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How to Treat Financial Risks in Your Life

Kevin Wenke

Kevin Wenke

CFP | CLU | Investing | Insurance | Taxes

How to treat risk in your life will vary on the situation, the degree of potential loss as well as the individuals risk tolerance. Generally Speaking, one risks are identified, there are four options one has in handling them

First, they could avoid the risk outright.
For example, if someone is afraid of dying in a plane crash, they can avoid that risk by never flying. This was something that ex-NFL coach and broadcaster John Madden is famous for. He never flew. Problem solved!

Of course, in doing so he increase the risk of dying in the new alternative of travel he chose (his bus) but you get the point.

In life there are risks we can avoid effectively. Travel may be hard to avoid all together but you could easily avoid the risk of dying from a sky diving accident if you decide to avoid sky diving.

Secondly, you could reduce the risk by taking precautions.
When John Madden took his bus to games, he may have reduced his risk of being injured or dying in an accident by making sure his driver obeyed the speed limit or had enough sleep so they didn’t fall asleep at the wheel.

You can reduce your risk of dying in a skydiving accident (if you absolutely have to do that) by making sure you wear a parachute (significantly reduce your risk doing this) and even more by making sure it is packed by an expert parachute packer.)

Thirdly, you can retain the risk.
Generally speaking, it is smart to retain risks that have relatively high probabilities of occurring BUT if they do occur, the consequences are not catastrophic. For example, if you own a business, you might retain the risk you get sick for a day or two and need to stay home.

It could happen. You could lose money but when you are better you will go back to work and get back just about where you started.

From an insurance standpoint, insurance policies are designed with various forms of optional risk retention that most people are familiar with. Two of these are co-insurance amounts and deductibles found in homeowners, auto and medical insurance plans. 

These are dollar amounts and percentages that the policy owner retains, and must pay with their own funds, in the event a covered event occurs. Other risk retention features inside insurance policies are waiting periods for disability and long-term care insurance as well as the amount of time these policies cover (for example 2 years vs. lifetime.)  

Which brings us to the last way to manage financial risk and that is to transfer risk away.
This is the concept of insurance. Transferring risk with an insurance company is done by paying a small premium that obligates the insurance company to provide financial compensation to the policy owner if the covered event occurs.

In order for an insurance company to accept a risk, there needs to be certain elements present with that risk.

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