What Do The California Wildfires Have to Do With Risk Management?

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Risk: noun, “the potential of gaining or losing something of value. Values can be gained or lost when taking risk resulting from a given action or inaction” Wikipedia goes on to say the Oxford dictionary definition; “risk is an uncertain event or condition that, if it occurs, has an effect on at least one objective.”

Understanding and Managing Risks Can be the Difference Between Financial Security and Disaster

When I woke up last Monday morning and went through my regular morning routine, I noticed that the local news didn’t end when the Today show came on. As I listened in shock, the news anchor was telling us about the horrific fires raging in wine country. It seemed so surreal. I hadn’t watched the news the night before as I had gone to bed early, so I had no indication that fires had started.

The pictures of exploding trees, cars fleeing and structures burning were to become the background for days. Even though we were more than 20 miles from the closest fire, the air was so thick with smoke and ash that, if you didn’t wear a breathing mask, your eyes would burn, your lungs would hurt and your throat would be so sore speaking became a challenge.

As the week wore on, there were more and more interviews with people who were displaced into evacuation shelters, many of whom had lost everything they owned. As I listened to these people discuss what had happened and their outlook for their future, I was struck by the difference in outlook from those who were confident in their ability to rebuild and resume their lives and those who’s faces were filled with fear and anxiety because they didn’t know where they would end up and how they would rebuild their lives. In many cases, those people who were anxious and afraid admitted they didn’t have fire insurance and had lost their home and all of their possessions. It didn’t matter if they were renters or owned their home; the look of devastation was the same.

So, how do these devastating fires relate to your financial security?  For some time now, I have felt that anticipating and managing risk is the single most important task in planning one’s finances. Often it is the difference between a situation being a bump in the road and catastrophe. If you never get sick or injured, not having health insurance is no big deal. If your house never burns down, not having fire insurance is no big deal. If the stock market never drops, it doesn’t matter what stocks you own. I used to say that “there is no risk, until there is.” After all, tech stocks only went up in 1999, home prices only went up in 2006, so there was no risk…….until everything changed.

Charles Bitello of Pension Partners sums my feelings up nicely: “The absence of risk, does not mean the elimination of risk, just as if the absence of rain does not mean there will never be another storm”.

We know that things are coming, yet we fail to make a plan that would make things easier, more secure and less disruptive if we have a plan to deal with things when they happen. The old saying “out of sight out of mind” is based on this element of human nature.

In fact, there is a new school of economics; called Behavioral Economics, based on our in bred bias to believe what is currently happening is going to continue forever. Hence the headlines in 2008 “Dow is going to 1,000” when the market was going down. These days I am seeing “Dow Jones average will be 30,000, 40,000 or higher!” Although we know that the stock market goes up and down, the longer it goes in one direction, the more likely folks are to forget about movement in the opposite direction.

We hear about this phenomenon after natural disasters all the time. The person who won’t evacuate because they didn’t lose their home last time or there is no fire in the neighborhood now, so I won’t leave have made logical decisions based on their immediate circumstances and their historical personal experience. Intellectually, they know people die in these situations, but it couldn’t possibly be them or it would have happened already.

Today, we are enjoying one of the longest uninterrupted stock market rallies of all time. For nine years this market has been going up without a normal correction. As a result, many people I talk to no longer think another upheaval like the one we had in 2008 could happen again. “I made 15% last year, why would I change anything?”, is a response I am hearing more and more.

All of the traditional measurements of optimism are setting records. There is very little fear in the market (as indicated by the VIX market indicator), individual investors are becoming more bullish (as measured by the American Association of Individual Investors bullish consensus), even as logic would suggest that a significant market correction would happen at some point. When I get asked what I think about the market, people don’t want to prepare for the inevitable drop, even though they agree it is likely to happen at some point.

What Your Financial Planner Should Be Telling You

Well, as a planner, my responsibility is to figure out what can go wrong and help clients to have a contingency plan in case those things go wrong. See, nobody offers you an investment suggestion by saying “you could lose half your money in the next 6 months,” instead they will be talking about the “potential to double your money over the next 5 years,” and so that is what we focus on.

When I work with a financial planning client, one of the things we do is a risk assessment. We go through their insurance coverages to figure out what risks they can accept and which they cannot. For example, losing your entire house and contents would have a huge financial impact on most people, but if a neighbor’s kid threw a ball and broke your window, you could probably afford to fix that yourself, with very minimal long term financial impact. For many people their coverage is backwards. They have a low deductible, which will increase premium, even though they could easily afford a higher deductible and may reduce the replacement cost of the house because they think that they will never have a “total loss.”

Why This Matters!

Take for example what one of my clients did after we completed his financial risk assessment meeting — He increased his replacement costs and code upgrade coverages and raised his deductible which actually caused his overall premium cost to go down.

Four months later, we experienced the Oakland hills fire and his home was burned to the ground, a total loss. If you lived in the Bay Area at that time, you know how terrible the damage was. Over 3,000 homes were destroyed and many people were very unhappy with their insurance outcomes. There was years of litigation over claims, most with a very large, well known company that had the most policies in the burn area.

My client’s coverage was with the same company that many were suing, but my client came into my office two weeks after the fire holding a check for $475,000 to rebuild his home. He was very happy. Then a week later, he skipped into my office with another check for $360,000, as the policy provided for contents at 75% of the building replacement cost, if there was a total loss. He wasn’t just happy, he was ecstatic!

Since we are exposed to risks all day, every day; this becomes a very important exercise. Think about the things that would have potentially ruinous outcomes if they happened. What if you got sick and had no health insurance? You could get stuck for hundreds of thousands or more in costs; would that have an impact on your financial security? How about a 60% market drop like in 2007-2009? What if you needed assistance with activities of daily living like getting dressed or getting out of a chair? Full time home assistance can run $50-100,000 or more a year! How long could you pay that without worry? See, these are all risks that could result in financial devastation. Unreimbursed costs for health and custodial care are the biggest reason people go bankrupt or lose their homes.

Here are some risks to consider in order for you to avoid a personal disaster:

1. Take inventory. What do you own? What can you afford to replace, and what can’t you afford?
2. What assets do you have available? If I only have $10,000 in the bank, I probably couldn’t afford to replace all my stuff.
3. Review your insurance coverages after doing step one and two. Call your agent and sit down to discuss your options.
4. How is your health? What is your family history for health? Do I have a strategy that guarantees I won’t run out of money?
5. Evaluate and quantify potential large expenses. Will I be remodeling, buying a car, or paying for school?
6. What are my tax liabilities? Do I have a lot of tax deferred assets (appreciated stocks or real estate, retirement plan balances, etc.) that will increase my tax burden?
7. If markets change, how much exposure do I have to potential losses? Some of the highest flyers when things are good are often the biggest losers when markets change.
8. Is there any reason I may have to move in the future? If your house is on multiple levels, will you be able to go from the living room to the kitchen to the bedroom as I age?
9. Will I have to care for a parent or child who is disabled or can’t care for themselves physically, financially or emotionally?

These are but a few of the risks that you should address to make sure your future is secure and your retirement is relaxed, happy and care free. If you have a business, an extended family or other potential issues that will bring other considerations into the picture, you must include them in this exercise. Once you have identified all of your potential risks, then take that inventory and create contingencies that address each of them, should they occur. This will build your confidence and peace of mind because you are ready.

You Can Protect Yourself Now and For the Future

I hope I have expressed how important this issue is for your security and happiness. When the fires hit, Davi and I went through the house and identified what we would take, and each packed a bag for the car, even though the fires were miles away. We knew if the call to evacuate came, we probably would not be thinking clearly and would have little time to react, so that preparation helped us relax and be confident that we could handle the fire if it came. If this idea seems overwhelming to you, give us a call and we can help you break these issues down into bite sized pieces. No matter what, please take the time now, before the risk turns into imminent danger.
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