Risk Management and Insurance

It may seem surprising that the term risk heard so frequently in casual conversations and in discussions with financial professionals, has no single, widely accepted definition. However, all definitions share the concept of uncertainty. From the perspective of the individual, uncertainty arises for two reasons. First, even though the probability of occurrence can be predicted for a group (e.g., the risk of death at a specific age), its timing cannot be predicted for an individual. Second, even though the average loss from an event’s occurrence may be estimated, variations in actual losses across individuals will occur. Thus, the risk of retired-life events can be considered in two parts; (1) the probability of occurrence, and (2) the loss associated with an event’s occurrence.

A review of the pattern and economic costs of post-retirement risks suggests that retirement income distributions may not be well matched to the risks faced in the post-retirement years. Social Security benefits are paid to couples as a family, and reflect the work history of both members of the couple. In addition, benefits are continued to the surviving spouse. These benefits are indexed to provide increases linked to increases in living costs. Private pension benefits may be distributed in one of several forms: as a lump sum, as a level income, as an indexed income, and as an income with continued payment to a survivor after one of the annuitants dies. None of these forms has any component linked to changing consumption needs. Insurance can help provide security and help protect against some changing needs, but it does not offer a perfect solution.