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Volume 15, Issue 3

Insurance: A Method for Managing Risk

An unexpected occurrence, such as a death, disability, or other personal loss, is certainly not something for which you can easily plan. Yet, the financial ramifications can be staggering—not only to you, but to your family, as well. Therefore, it is important to make a personal risk management plan part of your overall financial strategy.

Insurance, in all its varied forms, is simply a method for managing risk. In order to plan an effective insurance program, consider what risks you and your family are exposed to and how financial loss would affect you. For each risk exposure, the key elements to consider are the severity and frequency of loss.

All Risks are not Created Equal

Some risks may be so small that you decide to accept full responsibility for any potential loss. In insurance language, you “self-insure” for such risks. For example, it is rarely cost-effective to carry collision coverage on a ten-year-old automobile. Collision coverage generally pays actual cash value, and since a ten-year-old car may have little current fair market value (FMV), it is common to self-insure in such cases. In making this choice, you assume full responsibility for any accidental damage you may cause to the vehicle.

In other situations, the risk may be so large (or the cost of any potential loss so great) that the best strategy is to try to avoid the risk entirely. You practice risk avoidance in daily life when you say something is “not worth the risk.”

Sometimes, risk can be reduced. For example, installing an automobile anti-theft device or home security system is a strategy for reducing the risk of loss.

Risk Transfer and Risk Sharing

Buying insurance coverage is a method of transferring risk you cannot afford, or choose not to accept. Even in situations of risk transfer, it is common to share some risk. For example, the deductibles and premiums you pay for insurance are a form of risk sharing—you accept responsibility for a small portion of the risk, while transferring the larger portion of the risk to the insurer.

Between the ages of 25 to 35, for example, couples are just starting out—getting married, establishing families and careers. During these years, the death of one partner could seriously jeopardize the surviving spouse’s or family’s financial future. In such situations, life insurance can be used to help create an “instant estate.” A life insurance policy death benefit can be a source of funds to help provide a continuing source of income, pay off a mortgage,or save for a child’s education.

Additionally, many people give little thought to how they would handle financial responsibilities, such as mortgage payments, car payments, college tuition, and utility expenses, if their income suddenly stopped for an extended period of time due to an illness or disability. Disability income insurance can help fill the financial void that occurs when income stops, and proceeds can be used to keep up with ongoing expenses.

Furthermore, since you may be unable to afford to rebuild your home in the event of fire, for example, you may choose to transfer that risk to an insurer by purchasing a homeowners policy.

Taking a closer look at different types of risk that may occur can help you answer some important questions. What should I insure? What type of insurance do I need? How much coverage should I purchase? Remember, the fundamental rationale behind all forms of insurance is to determine what risks can be transferred on a cost-effective basis.

Credit Problems May Hinder Job Search

When you are searching for a job, demonstrating relevant experience and acing the interview are important. But, they may not be enough to secure the position. Regardless of the type of job you are seeking, you could be turned down by an employer if you bounced some checks or were late in paying your bills. Concerned about theft and liability issues, growing numbers of employers are running credit and other background checks on job candidates before making offers of employment.

Employers are permitted by law, with some restrictions, to conduct background checks on job candidates during the hiring process and when evaluating current employees for promotion, reassignment, and retention. In an effort to minimize their own risk for theft and liability, it is increasingly common for employers to compile a consumer report detailing a job candidate’s personal and credit characteristics.

While screening job candidates for credit problems has long been routine in banking and financial services, the practice is now spreading to other industries. A 2006 survey of U.S. employers by recruiting firm Spherion showed a 55% increase in the use of credit checks during the hiring process over the previous five years.

Why do employers investigate a job candidate’s credit history? Some employers may be concerned that an employee with financial problems may be tempted to steal, especially if the employee handles money. Depending on the position, employers may also view an employee who is under financial pressure as a security risk, subject to bribery and vulnerable to offers from competitors trying to buy confidential information. In addition, employers may view a history of bad credit as a sign of irresponsibility that could be indicative of the candidate’s future job performance.

Before embarking on your job search, request copies of your credit report from the three nationwide consumer credit reporting companies: Equifax, Experian, and TransUnion. With identity theft on the rise, it has become more important to remain vigilant about your personal credit records. You are entitled under Federal law to request one free credit report a year from each of these credit bureaus. To order your reports, call the Annual Credit Report Request Service at 1-877-322-8228, or go to www.annualcreditreport.com.

When you receive your reports, check for any mistakes that might negatively affect your credit score. Common errors that can appear on a credit report include mistakes involving your name or a similar name, inclusion of someone else’s credit problems in your file, incorrect balances on current credit accounts, closed accounts listed as current, accounts of ex-spouses still listed with yours, and an inaccurate Social Security number.

Notify the credit reporting agency that issued the report of any information you believe to be incorrect.The agency is then required to reinvestigate and, subsequently, confirm, correct, or delete the information. Even if the reinvestigation shows the information to be accurate, you may add brief explanations of extenuating circumstances to your reports.

If, however, your credit report reveals some legitimate problems, you may have time to repair some of the damage before you begin your job search. While most negative information can be reported for seven years, you may be able to improve your score by paying off outstanding debt, taking on no additional debt, and paying your bills in a timely manner.

Under the Fair Credit Reporting Act (FCRA), the employer must obtain written authorization from the job candidate before requesting information on the candidate’s credit history from a consumer credit reporting company, and the employer must notify the candidate if information contained in the report results in an adverse employment decision.

If a prospective employer requests permission to review your credit history, you are within your rights to refuse to sign the authorization. But, this would likely jeopardize your chances of getting the job. Therefore, a better approach may be to tell the employer up front about any credit problems you believe may be revealed by your report. You may be able to explain, for example,that your financial difficulties were the result of exceptional circumstances, such as a divorce, a medical crisis, or a period of unemployment. The employer may be willing to overlook a bad credit report if you are otherwise qualified for the position and are open and honest about your situation.

Understanding the Consumer Price Index

The highs and lows of the economy affect people and markets in a variety of ways. While some sectors may be thriving, others may be sluggish. One economic indicator used to gauge the state of the American economy is the Consumer Price Index (CPI), which measures the rate of inflation in the U.S.

Inflation, which is defined as a rise in the average price level of all goods and services, can have a significant impact on the American economy and your financial affairs. Understanding the CPI, and the ways it measures inflation, can provide a strong foundation for understanding not only market and economic swings, but also the ways in which fiscal and monetary policies affect America’s finances, as well as your own. Let’s take a look at the information used by the U.S. Bureau of Labor Statistics (BLS) to compile CPI data.

Determining the Market Basket

Each month, the BLS surveys prices for a “market basket” of goods and services in order to create an economic “snapshot” of the average consumer’s spending, which is quantified as the CPI. Actual expenditures are classified into more than 200 categories and eight major groups. These include the following:

  • Food and Beverages: common groceries, alcoholic beverages, and full-service meals
  • Housing: rent, furniture, and utilities
  • Apparel: clothing, shoes, and jewelry
  • Transportation: vehicle lease and purchase costs, gasoline, auto insurance, and airfare costs
  • Medical Care: doctor’s visits, hospital care, and prescriptions
  • Recreation: cable television, pets, events, and sporting equipment
  • Education and Communication: school tuition, postage, telephone service, and computer equipment
  • Other Goods and Services:tobacco, haircuts, personal services, and funeral expenses.

Because the CPI assesses expenditures in these fixed categories, the CPI is a valuable tool for comparing the current prices of goods and services to prices last month or last year.

Interpreting and Using the CPI

As a measure of inflation, the CPI has three main functions. First, the CPI serves as an indication of the health of the economy and the effectiveness of government policy. To a certain extent, some inflation indicates a healthy economy; however, too much inflation, or no inflation at all, can indicate economic trouble. In fact, one of the primary U.S. economic policy goals is to maintain an inflation rate ranging from 1% to 3% each year.

If there are constant fluctuations in the CPI, Congress and the Federal Reserve Board (the Fed) will take measures to control the amount of inflation and stimulate economic growth. As a result, business executives, labor leaders, and private citizens may change their spending and saving patterns. For example, the Fed may attempt to curb rising inflation by raising short-term interest rates; this increase in the cost of borrowing money is likely to slow personal and business spending. Conversely, if the economy is not growing, the Fed may attempt to stimulate growth by lowering short-term interest rates. Lowering the cost of borrowing may trigger increased spending among businesses and individuals.

As a second function, the CPI helps determine the “real” value of a dollar over time by removing the effects of inflation. As prices increase, the purchasing power of a dollar decreases. Thus, more dollars are needed to purchase the same amount of goods and services. Comparing inflation-free wages and prices allows economists to determine the actual earning and spending patterns of the American consumer, including what percentages of money are being saved or spent in certain areas.

Lastly, the CPI is used as a means of adjusting salaries and government benefits to account for price changes. For example, as a result of collective bargaining agreements, the wages of over 2 million workers increase according to the amount of change in the CPI. The CPI is also used to determine the benefits of almost 80 million people covered under government programs, including Social Security beneficiaries, military and Federal Civil Service retirees and survivors, and food stamp recipients. In addition, changes in the CPI can be seen in the price of school lunches, as well as through rents, royalties, alimony payments, and child support payments as determined by private firms and individuals. Finally, the CPI has been used to adjust the Federal income tax structure to prevent increases in taxes caused solely by inflation.

For More Information

Inflation can have a serious impact on the American economy as it affects both government policy and the spending and saving patterns of businesses and individuals. Understanding and following changes in the CPI can help you understand how the value of the dollar changes and estimate how inflation may affect your future plans. The U.S. Department of Labor (DOL) publishes current information on the CPI each month through the BLS. For more information, visit their website at www.bls.gov/cpi.

The information contained in this newsletter is not written or intended as tax, legal, or financial advice and may not be relied on for purposes of avoiding any Federal tax penalties. Entities or persons distributing this information are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel.

The information contained in this newsletter is for general use and it is not intended to cover all aspects of a particular matter. While we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. Therefore, information should be relied upon only when coordinated with professional tax and financial advice. The publisher is not engaged in rendering legal, accounting, or financial advice. Neither the information presented nor any opinion expressed constitutes a representation by us or a solicitation of the purchase or sale of any securities. This newsletter is written and published by Liberty Publishing, Inc., Beverly, MA, COPYRIGHT 2009.



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