On insurance and risk.

Risk is more than market risk

Investment risk is real and is described at length in any adviser's disclosure documents: the value of investments rises and falls, sometimes sharply and for extended periods, and no method of analysis can eliminate the possibility of loss. But a household faces other risks that can be just as consequential and are often less examined:

• Concentration: too much of one's wealth in a single asset, employer, industry, or property.
• Liquidity: having resources that cannot be accessed when they are needed without selling at a poor time.
• Longevity and inflation: living longer than resources were planned for, or watching a fixed income lose purchasing power.
• Health and disability: the cost of care and the loss of earning capacity.
• Property and liability: damage to what one owns, and legal responsibility for harm to others.
• Operational and cyber: fraud, identity theft, and the compromise of financial accounts and information.

Listing these is not meant to alarm. It is meant to make the picture complete, so that attention and resources are directed at the risks that matter most for a particular household rather than only at the ones that make the news.

Four responses to risk

For any risk that has been identified, there are broadly four things one can do. One can avoid it, by not taking the exposure at all. One can reduce it, by diversifying, by maintaining reserves, by installing safeguards. One can retain it, accepting that a loss would be absorbed from one's own resources, which is a sensible choice for risks that are small or that would be costly to insure. Or one can transfer it, paying a third party to bear the loss if it occurs, which is what insurance does.

Most households use all four, whether or not they think of it in these terms. The purpose of a deliberate review is to make sure the choice for each significant risk has actually been made rather than arrived at by default, and that the risks being retained are ones the household could in fact absorb.

Where insurance fits

Insurance transfers the financial consequence of a defined event to an insurer in exchange for a premium. The main categories for households are life insurance, which replaces income or provides liquidity at death; disability insurance, which replaces income when illness or injury prevents work; health insurance; long-term care insurance; and property and liability coverage for homes, vehicles, and personal liability, sometimes supplemented by an umbrella policy for larger claims.

A few general points apply across all of them. A policy is a contract, and what it covers, what it excludes, and how much it pays are determined by its terms, not by its name. Coverage amounts that were right at one stage of life may be too much or too little at another. And insurance is most valuable for risks that are unlikely but severe; it is an expensive way to pay for small, predictable costs. Whether any particular policy is appropriate for a given household is a question that depends entirely on that household's circumstances.

A periodic review

Risk exposures change as life does. A new home, a new child, a change in employment, the sale of a business, a move to another state, the accumulation of wealth, and the approach of retirement each shift which risks matter and how much coverage, of what kind, makes sense. A review of insurance and other risk arrangements therefore belongs on the same schedule as the review of the financial plan itself, and should be triggered by the same events.

The review is practical rather than technical. It asks what has changed, whether the risks being retained are still ones the household can absorb, whether existing policies still fit, and whether there are exposures for which no decision has yet been made. Where the review raises questions about a specific policy or coverage, those are taken to a licensed insurance professional.