Tiêu đề LM5 Risk Management for Individuals IFT Notes.pdf ✅

LM5 Risk Management for Individuals 2024 Level III Notes © IFT. All rights reserved 1 LM5 Risk Management for Individuals 1. Introduction .......................................................................................................................................................3 2. Human Capital, Financial Capital, and Economic Net Worth ..........................................................3 Human Capital ..................................................................................................................................................3 Financial Capital...............................................................................................................................................4 Economic Net Wealth.....................................................................................................................................6 3. A Framework for Individual Risk Management ...................................................................................6 The Risk Management Strategy for Individuals ..................................................................................6 Financial Stages of Life..................................................................................................................................7 4. The Individual Balance Sheet ......................................................................................................................8 5. Individual Risk Exposures ......................................................................................................................... 11 6. Life Insurance: Uses, Types, and Elements.......................................................................................... 13 Life Insurance ................................................................................................................................................ 13 7. Life Insurance Pricing, Policy Cost and Amount Needed............................................................... 16 8. Other Types of Insurance........................................................................................................................... 21 Property Insurance...................................................................................................................................... 22 Health/Medical Insurance ........................................................................................................................ 23 Liability Insurance ....................................................................................................................................... 24 Other Types of Insurance .......................................................................................................................... 24 9. Annuities: Types, Structure and Classification .................................................................................. 24 10. Advantages and Disadvantages of Fixed and Variable Annuities ............................................ 27 11. Risk Management Implementation...................................................................................................... 30 Determining the Optimal Risk Management Strategy ................................................................... 30 Analyzing an Insurance Program........................................................................................................... 31 12. The Effect of Human Capital on Asset Allocation and Risk Reduction................................... 34 Asset Allocation and Risk Reduction ................................................................................................... 36 Summary ............................................................................................................................................................... 38 Appendix A: Life Insurance Calculations .................................................................................................. 43 This document should be read in conjunction with the corresponding reading in the 2024 Level III CFA® Program curriculum. Some of the graphs, charts, tables, examples, and figures are copyright
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LM5 Risk Management for Individuals 2024 Level III Notes © IFT. All rights reserved 3 1. Introduction This reading covers risk management for individuals. Section 2 outlines the concepts of human and financial capital. Sections 3-5 present a framework for individual risk management. Sections 6-10 describe insurance and annuity products that can help individuals manage their risk. Sections 11-12 discuss the implementation of risk management. 2. Human Capital, Financial Capital, and Economic Net Worth An individual’s overall wealth has two primary components, human capital, and financial capital. Human Capital Human capital is the “mortality-weighted net present value (NPV) of future expected labor income”. In simple terms, it’s the present value of future cash flows which an individual is expected to generate from his labor income until he retires. Human capital is a significant part of most working households’ total wealth portfolio. From a risk management perspective, it is important to understand the following: 1. The approximate total monetary value of an individual’s human capital. 2. The investment characteristics of an individual’s human capital, i.e. whether human capital is stock-like (in case of an equity trader) or whether it is bond-like (in case of a university professor). 3. The relationship between the value of an individual’s human capital and the value of his financial capital. Human capital can be estimated by using the following expression: In the above expression, HCo is the value of human capital today, wt is the income from employment, r is the appropriate discount rate and N is the length of working life in years. If a person is expected to retire after three years, then the value of his human capital can simply be estimated by discounting his wages for the next three years using an appropriate discount rate and the aggregate of these PVs will be the total monetary value of his human capital. To refine our estimation further, elements such as probability of survival “p(st)”, annual wage growth rate “gt”, and occupational income volatility “y” can be added to arrive at a more accurate estimate for the value of human capital. ( ) 0 1 1 N t t t w HC = r = + 
LM5 Risk Management for Individuals 2024 Level III Notes © IFT. All rights reserved 4 Example: Estimating the Present Value of Human Capital (This is Example 1 from the curriculum.) John Adam is 60 years old and plans on retiring in 5 years. Adam’s annual wage is currently $50,000 and is expected to grow 2% per year. The risk-free rate is 4%. Adam works in a job with a moderate degree of occupational risk; therefore, we assume a risk adjustment based on occupational income volatility of 3%. There is a 99% probability that Adam survives the first year, a 98% probability that he survives the second year, and probabilities of 98%, 97%, and 96% for the following years, respectively. Given this information, what is the present value of Adam’s human capital? Solution: The first step is to calculate the relevant discount rate which is the risk-free rate plus the income volatility adjustment: 4% + 3% = 7% = 0.07. Also recognize that the income growth rate is 2%. Hence the income at the end of Year 1 will be 50,000 x 1.02, income at the end of Year 2 will be 50,000 x 1.022, and so on. Year 1: PV of annual wages = ($50,000 x 1.02)/1.07 = $47,664 Mortality-weighted PV of wages = $47,664 x 99% = $47,187. Year 2: PV of annual wages = ($50,000 x 1.022)/1.072 = $45,436 Mortality-weighted PV of wages = $45,436 x 98% = $44,527. Year 3: PV of annual wages = ($50,000 x 1.023)/1.073 = $43,313 Mortality-weighted PV of wages = $43,313 x 98% = $42,447. Year 4: PV of annual wages = ($50,000 x 1.024)/1.074 = $41,289 Mortality-weighted PV of wages = $41,289 x 97% = $40,050. Year 5: PV of annual wages = ($50,000 x 1.025)/1.075 = $39,359 Mortality-weighted PV of wages = $39,359 x 96% = $37,785. Total value of human capital = $47,187 + $44,527 + $42,447 + $40,050 + $37,785 = $211,996. Financial Capital Financial capital can be categorized as tangible versus intangible, or current versus non- current, but the most important categorization in the context of this reading is personal versus investment assets. Personal assets are: • assets an individual consumes or uses in some form, such as a car, furniture, etc. ( ) ( ) ( ) 1 0 1 1 1 N t t t t t f p s w g HC r y − = + = + + 