BUSI 421 Week 7 Individual Application/Reflection Paper Example

Applying the Risk Management Process to My Own Household: An Insurance Planning Reflection

Introduction

Before this course, I thought of insurance as a set of bills: the car policy, the renter's policy that became a homeowner's policy, and whatever my employer offered during open enrollment. Dalton et al. (2017) describe a different way to see it, as one part of a risk management process. The planner identifies the exposures a household faces, measures how often each loss might occur and how severe it would be, chooses a technique for each, and then monitors the plan as circumstances change. This paper applies that process to my own household, a married couple in our early thirties with one child, a new mortgage and two incomes, and reflects on what I found.

Identifying and Measuring Our Exposures

The process starts with an inventory. The table summarizes our main exposures, my rough judgment of their frequency and severity, and how we were treating each one before this review.

Dalton et al. (2017) suggest matching the technique to the combination of frequency and severity: losses that are frequent but small are usually retained, losses that are rare but severe should be transferred through insurance, and exposures that are both frequent and severe should be avoided. Seen through that lens, the table shows our weak spots immediately. The most severe exposures, a long disability and a liability judgment, were the ones we had transferred least.

Health and Disability

Our health coverage through my spouse's employer is adequate, with an out-of-pocket maximum we could pay from our emergency fund, so I made no change there except to keep the emergency fund at that level.

Disability was a different story. My employer provides short-term disability for up to twenty-six weeks, but nothing after that. I had assumed Social Security would fill the gap. A Journal of Financial Planning article by Carroll et al. (2023) corrected me. The authors estimate that a healthy 35-year-old has roughly a one-in-four chance of a disability lasting ninety days or more before retirement, far higher than the odds of losing a home to fire, and they report that Social Security disability benefits average about $1,358 a month, with about two-thirds of initial claims denied. I had insured the house against a loss I will probably never suffer and left uninsured the income that pays for the house.

Dalton et al. (2017) explain that the definition of disability is the most important feature of an individual policy: an own-occupation definition pays if I cannot perform my own job, while an any-occupation definition pays only if I cannot work at all. They also describe how a longer elimination period lowers premiums. Based on that guidance, I priced an individual policy replacing 60 percent of my income to age 65, with a 90-day elimination period, which fits after our emergency fund, and an own-occupation definition for the first two years. The estimated premium is about 2 percent of my income, a cost I now see as part of protecting everything else in our plan.

Life Insurance

Our only life coverage was group insurance worth two times salary for each of us. Running the needs approach from the course showed a gap of roughly $500,000 to $700,000 for each spouse, once the mortgage, our child's education and the cost of replacing each parent's income and work at home were counted. Bernheim et al. (2003) found that many households hold life insurance that bears little relation to how much a death would lower the survivor's standard of living, and our situation fit that pattern. We are buying twenty-year level term policies of $600,000 on each of us, which cost far less than permanent coverage during the years our need is highest. Because group coverage ends if we change jobs, the individual policies also remove a risk I had not considered.

Property and Liability

Our homeowners policy insures the dwelling at replacement cost, which Dalton et al. (2017) identify as the key to avoiding a coinsurance penalty, and I confirmed that the coverage limit kept pace with local building costs. The weak point was liability. We carried only the state minimum limits on our autos, and $300,000 of personal liability on the house. A serious accident could produce a judgment far above those limits, and our home equity and future wages would be exposed. Raising our auto limits and adding a $1 million personal umbrella policy costs a few hundred dollars a year, which makes it one of the least expensive ways to transfer a very severe risk.

Action Plan

I will complete the disability application this month, while our health is good and underwriting is likely to be smooth; apply for the two term life policies at the same time; raise our auto liability limits and add the umbrella policy at the next renewal; and review the whole plan each year during open enrollment, or sooner if we have another child, change jobs or move.

Reflection

This assignment changed how I think about insurance. I had treated it as a list of products, and I had bought the ones that were sold to me or required by a lender. The risk management process showed me that the largest risks in our household were not the visible ones. As a future financial planner, I expect clients to make the same mistake, buying what is visible and familiar while overlooking what is rare but ruinous, and I now understand why a planner must begin with exposures rather than policies.

The exercise also has a spiritual side. Scripture calls believers to be faithful stewards of what God entrusts to them, and Proverbs commends the prudent person who sees danger ahead and prepares. Insurance is not a substitute for trusting God, but leaving my family exposed to a risk I could reasonably transfer would not be wise stewardship. Planning for what could go wrong is a way of caring for the people who depend on me. Paul wrote that anyone who does not provide for his household has denied the faith (English Standard Version Bible, 2001/2016, 1 Timothy 5:8); for a family whose security rests on two incomes, providing includes protecting those incomes against the risks this review uncovered.

References

Bernheim, B. D., Forni, L., Gokhale, J., & Kotlikoff, L. J. (2003). The mismatch between life insurance holdings and financial vulnerabilities: Evidence from the Health and Retirement Study. American Economic Review, 93(1), 354-365. https://doi.org/10.1257/000282803321455340

Carroll, D., Hadjian, A., Collier, N., & McCoy, M. (2023, July). Disability insurance: The financial planning industry's great blind spot. Journal of Financial Planning. https://www.financialplanningassociation.org/learning/publications/journal/JUL23-disability-insurance-financial-planning-industrys-great-blind-spot-OPEN

Dalton, M. A., Dalton, J. F., Langdon, T. P., & Gillice, R. R. (2017). Insurance planning (5th ed.). Money Education.

English Standard Version Bible. (2016). Crossway. (Original work published 2001)