Michael and Marry are a married couple. They come to you for some financial advice. They are mostly concerned about accumulating sufficient wealth for their retirement, while at the same time living a relatively comfortable life and providing the highest possible education for their two sons. Michael and Marry own an organic health food store in South Yarra. The business is set up as a partnership. Although their revenues are relatively high at the moment, they are currently managing to operate the business without the help of any additional employees. Although both Marry and Michael are partners (and therefore owners of the shop), Michael is taking all responsibilities in terms of operating the business himself. Marry looks after the house and their two children. She feels that if Michael was not around, she would need to close the shop as she doesn’t feel capable of running it herself. After conducting in-depth interviews with the couple you derive the following information: 1. Expenses Mortgage payments (see following page) 28,700 Rates 2,000 Household (food, clothes) 49,000 Utilities (telephone, electricity, gas, water) 7,000 Car running expenses 3,000 Entertainment 15,500 Annual holidays 10,000 Work related 3,000 2. Assets and liabilities – expected as at 30 September 2014: Assets:
Item Cost and year of purchase Expected value - 30.9.2014 Family home $580,000 March 2003 $700,000 Cars (2 vehicles) $100,000 House contents $90,000 $100,000
Woolworths - 1,000 $8,000 – $34,000 shares March 2001
Incitec Pivot - 15,000
shares $93,300 - $46,000 February 2008
Westpac Bank - 650 shares
$15,184 - November 2010 $20,000 Savings account with $200,000 Westpac Bank Superannuation $250,000 -conservative fund Superannuation $50,000 -conservative fund
Liabilities: Item Amount Annual repayments – Interest rate outstanding includes principle and interest House mortgage $310,000 $28,700 6.5% p.a. -20 year Credit Card $8,000 - 18.75%
The couple’s two sons are expected to start school when they turn 6. Their older son (Frank) is currently 5 years old, while their younger son (James) is currently 3 years old. You estimate that the cost of schooling at primary school level (first 6 years of schooling) will be $10,000 pa. per child, whilst the cost of schooling at secondary level (further 6 years) will be $20,000 pa. per child. In addition to providing for their schooling, the couple also would like to be able to provide an allowance for each child between the ages of 18-25 of $10,000 pa. per child. Additional information: x You can ignore the impact of inflation when making the necessary calculations. This means that when making projections about the future, you do not need to adjust the anticipated expenses by inflation. x You can assume a market interest rate of 7.5%. x You can assume that in case of one of the couple dying prematurely, the living expenses will go down by 25%.
x You can assume that funeral and final medical expenses are $15,000. x Michael and Marry intend to retire in 25 years, at which time they will live from their accumulated superannuation moneys. Required 1. Identify the potential losses the couple are exposed to. In your answer divide the potential losses into property losses, personal losses, and liability losses. Quantify these loss exposures (note: you do not need to quantify the liability losses). 2. If Michael were to be disabled, the additional cost of maintaining him would be $20,000 pa. (for the next 25 years). How would your evaluation of the personal loss exposure from Question 1 change if you were to take disability rather than death into account? 3. Discuss the techniques available to Michael and Marry which could be used to manage their risk exposure. Discuss the different options open to them including the benefits and weaknesses of each. 4. Discuss some specific insurance products which could be used to manage the couple’s risk exposure. Your discussion should include a justification why a specific type of insurance product is appropriate given the couple’s circumstances. 5. Michael and Marry are skeptical about the idea of paying a high premium on a periodic basis for protection against losses which are unlikely to eventuate. Explain to the couple why managing risk exposures effectively is an essential element of their financial strategy. Also, suggest some ways in which their insurance premiums can be reduced (note: you should provide how changes to insurance contract terms could be used to lower the premium).