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Risk Management for Individuals (Financial stages (Education phase…
Risk Management for Individuals
Human vs Financial capital
HC
:
PV of future earnings & wages
often the dominat asset on a household
discount rate used usually equal risk of wage growth and consistency
-> rf + premium for occupational income volatility
professions differs in wage and sensitive to business cycle
FC
personal (consumed) vs investment assets (held for potential to increase to value)
Net worth = traditional assets - liabilities
Net wealth = HC + Investment assets + PV future pension benefits - liabilities + PV future liabities
Financial stages
Education phase (investing in education)
Early Career (to mid 30s)
Career Development (35-50)
Peak accumulation (51-60)
Pre-Retirement (61-65)
Early retirement
Late retirement (length of time unpredictable - longevity risk)
Economic balance sheet
Traditional BS
Net worth = Assets - liabilities
net worth at early stage is negative, HC is ignore
Economic Balance sheet
includes HC
Individual Risk exposures
Earning risk
events that could affect HC and FC
health risks, unemployment, loss of job later in life
Premature death risk
Longevity Risk
Property risk
Liability risk
legal liability for property damage or physical injury
Health Risk
Insurance
Life insurance
hedge against the risk of premature death of an owner
provides liquidity to the beneficiary without the delay of probate
also used for tax-sheltered saving instrument
Temporary/Term
= specific period of time, premiums remain fixed over the time, no cash value
permanent
= provides lifetime coverage, premiums fixed, some cash value
Whole Life
= insured entire life, ongoing fixed premiums
Universal life
= more flexible, policy can pay lower/higher premium
Stock companies: profits to shareholders
mutual companies: profits accrue to policy holders (policy dividends)
mortality expectations
discount rate: net premium = discounted value of the future death benefit.
load = other expense + profit
3.
Disability income insurance
Property insurance
homeowner policy
auto insurance
Health insurance
Annuities
Parties
Insurer
annuitant = person who receives the benefits
contract owner = person who purchases the annuity
beneficiary = person who would receive any proceeds upon death of the annuitant
Immediate annuity
= amount of money is paid in exchange for specific future monthly payments over a specified period of time (# years or life of annuitant)
Deferred annuity
= payments begins later date
Deferred variable annuity =
individual chooses investment option, contract holder has right to exit the contract with penalty, does not guarantee lifetime income