Are Your Wealthy Clients at Risk with Mass-Market Insurance?

Journal of Financial Planning; March 2020

 

 

David M. Cordell, Ph.D., CFA, CFP®, CLU®, is director of finance programs at the University of Texas at Dallas.

Cliff Layfield, CIC, ARM, is vice president of IMA Select, where he specializes in working with families to develop cost-effective, personal risk management programs. He served as the 2012 president of FPA of Dallas/Fort Worth.

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Consider the client whose adult life and career started normally, but then they flourished and became wealthy. Now they own multiple homes, enjoy the lifestyle financial success can bring, and perhaps they even attract media attention. With increasing success, their financial planning needs evolve, too. They look beyond 401(k)s for a broader set of investment alternatives, and eventually they seek the help of a financial planner who can manage the complexity and scale of their financial needs.

Typically, though, financial planners have a distinct weakness in the area of property and casualty insurance. Their advice to clients is often to find a good insurance agent. And their clients’ insurance coverages frequently do not keep up with their prosperity. It is common to see even very successful clients clinging to policies and agents they obtained early in their careers when price was everything and quality and thoroughness of coverage were an afterthought or no thought at all. Failure to adjust coverages with the changing financial situation can leave successful clients dreadfully exposed.

Consider the actual case of a financial planner who took on new clients who had finished building a home that was then covered by a very large mass-market insurer for $6 million. The home was 22,000 square feet; the planner quickly recognized that the current coverage was far below actual replacement cost.

One of the authors of this column set up a meeting at the house on a Saturday morning and brought an appraiser from a high-net-worth insurance carrier to provide an accurate replacement cost. At the end of the process, replacement cost not $6 million; it was $14.5 million. The client had been paying a premium of $45,000 for only $6 million of coverage. The high-net-worth carrier offered a premium of $19,000 for $14.5 million of coverage—far more, and appropriate, coverage for far less money.

It is common for otherwise sophisticated clients to overpay and underinsure their assets, but it takes a recommendation from a trusted adviser, like you, to put the client on an optimal path.

Financial planners can help clients and simultaneously protect assets under management by developing a strong relationship with an insurance professional who is experienced in working with financially successful clients and who has excellent relationships with insurers that specialize in high-net-worth clients. The right professional knows the questions to ask and has the experience to provide creative solutions for the client to review. They commit to annual reviews to keep the program up to date and will be the client’s advocate with the carrier if a claim is necessary.

Sample Risk Exposures

Board work. Involvement in charities, foundations, and even neighborhood associations by your wealthy clients can expose them to liability. Of course, you should advise clients that, if they are asked to join a board, that they inquire about the organization’s liability coverage. Although such entities typically carry liability insurance, it is prudent to confirm that they really do. Your client should request a copy of the policy or certificate of insurance and share it with an insurance professional who is familiar with the types of issues that board service can raise and who is competent to evaluate whether the coverage is adequate. In jurisdictions in which “joint and several” liability applies, it is possible that the plaintiff could sue your client for the entire amount, and your client may have to sue the other board members for their portions.

Visibility. High personal and professional visibility has its potential perils, too. You may have seen clients whose wealth has increased exponentially because of a major liquidity event, such as an IPO, an inheritance, or a lottery win, yet their risk management program fails to evolve to meet their new risk profile. Their newfound success and accompanying visibility create a heightened risk profile.

Lifestyle. Lifestyle is another source of risk. Clients’ homes should be visited as part of the risk management process because issues such as swimming pools, trampolines, fishponds, private staff, jet skis, and even children are all factors in a comprehensive insurance program. The visit can often spot assets/exposures owned but not insured, such as art, antiques, wine collections, etc. We’re aware of a client who had a zip line in the back yard that he never thought to mention to his insurance agent. Zip lines are unlikely to be on a mass-market insurance questionnaire! Another client owned a trampoline that was outside of his fenced property. What’s more, it was under a tree; a visiting child could easily have hit his head on a limb or been tempted to try to grab onto a limb, with obvious potential pitfalls.

The son of one of the authors once had a backyard pool party for his middle-school friends. The author walked out to see how the party was going, only to see a visiting child standing on the edge of the roof, poised to make a long leap into the pool. Imagine the liability if the child had hit the stone pool deck and incurred a serious, permanent brain or spinal cord injury.

Homeowner’s insurance policies can vary dramatically, especially when luxury homes are involved. If the client has a severe loss, a mass-market carrier may pay only a portion of the repair/replacement costs. By contrast, a policy designed by a high-net-worth carrier often features loss provisions that allow replacement with the same quality that was originally in a luxury home. And a cash settlement option allows the client to take the cash rather than rebuild.

Similarly, a collections policy from a high-net-worth insurance carrier typically offers broader coverage and payment terms for valuable art and jewelry. Such treasured possessions are often unique, so they need more than generic mass-market insurance.

Staff. Wealthy clients often have full-time household staff members such as nannies, housekeepers, cooks, gardeners, etc. Often these employment relationships are informal and may not comply with employment regulations. Each of these relationships represents a potential problem with authorities and a potential lawsuit. A disgruntled employee, whether justified or not, may sue for sexual harassment, for example, and a fired employee may sue for wrongful termination. A mass-market homeowner’s policy may not provide full coverage for such situations. Note also that even a threat to sue can generate legal expenses, and many policies do not include coverage until there is a suit. Further, an insurance professional who works with high-net-worth clients and who is familiar with non-insurance risk management techniques could direct the client to create and document employment structures, such as formal job descriptions and annual reviews, that will help avoid such problems.

Umbrella policies. Umbrella coverage with mass-market carriers is also a concern, because such carriers tend to offer lower liability amounts that can leave your client exposed, especially since juries tend to favor the “little guy” plaintiff over wealthy defendants. Mass-market carriers rarely offer third-party liability coverage. Many of your clients may not even have an umbrella policy, or the limits on the policy they do have are inadequate. Many clients do not realize that the umbrella typically does not cover aircraft liability, thus they must obtain a separate aircraft liability policy. Similarly, clients may not realize that their umbrella policy does not provide liability coverage for the jet ski that they rent on vacation.

After a liquidity event that generates a large increase in wealth, clients often neglect to contact their insurance person about the need to increase limits. This failure is especially prevalent when business assets become personal assets.

LLCs. Other risks involve complex estate mechanisms. Financially successful clients who own multiple properties often place them all in carefully devised limited liability corporations (LLCs). We have seen families create multi-property, multi-state portfolios of homes, and then fail to name the LLCs in their policies, which can jeopardize their coverage.

Consider another actual swimming pool situation. The client had a party at a vacation home that he had transferred into a trust. A guest accidentally fell into the pool, hitting her head on the diving board and incurring severe injuries. A plaintiff’s attorney filed a suit on behalf of the injured guest against the trust that owned the property. The client informed the insurance agent of the suit, only to find that the trust was not an insured under the policy, so there was no insurance coverage for liability or legal expenses.

Aircraft. Another liability situation occurs when financially successful clients enter a contract for fractional ownership of an aircraft. They receive a certificate of insurance, which specifies a limit on liability that usually relates to the hull value of the aircraft. The client generally does not understand that the limit is an aggregate limit of liability for all of the owners on that contract. If there is an accident with that aircraft and lawsuits start flying, the client’s wealth is at risk because that limit of liability is reduced by every settlement and may be exhausted, leaving the client exposed. Again, the term “joint and several liability” is a very meaningful phase. An insurance professional experienced in the needs of wealthy clients would advise to secure excess aviation liability coverage to protect the client’s personal assets.

Final Thoughts

We live in a litigious era in which a successful individual’s insurance and risk management approach needs to be as sophisticated and customized as their wealth management and financial planning.

Annual risk assessments of new and ongoing exposures are critical, especially for wealthy clients. Just as important is for the insurance/risk management professional to be competent and experienced in topics relevant to the needs of wealthy clients. Financial planners facilitate this process by maintaining relationships with these special insurance professionals and making sure their clients take advantage of this expertise. Doing so benefits the client and helps cement the relationship between the client and the financial planner.  

Topic
Risk Management & Insurance Planning