This year, I retired from a Fortune 500 Chemical company as a Manufacturing Advisor after 29 years. I learned many things about managing risk during that time. The typical industry approach to risk management is a 6 step process.
- Step 1: List all assets and assign importance to each one.
- Step 2: Develop a plan for the most critical assets that identifies all risks associated with each one.
- Step 3: Evaluate the probability of occurrence and the consequences of each risk.
- Step 4: Prescribe cost effective actions to eliminate or reduce each risk to an acceptable level.
- Step 5: Perform these actions on schedule.
- Step 6: Reassess the plan by evaluating the cost effectiveness of the actions performed and identifying any new risks.
We use a very similar approach when helping our clients manage their personal risks.
We start by getting to know you and your values and creating a list of your assets, needs and goals. Assets include your Home, Autos, Boats, RV, Business, Savings & Investment. Your needs might include Replacement income or final expenses. Your goals may be a College education for your children/grandchildren or funding a favorite charity or endowment.
We work with several Fee Only Financial Advisors and recommend our clients consult with theirs to develop a needs assessment. If you don’t have one, contact us. We’d be happy to recommend a few! Once we have this list, we work with you to understand your order of importance of each. That’s Step 1.
Next, Step 2, we create a plan for each of the most important items identified in the above. Developing this plan starts with identifying the risks to each item.
Typical risks to your home are Fire and Lightning, Wind, and Flood while your Savings & Investments could be threatened by market corrections, liability lawsuits, critical illness, or even criminal charges.
Once the risks are identified, it’s necessary to evaluate the probability and consequence of each and every risk.
Probability is best defined as the ‘likelihood of occurrence‘ while my best definition of Consequence is the ‘impact of an event measured in the cost to restore the prior value of your asset‘.
It’s important to understand probability NEVER changes. The fact that an event has never occurred before, doesn’t decrease it’s likelihood of occurring. Conversely, the recent occurrence of an event does not increase it’s probability of occurring again. Think of it as a coin toss. Because there are 2 sides to a coin, the chances of a coin toss coming up heads is 50% each time time it’s tossed. While it’s possible to for it to come up ‘heads’ twice in a row, the probability remains the same for the subsequent tosses, 50%.
Another common mistake is to confuse the consequence with probability. Scary high consequence does not increase the probability of occurrence.
Lastly, it’s important to understand that consequence, the cost to restore the your prior value, is directly proportional to your net worth. A $100k lawsuit against you is a HIGH consequence if your net worth is only $1M, but it is much lower if you are Jeff Bezos.
Once these two risk factors are evaluated, you could plot them on a matrix like the one below.
Common, medium to large risks with medium to high probability should be addressed with an action. Mitigating HIGH consequence risks with a very LOW probability, like an alien invasion, are unrealistic and expensive to address, while very LOW consequence HIGH probabilities are easy to address but not cost effective. It’s like purchasing a $15 warranty on a $100 microwave. That’s Step 3.
There are 4 methods commonly used to manage risk. Avoidance, Reduction, Retention, and Transfer
For example, here are some options for managing the risk of an auto accident that should be :
- You might chose to avoid the risk of an auto accident by taking an Uber.
- You could reduce the risk by only driving on weekend and avoiding traffic.
- You could retain the risk by depositing $40k with the Texas Department of Insurance and self insure.
- You could transfer the risk by purchasing an auto insurance policy
Identifying the most cost effective solution is Step 4.
Step 5 includes using an independent agent to transfer as many risks that are affordable and avoiding, reducing or retain the others.
The last step, Step 6, is a periodic or annual reassessment of your plan with your trusted independent insurance agent and financial advisor. Meet with your financial advisor to reassess your net worth, your needs and your goals.
Finally, meet with your independent insurance agent to review your policies current policies for appropriate coverage and better rates.
Call us today at (832)554-9815 or book some time on our calendar today and let’s get to know each other.
All the best,