The Planner's Perspective: Low Probability, High Impact
By Paul Morrone CFP®, CPA/PFS, MSA
When we say an event is low probability but high impact, a good analogy is winning the lottery. This sudden windfall of cash is predicated on nothing more than your decision to play the game and above all else, some really good luck. But what happens when bad luck strikes, the proverbial worst-case-scenario? These low probability, high impact events can completely destroy even a financially sound family’s plan and can deplete six and seven-figure savings in the blink of an eye.
We’re talking about things like a premature death, total (or substantial) loss of your home, being subject to a major liability lawsuit or even developing a prolonged degenerative disease. Very few households can overcome the detrimental economic impact of having to address even one of these issues, which is why preventative risk management planning is critically important to any sound financial plan. Most of these types of events are often (relatively) cheap to insure against, meaning that for a nominal cost you can transfer the majority of the risk onto an insurance company to absorb major losses should the worst happen. As with any planning, there is no silver bullet and each individual’s risk management plan should be tailored to the unique risks in their life and their individual risk tolerance.
A comprehensive risk management plan should address potential losses related to your health (excessive medical/dental expenses), person (premature death, becoming disabled, requiring extended long-term care), losses due to fire, theft or damage of personal assets (home, auto, boat, etc.) and losses that could arise from liability exposure (which are virtually limitless in today’s world). A carefully constructed risk-management plan should strike a balance between the cost/benefit of protecting you and your family from the many perils in life, while providing adequate protection in all areas in the event there is a substantial loss.
Risk management is not a set-it-and-forget it process, and your plan should be reviewed at least annually. Just because you are paying a high premium and see big numbers on your policy doesn’t mean that coverage is designed to meet your unique needs. Changes in the insurance marketplace and economy as a whole warrant paying close attention to your insurance portfolio, as values of your home, autos, net worth and risk tolerance all change on a day-to-day basis. Furthermore, as your life changes, your insurance policies should evolve to cover the new types of risks you may be subject to. Marriage, births, deaths, changes in occupation and employee benefits all have a material impact on your overall risk profile and are often overlooked without proper oversight.