Risk Management- The Five Step Process

by Geoffrey Sgarbossa, CFP, RIS, CD Wealth Advisor Keill & Associates- Advisory Team

Murphy’s Law is a very optimistic law, stating that if anything can go wrong, it will.

Risk is an unavoidable reality, apparent in all facets of life. By sheer force of luck, some folks go through life avoiding every available catastrophe, blissfully unaware of how many times, today alone, their life was “this close” to changing forever. Others are not so lucky, and Murphy tends to crash every party. Life is not fair, and luck tends to run out for us all eventually.

For the most part, managing risk can be a rather intuitive process that, to some degree, we all do it daily whether we realize it or not. Sometimes we do it of our own accord by putting up baby gates before the new baby begins to crawl. Other times, we are forced to do it by imposition of law to wear your seat belt when driving a car as an example.. Risk, and risk management strategies are inherent in everything we do. By implementing a systematic process to help us identify what risks we may be exposed to, we can then start to identify probability and the severity of a thing happening and come up with a plan to handle those things if/when they come to pass.

While topics in this discussion paper will be looked at through a financial lens, this process can be used to identify and mange risks in all areas of your life- both professionally and personally. The risk management process can be broken down into 5 steps. Let’s explore these steps now.

Step One: Setting risk management objectives

Most people seek the help of a financial planner because they have identified a risk management objective and are not sure how to address it. Common examples of this could be:

• Will we have enough money in retirement? How do we avoid outliving our money? I am the only income earner.

• Will my family be ok if I die prematurely?

• Will we be ok if I become disabled due to accident or illness?

• Will we be ok if there is a substantial market correction, or a class action lawsuit and/or a company goes bankrupt?

  
  

Step Two: Identifying and evaluating risks

Next, we need to define what risks may be present, the probability of an event occurring, and the severity of the consequences should it happen. This severity of outcome can be broken down into 3 levels.

• Catastrophic Consequences are those that could result in significant financial losses, generally leading to the disposition of most or all assets and thereby damaging your quality of life.

• Substantial Consequences are when the individual or family would face serious financial difficulties that lead to a reduced quality of life; and

• Minor Consequences are those where the potential loss is very low with little risk of affecting overall quality of life.

  
  

  

  
  

Once we have identified the probability of a thing happening, and the severity of outcome, we can start those potential outcomes to help prioritize which risks we need to address first. It will also prove easier to determine how we are going to address each risk in step 3. Identified risks that fall at the top right of this graph should typically take priority and would be foolhardy to ignore, while risks that land bottom left might be less of a concern and lower priority.

Step Three: Selecting Strategies

Now that we have a clear picture of the various risks associated with a thing, we can now start to identify Risk Control and Risk Financing strategies.

Risk Control is intended to reduce the probability of a thing happening, and/or reduce the severity of consequence if it does happen.

• Risk avoidance- As the name implies, means avoiding the risk all together to eliminate the probability of a thing happening. High probability of a company going bankrupt and destroying your retirement savings? Don’t invest in that company! This may be obvious but is not always possible for a myriad of reasons. We need to save for retirement, so completely avoiding the activity to avoid the risk of a company disappearing, brings the same risk of not having enough money in retirement, but for a different reason! When we can’t completely avoid a risk, we can look at ways to reduce the probability and severity.

• Risk Reduction- When you are unable, or unwilling to completely avoid a risk, we can take steps to reduce the probability of a thing happening, and/or reduce the severity of consequence when it does. You may not be able to stop driving to work because you need to go to work! However working from home a couple days a week could help reduce the probability of an accident happening. Wearing your seatbelt and adding airbags will help reduce the severity of an accident when it does happen.

• Segregation- I’m sure you have heard the saying “don’t put all your eggs in one basket”. A well diversified portfolio will not reduce the probability of a company going bankrupt. However, adding many companies from different sectors and regions will reduce the severity when said company goes bankrupt.

Risk Financing involves strategies that assist in managing costs associated with a thing.

• Risk Transfer/Sharing can take many forms. Joint ownership of a rental property is a form of sharing the rental income, but also the risk if you get a bad tenant, or no tenant. We will get into this in more detail in another discussion paper, but risk sharing and transfer is the primary role of the various insurance policies available. Life Insurance will transfer the risk of premature death to an insurance company, in exchange for a monthly premium. Auto insurance will transfer the financial risk losing a mode of transportation, or getting sued in the case of an accident. A deductible on that insurance coverage will help to share the risk between you and the insurance company will handle the rest. The insurance company will typically offer coverage at a lower monthly rate the higher the deductible is because you are sharing more of the risk.

• Risk Retention is when you agree to retain the risk. If you carry substantial dental costs due to children needing braces, you can transfer/share the risks by purchasing dental insurance. If minor dental costs typically don’t exceed the couple hundred dollars a year on cleanings, then you may decide to retain the risk.

Step Four: Implementation

Even the best laid plans are of no use until the plan is implemented. Your planner has a professional responsibility to assist in scheduling the necessary steps and to work with you as needed. Depending on the complexity of the plan, there ma be considerable work, and many professional advisors required at this step.

Step Five: Monitoring Change is inevitable

No plan survives first contact is a common saying in the military. There must be periodic reviews to ensure the plans as implemented are still achieving the desired goal. This is a two way street! Financial products and services are always changing and evolving. If there is a change that materially affects our plans as implemented, the planner needs to reach out to review with the client. It is just as important that you reach out to your planner immediately when significant life events such as a loss of job, marriage, birth or death occurs. These life events will almost always require a revision to the plans.

Conclusion

When a financial professional utters the term ‘ risk management” the typical reaction is to steel yourself against the inevitable insurance sales pitch to follow! However, as we have seen here, actual product discussions are only a small fraction of the overall process. At Keill & Associates we truly believe that process and strategy lead product decision and not the other way around.

There are all sorts of benefits gained from a fully implemented and monitored plan. Reduced stress, stronger relationships, quicker reaction times to unfortunate events to name a few. If you are avoiding the entire risk management process because you don’t trust the advisor has your best interests at heart during one step of the process, then it is a good indicator that it may be time to find a new Wealth Advisor.

Murphy does not discriminate. At some point your luck will run out whether you’re ready for it or not, and oftentimes, it is our loved ones who pay the price for our inaction. Speak to one of our highly qualified Wealth Advisors at Keill & Associates to learn more about Risk Management in your life.

Disclaimer and Notice to Reader: This Discussion Paper should not be construed as legal or tax advice but rather only as a general statement and explanation of the topic matter. Professional tax and legal advice should be obtained for the readers own personal situation. For more information on this topic or how it applies to your family, please contact our Wealth Advisory team.

Last Edit Feb 3, 2025