Personal insurances: The risk probability/impact matrix

A vital part of wealth accumulation is putting appropriate strategies in place to manage risk. Importantly, this can involve multiple areas of your personal finances, for example, superannuation (e.g. retirement planning), investments (e.g. diversification and dollar-cost averaging), insurance planning (e.g. general and personal insurances) and estate planning (e.g. will and powers of attorney).

In this article, we focus in on personal insurances and the management of certain lifetime risks through the lens of the risk probability/impact matrix.

The risk probability/impact matrix
The risk probability/impact matrix (the matrix) is a common tool used in risk management circles. In summary, the matrix is a framework to understand whether a certain risk may or may not require action from a risk management perspective. The matrix consists of two main components:

  • Probability, the likelihood of a risk occurring, e.g. rare, unlikely, moderate, likely, or very likely.
  • Impact, the consequence severity (financial and/or health-related) associated with a risk occurring, e.g. trivial, minor, moderate, major or extreme.

Furthermore, a risk that is identified and subsequently assessed against probability and impact is then assigned a risk grade, e.g. low, moderate, or high. Below is an example of what the matrix can look like:

The Risk Probability/Impact Matrix
  Impact
Probability Trivial Minor Moderate Major Extreme
Rare Low Low Low Medium Medium
Unlikely Low Low Medium Medium Medium
Moderate Low Medium Medium Medium High
Likely Medium Medium Medium High High
Very Likely Medium Medium High High High

With this in mind:

  • A risk that is assigned a low grade is often disregarded and managed via a risk retention strategy, i.e. you choose to retain the risk.
  • Whereas, a risk that is assigned a moderate to high grade becomes an actionable item through
    • A risk transfer strategy, i.e. you choose to share the risk with a third party, such as an insurance company (upon which they conduct their own risk assessment).
    • And/or a risk reduction or avoidance strategy, i.e. you choose to mitigate the risk.

The personal insurance perspective
With consideration of above, let’s look at some information pertaining to risks of a health-related nature, the probability/impact, and the action of a risk transfer strategy via personal insurances.

Risk probability (general focus)
When it comes to claiming and your personal insurances, have you ever wondered what the ‘risk probability’ is with regards to any of the following?

  • How long am I likely to live?
  • What is the probability of claiming on a personal insurance policy?
  • What is the lifetime risk of being diagnosed with cancer?

In the below tables, we look at answers to these questions (as well as a few others) through the results pertaining to a male and female, both aged 30. Please note: Whilst elements such as gender and age are taken into account, other lifestyle factors such as exercise, smoking and alcohol consumption are not. Furthermore, these are statistical averages, which means that they may not be indicative of your own personal circumstances.

Risk Probability*

(Life, Trauma & TPD Insurance Focus)

Gender Current age Average life expectancy General probability of claiming on a policy by 65 Most likely factor to cause you a disability
Male 30 Age 82

27.96%:

3.49% chance of Life insurance claim

24.47% chance of Trauma & TPD insurance claim

72.04% chance of no claim

Sickness = 65%

Accident = 35%

 

Chance of disability lasting 3+ months = 37%

Female 30 Age 86

23.33%:

1.72% chance of Life insurance claim

21.61% chance of Trauma & TPD insurance claim

76.67% chance of no claim

Sickness = 83%

Accident = 17%

 

Chance of disability lasting 3+ months = 46%

Risk Probability*

(Cancer Focus)

Gender Current age Lifetime risk of acquiring cancer before 75 Relative survival rate for a cancer
Male 30

All cancers = 1 in 3

Breast = 1 in 1,477

Kidney = 1 in 78

Colorectal = 1 in 19

Lung = 1 in 26

Melanoma = 1 in 23

Non-Hodgkins Lymphoma = 1 in 59

Prostate = 1 in 7

Lung Cancer = 1-Year (74%) and 5-Year (44%)

Melanoma = 1-Year (97%) and 5-Year (94%)

Prostate = 1-Year (96%) and 5-Year (86%)

Colorectal = 1-Year (90%) and 5-Year (71%)

Female 30

All cancers = 1 in 4

Breast = 1 in 11

Kidney = 1 in 159

Uterus = 1 in 65

Colorectal = 1 in 28

Lung = 1 in 41

Melanoma = 1 in 33

Non-Hodgkins Lymphoma = 1 in 88

Lung Cancer = 1-Year (74%) and 5-Year (44%)

Melanoma = 1-Year (99%) and 5-Year (97%)

Breast = 1-Year (99%) and 5-Year (87%)

Colorectal = 1-Year (91%) and 5-Year (72%)

Risk impact (cancer focus as an example)
One of the important considerations regarding potential risks of a health-related nature is the risk impact to you and your household, especially from a financial impact perspective.

As can be seen from the above tables, cancer is a big one with a lifetime risk of diagnosis being 1 in 3 (male, aged 30) and 1 in 4 (female, aged 30). With this in mind, let’s look at the risk impact of cancer, which can be broken down into two main components, which when combined form the total expected lifetime economic cost of cancer:

  • The non-financial costs (but still financially quantifiable), i.e. burden of the disease (the pain, suffering and premature death that can result from being diagnosed with cancer).
  • The financial costs i.e.
    • Health system expenditures (hospital treatment, GP and specialist medical services, allied health services, medication, etc.)
    • Productivity/loss of income costs (work absenteeism/presenteeism, premature mortality, informal carer costs such as a spouse taking time off work to be a primary carer, etc.)
    • Transfer costs (taxation revenue forgone from work absenteeism for example, as well as income support payments, in the form of things, such as the Carer Payment/Allowance and the Disability Support Pension etc.)
    • Other financial costs (respite and palliative care, home modifications, community support programs, funeral costs, etc.).

Importantly, as you can see from above, cancer can have a financial impact beyond the direct costs of diagnosis, treatment etc. Furthermore, the associated costs can be borne by patients, friends and family, employers, Federal/State/Local governments, and others (not-for-profit organisations).

Although dated, but still insightful, a research paper by Access Economics highlighted the total expected lifetime economic cost of cancer per person in dollar terms, namely, $966,000 (the burden of disease is $851,600, and the financial cost is $114,500). Furthermore, due to the burden of the disease, it was noted that the patient often bears 93% of the total cost; however, only 40.4% of the financial cost is borne by the patient.

Please note: Despite the above quote, the total expected lifetime economic cost of cancer per person can vary according to many factors. For example, but not limited to the following:

  • The type of cancer (as seen in the below table) as well as the stage of the cancer upon diagnosis.
  • Whether diagnosis, treatment and survival are undertaken in the public or private system (where out-of-pocket costs can vary considerably).
  • And, if a person lives in a rural or remote area (access to care, as well as transport and accommodation costs).

Lifetime Economic Cost of Cancer, NSW, 2005*

($Per Person)

Cancer Burden of disease Financial cost Total economic cost
Melanoma 359,700 32,100 391,800
Colorectal 855,600 101,600 957,200
Prostate 405,800 64,800 470,600
Breast 589,300 64,300 653,600
Lung 1,619,700 132,200 1,751,900
Non-Hodgkin’s Lymphoma 1,050,600 167,200 1,217,800
Leukaemia 1,194,800 258,800 1,453,600
Bladder 734,700 78,800 813,500
Kidney 863,000 114,100 977,100
Stomach, Liver and Pancreatic 1,517,600 158,800 1,676,300
Uterine, Ovarian and Cervical 911,100 90,700 1,001,800
Brain 1,566,300 325,600 1,891,900
Head, Neck and Thyroid 1,107,300 163,300 1,270,500
Other 836,500 185,300 1,021,800
All Cancers 851,600 114,500 966,000

*Access Economics. (2007). Cost of Cancer in NSW: A report by Access Economics Pty Ltd for The Cancer Council NSW.

Risk transfer (personal insurances)
When it comes to risks of a health-related nature, there can be the avenue to undertake strategies, such as risk retention (leveraging off sick leave/annual leave entitlements, redraw facility, savings etc.) and risk reduction (focusing on modifiable risk factors, such as smoking, physical inactivity, diet, stress and alcohol).

Despite this, given the risk probability/impact matrix, risk transfer strategies may also need to be an important consideration due to the finite (financial) resources at your disposal and the common unexpectedness of risks of a health-related nature. Consequently, although we have focused on cancer, personal insurances are frequently implemented to manage the often moderate to high financial impact that can result from an unexpected passing, a traumatic event or a disabling sickness or injury.

As such, appropriately established personal insurances, whilst sometimes seen as a ‘grudge purchase’, can hold an important place in terms of wealth accumulation and the management of certain lifetime risks.

Moving forward
Although a somewhat daunting and confronting look at personal insurances from a risk management perspective, it hopefully helps to highlight the value that can be derived from personal insurances.

If you would like to discuss anything in this article, then please contact us.