The sudden return of market volatility this year should be a reminder of the critical role financial advisors play in helping clients to protect their assets. However, as advisors proactively take measures to protect portfolios against inevitable market declines, their clients’ wealth remains exposed to unpredictable but largely avoidable liabilities. According to David Spencer, senior vice president of ACE Private Risk Services, “The most serious threats to a retiree’s net worth involve exposure to high-stakes liability lawsuits and significant property loss at home.”
In protecting their clients’ portfolios, it is no longer enough for advisors to focus solely on investment risks. Their high net worth clients are surrounded by financial exposures which could do far more damage than a temporary market decline.
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Most Wealthy Families Unprepared
In a society deemed to be the most litigious in the world, the stakes for people with wealth have never been higher, yet many are dangerously unprepared. As might be expected from a financially sophisticated portion of the population, the reason is not necessarily due to a lack of awareness of the risks. Rather, it is generally due to underestimating their liabilities. Underestimating liability is more likely to occur among HNW individuals climbing the wealth ladder who suddenly outgrow the capacity of their property and casualty coverage.
Consider the real life example of Greg and Jackie Smith who decided to put up a bounce house for their daughter’s birthday party. Greg and Jackie have a net worth of $6.75 million, including $450,000 in home equity and $4.5 million in investable assets.
As the party of 10 children take the bounce house by storm, one of them is severely injured. The child’s parents, who are also neighbors, successfully sue the Smiths for $2.5 million in medical damages and negligence. The Smiths have $300,000 in homeowners liability coverage (the basic coverage for most policies) and a $1 million umbrella persona liability policy.
The insurance coverage of $1.3 million falls well short of the $2.5 million in losses, not including legal fees for lengthy litigation of more than $400,000. The couple has to deplete all but $1.5 million of their investment portfolio to cover the costs – a nearly 70% loss!
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Targeting Deep Pockets
The obvious solution would have been for the Smith to own a larger umbrella policy. For an additional few hundred dollars a year, a $5 million policy would have fully protected their investment portfolio. Obviously, it’s not the cost of coverage that deters HNW individuals from obtaining the proper amount. It is the underestimation of their exposure. According to an ACE Private Risk Services Survey on Personal Liability Perceptions and Behavior Among Wealthy Households, more than half of HNW individuals believe that the highest amount of damages they could be liable for is $5 million. Now consider some actual verdicts and settlements in recent years:
- $49 million awarded to a college student left in a coma following a multi-vehicle crash
- $31 million awarded to two people swept off a boat and injured by its propellers
- $29 million awarded to a four-year-old boy for a spinal cord injury resulting from a vehicle crash
- $21 million awarded for the death of a female student killed in an auto accident
- $20 million awarded for the death of a teenage boy killed when riding an ATV on a neighbor’s property
Besides the massive size of these verdicts, the one thing they all have in common is the defendants’ deep pockets. According to ACE, the liability laws in some states encourage the targeting of deep pockets, allowing wealthy individuals to be held 100% responsible for damages even if they may have only been 1% at fault.
Growing Fear Among Wealthy Clients
While wealthy households might be underestimating their financial exposure, many are becoming increasingly anxious about their deep pockets becoming a target. According to the ACE survey, more than half believe their lifestyle and wealth make them a target for lawsuits, and two-thirds believe that the public perception of the affluent has become increasingly negative over the last 10 years. Many families believe that very perception increases their chances of being targeted for a lawsuit.
The chasm between the wealthy’s misperception of their actual financial exposure and their fear of being targeted for lawsuits presents an opportunity for financial advisors to open a broader discussion about asset protection beyond investment risk. Some financial advisors may insist that risk management in this regard is not in their purview – as it does require expertise outside their primary discipline.
However, for advisors who profess to take a holistic approach to wealth management, it is an opportunity to solidify a key cornerstone of their clients’ financial foundation, while protecting the work they do in growing their assets.
Clients Need/Want Advisors to Take the Lead
According to a survey by Oliver Wyman Consultants, clients appear to be leading the charge on encouraging their financial advisors to offer risk management guidance. More than three-quarters of advisors’ clients say they would find value in holistic asset protection advice, which includes access to risk management and property & casualty counsel. Nearly 40% said they might consider switching to an advisor who provided such advice.
And, financial advisors with growth ambitions may be interested to know that more than a quarter of those surveyed indicated they would turn over more assets to their advisor, while half said they would be more likely to refer friends and colleagues if their advisor were a risk management resource.
Advisors can help alleviate their clients fears and at the same time protect assets under management by developing a relationship with an independent risk management specialist. Stay away from property & casualty agents as most have neither the capacity or expertise to address the more sophisticated needs of high net worth clients. Having an experienced risk management specialist as part of the advisory team to conduct yearly asset protection reviews can add significant value to the client relationship.