance for a risk you take, it is the same thing as “risk-taking”. Example: Suppose that Joe’s house burns down because of a low quality electrical appliance. The replacement value of the house is 200,000 euros. If Joe has insurance that protects his house, then a large part of the losses will be paid by the insurance company. If Joe does not have insurance, then he has to pay the losses out-of-pocket. 6  What does it mean to have insurance? Stop loss Coinsurance Coinsurance stathero poso pososto se kathe zimia pano stin zimia Deductible Deductible Insurance Consumer’s company’s share Share 7 What does it mean to have insurance? Deductible 500 Coinsurance 20% Max Threshold 1000 Stop loss 600 Actual cost Consumer's Insurance Total (euros) Cost (Euros) Company's Cost Cost 0 0 0 0 100 100 0 100 200 200 0 200 300 300 0 300 400 400 0 400 500 500 0 500 600 520 80 600 700 540 160 700 800 560 240 800 900 580 320 900 1000 600 400 1000 1100 600 500 1100 1200 600 600 1200 1300 600 700 1300 1400 600 800 1400 1500 600 900 1500 8  Types of Risk TYPES OF RISKS Peril is the cause of a possible loss, such as fire, windstorms, explosions, robbery, accidents, and premature death. Hazard increases the likelihood of a loss, such as defective house wiring. Financial Risk has both positive and negative outcomes. If you invest in an asset, you might have a positive or a negative return. (we will examine in a few weeks’ time) 9 Types of Risk Pure Risk The most common risks are classified as personal risks, property risks, and liability risks. Insurable risk; chance of loss not gain. Accidental and unintentional risks. Nature and financial cost of the loss can be predicted. Speculative Risk Chance of either loss or gain, such as starting a small business or gambling. Uninsurable risk. 10  Risk Management Methods Risk management is an organized strategy for protecting assets and people. Risk Management Techniques Risk Avoidance Risk Reduction Wear seat belt, install smoke alarms, eat a balanced diet and exercise. Risk Assumption Self-insurance Risk Shifting Transfer risk to insurance company. A deductible is the set amount that the policyholder must pay per loss on an insurance policy. 11 Property and Liability Insurance 12  Property Insurance We had some rare but costly events in Cyprus from earthquakes, (small) tornadoes, but also from floods and fires. If our property is not insured, then we will have to pay for losses from our pocket. Main risks related to a home and an automobile are property damage and your responsibility for injuries to others and their property. 13 Potential Property Losses Personal belongings subject to potential property loss: Houses, automobiles, furniture, clothing, and other personal belongings Risk: Physical damage Caused by hazards such as fire, wind, water and smoke. Destruction of property or temporary loss of use. Risk: Loss of use Due to robbery, burglary, vandalism, or arson. 14  Liability Protection Liability. Is legal responsibility for financial cost of another person’s losses or injuries. Negligence. Failure to take ordinary or reasonable care, such as failure to supervise children in a pool. Strict Liability. A person is held responsible for intentional or unintentional actions. 15 Home Insurance 16  Home Insurance: Determining How Much Coverage You Need 17 Home Insurance Factors FACTORS THAT AFFECT HOME INSURANCE COSTS. Location of Home. Type of Structure. Brick house cost less to insure than wood house. Coverage Amount and Policy Type. Deductible affects cost of your insurance; increase deductible to lower premium; common deductibles are $500 or $1,000. Also any coinsurance amount (if any). 18  Reducing Home Insurance Costs Home Insurance Discounts. Alarm system, smoke detector, fire extinguisher, nonsmokers, if you insure your car with the same company. Company Differences. Compare costs, coverage, and service. Consider how claims are settled. 19 Automobile Liability Insurance Coverage 20  Renter’s Insurance Protection against financial loss due to damage or loss of personal property. Additional living expenses. Personal liability and related coverage. A building owner’s insurance usually won’t cover renter’s personal property. Only 4 out of 10 renters have insurance. 21 Automobile (Car) Insurance 22  Motor Vehicle Property Damage Coverages Comprehensive Physical Damage. Covers damage to your vehicle that is not caused by a collision, such as... Fire, theft, or vandalism. Glass breakage. Wind, hail, flood, tornado, etc. Falling objects or hitting an animal. Some things in your car, like some radios and stereo equipment, are not covered. 23 Automobile Insurance Premium Factors Automobile Type. Year, make, model, and theft rate. Rating Territory. Different costs due to number of claims made in the geographic area where you live. Driver Classification. Age, sex, marital status, credit history, driving record, and driving habits. 24  Reducing Automobile Insurance Premiums Comparing Companies. Rates may be compared online Premium Discounts. Establish and maintain a safe driving record. Avoid accidents and traffic violations. Install security devices such as a car alarm. Increase deductibles. Non-smoker. Insure two or more vehicles with the same company. 25 Health Insurance 26  Cyprus’ “General Healthcare System” (GHS or ΓΕΣΥ) ΓΕΣΥ = Γενικό Σχέδιο Υγείας. GHS covers all citizens of Cyprus. Aims to allow a choice between the services of doctors or other healthcare professionals. Citizens will enjoy health services independent of their financial status, contributing a small percentage of their monthly income to help fund the operation. 27 GHS “out-of-hospital” coverage GHS started out-of-hospital coverage on June 1st 2019. This coverage included: Introduction of personal doctor specialist doctor services, laboratory tests and pharmaceutical products for out-patients. 28  GHS “out-of-hospital” coverage Contributions* started in March 1 2019. Employees and pensioners 1.7% of their income / on their pension Employers 1.85% on the salary of every person employed The state 1.65% on the salary of employees, remuneration of self-employed, officials and on pensions Self-employed people 2.55% on their remuneration 29 GHS “in-hospital” coverage – Full implementation GHS added in-hospital coverage on June 1st 2020, such as: Accident and Emergency services, Ambulance services, palliative care, services from nurses, midwives and allied health professionals, medical rehabilitation, preventative dental care and home visits. 30  GHS “in-hospital” coverage – Full implementation Contributions* started on March 1st 2020 - Employees and pensioners 2.65% of their income / on their pension - Employers 2.9% on the salary of every person employed - The state 4.7% on the salary of employees, remuneration of self- employed, officials and on pensions - Self-employed people 4% on their remuneration *Contributions are collected by the Social Insurance Services, Tax Department and Treasury of the Republic.* 31 GHS “in-hospital” coverage – Full implementation For every natural person the total maximum annual amount on which contributions will be paid is € 180,000 If the natural person is not a tax resident of Cyprus, he/she will pay contributions only for the income, earnings, and pensions that derive from the Republic of Cyprus, excluding dividends and interest. Employers’ contributions and employees’ deductions are calculated on the gross salary (up to €180,000) and will be paid through Social Insurances. 32  The future of GHS GHS is under continuous development to address issues related to its software Potential abuses of the system Inclusion of more health care professionals Many organizations still carry their own private health care insurance programs. 33 What Can You Do to Reduce Personal Health Care Costs? Stay well: Eat a balanced diet and keep your weight under control. Avoid smoking and don’t drink to excess. Get sufficient rest, relaxation, and exercise. Drive carefully and watch out for accident and fire hazards in the home. Maintain a healthy lifestyle. Get recommended health screening and manage chronic conditions. 34  Life Insurance 35 Life Insurance: An Introduction Life insurance A person purchases a policy by paying a premium and the insurance company promises to pay a sum of money at the time of the policyholder’s death to the designated beneficiary. 36  Purpose of Life Insurance Protect someone who depends on you from financial loss related to your death. Proceeds may also be used to: Pay off a home mortgage or other debts at the time of death. Provide lump-sum payments to children when they reach a specified age (endowment). Provide an education or income for children. Cover medical expenses and funeral costs. Accumulate savings or establish income for survivors. Make estate and death tax payments. 37 Principle of Life Insurance and Life Expectancy THE PRINCIPLE OF LIFE INSURANCE. Mortality tables show the number of deaths among various age groups and gender during any year. LIFE EXPECTANCY. Individuals are living longer due to improved medical care, healthier lifestyles, and education obtained. Women outlive men. 38  Determining Your Life Insurance Needs DO YOU NEED LIFE INSURANCE? Do you have people you need to protect financially (spouse, children, parents)? Influenced by your stage in the life cycle and the type of household you live in. Households with small children have greatest need for life insurance. 39 Determining Your Life Insurance Objectives How much money do you want to leave to your dependents if you were to die today? Will you require more or less insurance protection to meet their needs as time goes on? When would you like to be able to retire? What amount of income do you believe you and your spouse would need in retirement? How much are you able to pay for your insurance program? Are the demands on your family budget for other living expenses likely to be greater or lower as time goes on? 40  Estimating Your Life Insurance Requirements The Multiple of Income Method. Needs range between 5 and 8 times your annual gross income. The Easy Method. Typical family needs 70% of your salary for seven years before they adjust to life without your income. The DINK (dual income, no kids) Method. Funeral costs and one half of the debt outstanding. 41 Estimating Your Life Insurance Requirements 2 The “Nonworking” Spouse Method. Multiply the number of years until the youngest child reaches 18 by $10,000. (or about 5000 euro; number based on comparison of GDP per person in US and Cyprus) The “Family Need” Method. More thorough because it also considers employer provided insurance, Social Security benefits, and liquid assets. Online Calculators and Applications (Apps). 42  Types of Life Insurance Policies Temporary Insurance (term, renewable term, convertible term, or decreasing term insurance). Permanent Insurance (called whole life, straight life, ordinary life, or cash value life insurance). 43 Term Life Insurance Term life insurance (temporary life insurance). Protection for a specified period of time. If you stop paying premiums, coverage stops. Renewability Option: renew the policy at the end of the term without a medical reevaluation. Multiyear Level Term: popular because you pay the same premium for life of policy. 44  Whole Life Insurance Whole Life Insurance (permanent life insurance). Also called straight life or cash-value life or ordinary life. You pay specified premium as long as you live. Premium depends on your age when you start the policy. Provides death benefits and a savings account (accumulates a cash value). Makes sense if you intend to keep the policy for the long term or must be forced to save. First consider other savings and investment options before investing in whole life insurance. 45 Summary What is risk? What is insurance? Insurance pricing. Risk management strategies. Types of insurance: – Property – Liability – Automobile (Car) – Home – Health – Life 46 46