From the October 2007 issue of Wealth Manager Web • Subscribe!

October 1, 2007

Risks for the Rich

Getting your clients to talk about insurance is a little like getting them to eat their greens. Sure, they know they need it and it's good for them; it's just so much less interesting than the other stuff on their plate--the sizzling steak or creamy pasta equivalents of real estate or stocks and private equity. "They always say I've made good points--and then ask if it can wait until next year," says Mary Claire Allvine, who splits her time between Chicago and Atlanta as a principal at Brownson, Rehmus & Foxworth. Still, "The best way to fight the 'I-don't-do-insurance' instinct is to arm yourself with information," she continues. That's how you get your clients on a balanced diet.

"You can help your clients gather the documents and other things they need to have a good review with the [insurance] broker, and then you can review the review to make sure it works with the rest of their plan," says Harold Evensky, president of Evensky & Katz, the prominent Miami wealth advisory firm.

In particular, it's important for the wealth manager to make sure the insurance broker is aware of any trusts or other special vehicles the client might have set up to protect a home or vacation home. "An insurance policy is a contract between a carrier and an individual, and a trust is not an individual," explains James Fiske, U.S. marketing manager for Chubb's personal insurance line. For example, he says, if the house burns down, "the trust probably doesn't own the stuff in the house." While the policy will most likely cover rebuilding, it might not cover replacement of the furniture, rugs, clothing and other contents. This is remediable with the right policy language, Fiske says, and a good wealth manager will work with the broker to make sure these potential gaps are filled.

In addition, wealth advisors and insurance brokers find that clients who have created their own wealth often wind up underinsured. "They have mass-market insurance with the guy their family has always used, and it's hard to persuade them that they need to go to a firm that specializes in the affluent market," says Allvine, who is co-author of The Family CFO (Rodale Press, 2004) and The 7 Most Important Financial Decisions You'll Ever Make (Rodale Press, 2005).

Allvine points to a client who recently decided he needed $10 million in liability insurance. His old reliable insurance agent would have had to write to his regional office to get special permission to write it. "This should have told him he's not part of the broker's usual group; he's an outlier. That's not a situation you want to be in because if you have to file a claim, it's not going to be the sort of claim they see every day," she says. "You want to go to someone who writes $10 million policies every day and pays claims on them every day because that's their business."

In situations like this, she adds, her objective view is one of the valuable things she brings to the table: "It's best for the person who doesn't profit from it to say there is a reason why your insurance costs $25,000 not $2,500 anymore."

Knowing the Basics

Since property insurance protects the physical structure as well as the contents of the home, policies for the affluent market typically have higher than normal limits: AIG will write up to $100 million in coverage for example, while mass-market policies might top at a mere $1 million.

These higher-end homeowner's policies usually provide the replacement cost for items that depreciate over time like clothes and electronic gear. They also allow for a home to be repaired or rebuilt with materials that are as close as possible to the originals. This is especially important for clients whose homes are likely to contain unique and custom-made materials.

"We have a client who was traveling in Europe and came upon a church made with logs he liked, so he bought the church and had the logs shipped to the U.S. to use in a house he was building," recalls Donald Soss, chief underwriting officer and vice president of personal lines for Fireman's Fund. "Even if it's a one-of-a-kind thing like that, we'll try to get as close as we can to the same quality."

Typically, when an insurer writes a high-end homeowner's policy, the company sends someone to appraise the house. That person will spend an hour or two inspecting the property, taking note of unique architectural details and features such as Italian marble kitchen counters and gold-plated bathroom fixtures.. They will then determine the home's replacement value and next, estimate the value of the contents at somewhere between 50 percent and 75 percent of the home's value. So, if for example, a home was valued at $10 million, the policy would provide another $5 to $7.5 million in contents coverage.

If the content coverage seems too high or too low, your client can hire an inventory specialist--the insurer or broker can usually recommend one--who will survey the house from top to bottom, taking note of everything from the Armani suits in the bedroom to the crystal in the dining room to the electronic gear in the kids' rooms. The grand tally will let your client know whether they are properly insured. Moreover, it will provide a record of the contents (sometimes with photos) so clients don't have to count on memory to remember everything they own should it become necessary to make a claim.

Finally, a good high-end homeowner's policy should provide extensive coverage for living expenses while the house is being repaired or rebuilt. "The amount should be enough to put you in a comparable living space," says Soss. "And if it takes eight years to rebuild your house, it should be eight years of living expenses."

For everything these high-end policies do, there are also things they don't do. Homeowner's policies are typically "named risk" policies, which mean just that. They cover the events they specifically list--and no more. Floods, earthquakes, and backed-up sewers count among the perils that people wrongly assume are included in their coverage, says Charlotte Edmonston, who is based in Baton Rouge and is the managing director for private client services for Arthur J. Gallagher, a Chicago-based insurance brokerage.

Managing Costs

Although insurers were reluctant to discuss rates, all those bells and whistles make high-end policies cost more than run-of-the-mill coverage. "As we get more sophisticated, it gets harder to say a $1 million house should cost $2,500 to insure," says Fiske.

But there are ways to earn discounts that will bring down the cost of a policy. Chief among them is a higher deductible. "The idea of insurance is to cover things that are disastrous, not things that you grumble about," says Evensky. A high deductible is your client's way of agreeing to, in effect, self-insure against those small things. "If you raise your deductible from $200 to $2,000 the insurer doesn't worry about being nickeled and dimed, and it lowers your cost," Evensky says.

There's a limit, however, to how large a deductible you want to take. "A $10,000 deductible on a multi-million-dollar home is usually adequate," says Fiske, "Beyond $10,000, you need to have a big house to make the premium savings worthwhile."

Sandra Bravo, who heads the private client group in New York for Willis Group, a London-based insurance brokerage, recalls a client who offered to take a $2 million deductible on an $18 million house. "He thought he would get much better pricing, but insurers only have so many deductible options," she says, so he didn't save as much as he expected. "In the end he decided on a $50,000 deductible because most insurers waive the deductible entirely on losses of $50,000 or more," making it unlikely he would ever have to actually pay out that whole amount at once.

Lowering your risk is another way to save money. Appraisers also take note of features that make a home safer--and sometimes recommend them. Additions like household surge protectors to guard against lightning, high-quality alarm systems, a properly fenced pool area, good fire alarms and sprinkler systems, storm shutters in Florida or seismic-sensitive gas-shut-off systems in California will earn your client credits that will lower his premium.

Second-Home Coverage

Policies on second homes offer most of the same features as those for primary homes. However, there is usually little or no need for any loss-of-use coverage for a second home, Edmonston notes. The big difference, she says, is that, "Vacation homes tend to be located by the beach or in the mountains where you have high catastrophe exposure."

No one should be surprised at having to get expensive hurricane coverage for beachfront homes on the Atlantic or Gulf coasts. But other risks are less obvious. For ski homes or ranches out west, a remote location can pose a problem: The proximity of the nearest fire department or fire hydrant is a factor in places like Wyoming. And for a Colorado ski retreat, the insurance company will consider how easily the fire department can reach the home during the winter. For these homes, good risk management might not be about getting a discount on a policy, but being insurable at all.

Mitigating fire risk might be a matter of installing sprinklers in the home or putting a fire hydrant on the property. In a hurricane zone, adding storm shutters, upgrading to a tile roof, and installing hurricane-proof glass can make all the difference between being able to get a policy from a regular carrier or having to go to someplace like Lloyd's of London, where they specialize in high-risk coverage for a high price tag.

No matter the location, "In second homes, water is the big issue," says Maureen Hackett, vice president of property insurance for AIG. Properly insulating pipes and installing low-temperature sensors that turn the water off if the heat fails, or water shut-off systems that know when water shouldn't be running, will all curry favor with your client's carrier.

Allvine and others say that where they can, insurers who specialize in the affluent market will try to work with clients around these issues. "They'll say this is what we can insure and this is what you need to do to make the risk acceptable to us," she says.

The Art of Insurance

Art work and other collections often wind up with their own policies, but it makes sense to include them in any discussion about property insurance because there can be an overlap between policies, and your client might receive a credit on home coverage for items that are removed to the fine arts policy.

And these policies are not just for the dedicated aficionado, either. Even if the owner is not a serious collector, jewelry, rugs, antiques, vintage clothing and guns can wind up on these policies. For example, regular homeowner's policies often impose limits on jewelry coverage--at AIG it's $5,000--so clients with more valuable baubles often move them to a policy with higher coverage.

In addition, Edmonston explains, fine arts policies are usually all-risk coverage, meaning that unless something is specifically excluded, it's in there. "Things like floods, spilled wine, dog urine and vermin, which a homeowner's policy might exclude, would be covered by these policies," she says. Therefore, she adds, "If you have a few Persian rugs or a small collection of guns, or if someone left you a $50,000 armoire, and it's the only antique you have, it's worthwhile to put them on the art policy."

There are two basic variations on these policies: The blanket or loss-limit policy values the collection as a whole. This limit is the most you can be paid for a loss. There's also a cap on the amount you can collect for any one item, based on the worth of your most highly valued piece. So if your client owns several antique guns, and the whole collection is worth about $200,000, and the most valuable one is worth about $15,000, those would be the caps on his policy. The second variation is a scheduled policy, which lists every item in a collection and its worth. If your client makes a claim, the insurer pays the agreed-upon value. It's common for people to combine the two strategies, scheduling their most valuable pieces and using a blanket policy for the rest.

The biggest issue for art owners these days, according to several art insurance providers, is that a lot of new money has come into the art market from Russia, the Middle East and China, and these folks are bidding prices up--especially for certain categories like modern art. "The difficulty in a fast-moving market is not having the option to insure for full value," says Charles Dupplin, chairman of the art and private client division at Hiscox, a London-based insurer. He has seen clients insure a painting or sculpture based on an appraised value, only to see a work by the same artist sell a few months later for two- or three- times the expected price--rendering the original appraisal immediately obsolete.

If your client owns pieces in one of these fast-climbing markets, there a few things he or she can do to hedge their bet. Dupplin sometimes advises a policy--at extra cost, of course--that insures a piece for its market value, usually up to a certain limit--say 150 percent of its value at the time the policy is written.

Insurers and appraisers can also point you to services that will alert your client when something by an artist he owns goes up for sale, so he'll know if he needs a reappraisal.

The Liability Game

"Excess liability is a wealth-protection tool," says AIG's Hackett. As its name suggests, it covers liability your client might be sued for in excess of what's covered by his homeowner's or auto policy.

"If someone drowned in your swimming pool and sued you for $5 million, and your homeowner's policy had a $300,000 limit, it would pay that $300,000 and the excess liability policy would pick up the rest," she explains.

It's the area of an affluent person's life where it's hardest to control risk or predict claims, and it's the policy where experts most discourage skimping. "If they save money on the property side, they can invest it on the excess liability side," says Bravo. A property loss, no matter how large and emotional, is still a finite financial loss, she says. "But if you're worth $200 million and you're sued, you don't know what a jury will award."

Fiske estimates that a $10 million policy at Chubb should cost about $2,500 a year, but that assessing a person's risk is more art than science. "The first thing to look at is how much the customer is worth and ask what his risk factors are," he says. "Does he travel a lot? Does he have children? Are they of driving age? Does he entertain a lot personally or for business? Does he have a lot of domestic help?"

What does all this have to do with risk? Domestic help can sue for wrongful termination or sexual harassment, and guests can do something silly, like sustain an injury by slipping in high heels near your client's pool and blame him. But teenagers, especially those who drive, are the source of some of Fiske's most dramatic stories, like the one about the unlicensed 16 year old who managed to get into a hit-and-run accident during a short trip to McDonald's.

When his clients are in doubt, Fiske usually encourages them to err on the safe side because, he says, "This coverage isn't that expensive."

At Your Service

Insurance brokers and wealth managers say that along with their high premiums, insurers that focus on the affluent market usually offer a higher level of service. In fact, they've been known to provide additional services such as the home appraisals, deep-background checks on household help or advice on storing, moving or lending fine art at relatively little--or no--fees. And they'll provide referrals for services they don't do, like household inventory.

What's more, Allvine says these firms can be swift and accommodating when it comes to the most important thing--paying claims.

"I've seen situations where a library is flooded, and all the books are ruined; where a mass-market insurer will want the name of every book and proof that you replaced the books with your insurance check," she says. In comparison, the higher-end insurers are more willing to give the benefit of the doubt and ask fewer questions. "They'll write the check, and it's up to the customer whether they want to replace the books," she explains.

Now that's an anecdote worth passing along to a skeptical client the next time you need to bring up the insurance discussion.

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Ten Essentials for the Wealthy

These are issues that make an affluent person's insurance needs especially complex and that might not be sufficiently addressed by a run-of-the-mill policy aimed at the mass market. Wealth managers should discuss the following with their clients:

1. If your client has worked with multiple insurance carriers over the years, are policies well coordinated by a broker to assure that there are no gaps in coverage or unnecessary redundancies?

2. Does your client's work or philanthropy put her in the public or give her media exposure which could increase her risk of identity theft or nuisance lawsuits?

3. Does your client sit on for-profit or not-for-profit boards? What liability coverage does that organization provide, and how much coverage might your client want over and above that?

4. Are there domestic employees and has your client taken into account her exposure to such things as identity theft, or claims for workers compensations, sexual harassment or wrongful termination?

5. How much liability coverage, which is essentially wealth protection, might your client need to reasonably protect her liquid assets?

6. Does your client own property on a coast or in a catastrophic or remote location that can be costly to insure and may require extra risk mitigation such as hurricane or fire preparedness?

7. Does your client have international exposure through frequent personal or business travel, property ownership or a child studying abroad?

8. Does your client have art, jewelry, furs, wine, silver, antiques or rugs that are valuable and hard to replace and might warrant coverage separate from his homeowner's policy?

9. Does your client have any homes under construction that they might want to insure against theft, damage or loss during the ongoing work, or undergoing renovations that could affect terms of their policy, say if alarms are shut off or the family moves out temporarily?

10. Has your client put any real estate into Trusts, LLCs, FLPs, or other protective structures, and does the insurance policy on that property take this shelter arrangement into account? --EG

Source: Based on information provided by the Willis Group

Eileen Gunn, a freelancer whose work has appeared in the Wall Street Journal, the New York Times and Worth, is the author of Your Career Is an Extreme Sport.

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