From the December 2008 issue of Wealth Manager Web • Subscribe!

December 1, 2008

BEWARE THE DEVIL'S BARGAIN

For clients of wealth managers, the souring economy is a mixed bag. On the upside, a credit crunch gives those with lots of ready cash greater buying power. That makes it easier to pick up bargains in high-end real estate, cars, jewelry and art from over-leveraged, highly motivated sellers. But in a downturn, greater "visible" wealth also encourages everything from theft to nuisance litigation. Caveat emptor: "Bargains" that exploit an expectation of getting more for less (can you say fraud?) are also a concern. Then there's the temptation the cash-pinched, asset-rich client faces to cut corners in the care and protection of pricey personal assets he's holding for the long term (or at least until the next upturn). If squeezed enough, the "illiquid wealthy" may even cut back on measures that ensure the safety and security of themselves and their families.

In an Oct.10 New York Times article titled "Keeping Wary Eye on Crime as Economy Sinks," University of Missouri-St. Louis sociologist Richard Rosenfeld observed: "Every recession since the late 50s has been associated with an increase in crime and, in particular, property crime and robbery." He added there is usually "a year lag" between falling economic activity and rising crime rates. With that timeframe in mind, common sense argues that the more people have, the bigger a target they'll be during the year ahead. Wealthy clients also need to recognize how dire times, and the widespread financial desperation they can breed, will impact the closest of family, friends, domestic staff and key advisors. Risk Control Strategies, a New York-based security firm that maintains a proprietary database of crimes against the affluent, calculates that 80% of all incidents involve such inner-circle members.

Admittedly, there's no "good" moment to shirk on screening those with intimate access to a wealthy client's property and finances. But given the extra temptation insiders have to exploit trust when money is tight, this is easily the worst time. Clients must be encouraged to understand how much more likely it is that a longtime housekeeper--feeling panicked by a mountain of credit card debt--might stoop to some not-so-petty pilfering; how an au pair short on income may leave a window unlocked and the alarm disabled in exchange for payment from "friends" who then rob the place. And this is precisely the atmosphere that might lead a family accountant or attorney nearing retirement to embezzle.

Vendors and contractors pose a still greater threat. It is easier to defraud or outright steal from a client you don't personally know. Armed with your credit card or other financial information, a service provider you've never met might be tempted to solve a cash-flow problem by selling the data or using it himself. It's a small leap to rationalize such actions as a "harmless" crime against "somebody who can afford it anyway."

This may explain why one in five Financial Planning Association (FPA) members surveyed recently by Chubb Personal Insurance put "identity theft" at the top of their list of the three risks most likely to increase in 2009. Personal liability had always been the pre-eminent worry in past FPA queries. But with nine million Americans having their identity stolen annually--identity theft now surpasses drug trafficking as the nation's number-one crime, according to the Justice Department--the shift in professional concern is well founded. The increased risk of ID theft, coupled with the heightened motivation to target the visibly wealthiest for all sorts of other larceny, underscores the need for thorough background checks, and to step up physical and virtual security accordingly.

Unfortunately, the opposite is often the case. Even paper stock losses can lead a wealthy client to dangerously "under spend" in places that family, friends and colleagues won't see. They may continue to pony up for discretionary expenditures that sustain a reputation critical to their peer standing, influence and success. But disconnecting the alarm systems that protect the home from fire and theft is a "silent" economy. Nor is it unrealistic to expect someone with a bargain-hunting mindset to say: "Purchase of this $30,000 painting for $20,000 can't wait," then unconsciously add, "but the extra cost of appropriately caring for it can." And so, the owner may use a barebones shipping company to transport the painting rather than one that specializes in safe, secure transport of fragile works of art. Such hidden corner-cutting can range from not properly appraising and insuring a home and its contents against damage, to skimping on coverage that could help a family pay for the medical, psychiatric, and other expenses in event of a home invasion.

Wealth managers can correct this shortsightedness by gently reminding a client that a "bargain" item needs to be cared for in accordance with its true value. To do otherwise risks eventual neglect and serious depreciation. Clients also need to appreciate that choosing between protecting the family reputation and protecting one's actual family and prized possessions is a patently false choice. Trusted advisors are well positioned to remind their clients of what is really important in the long run.

Even when a client sticks with caretakers that have always performed well, risks remain. Tough market conditions can cause long-reliable contractors to suddenly do far less than their usual stellar job while continuing to charge their usual price. The dry dock that winterizes your 42-foot sailboat may quietly let some of its best people go to stay in the black. Or the garage that services and stores your prized 1963 Datsun Fairlady may dial back site security to cut costs. Desperation can also lead some businesses that store your valuable property to move it out the back door for black-market resale shortly before setting their establishment ablaze and declaring a total loss.

Here, again, retention of qualified security consultants is crucial. Better ones meticulously check and compare past and present legal, credit and customer-complaint histories of such vendors for red flags. The current financial crisis also calls into question whether certain insurers of the wealthy have the financial wherewithal to respond to a serious loss. Will they balk at legitimate claims while struggling to staunch their fiscal bleeding? Advice to clients regarding selection of a carrier should be the same as with any other service provider: Look for one with a pristine balance sheet and reputation.

Ironically, the healthier a client's personal balance sheet, the better the chances of being sued during an economic rough patch. A Stanford Law Review study titled "Changing Nature of Employment Discrimination Litigation" suggests clients with large personal staff (a driver, gardener, etc.) are especially vulnerable. Its authors conclude that "the national unemployment rate" is "the single largest predictor" of long-term growth in federal employment-discrimination litigation filings, which, historically, experience a "dramatic increase" during recessions. They also find "the average damage award to a successful plaintiff rises in business downturns, particularly with respect to employment discrimination suits...because of the length of time it takes for a plaintiff to find another job." In that light, clients should take great care to consult insurance agents and brokers for advice on the right liability coverage and limits. It's also wise to consult an attorney who specializes in employment law before terminating the services of any staffer. The grounds for laying-off a head chef of 20 years only six months after hiring a lower-salaried apprentice may be purely financial, but others' perceptions may differ and result in a wrongful termination suit.

Helping the wealthy manage the risks of bargain buying and cost-cutting in turbulent times can seem a fiendishly complicated task. Actually, it boils down to having well vetted experts with whom your client can discuss and delegate the thorniest details--which is where the devil always hides.

Andrew McElwee is executive vice president of Chubb & Son and chief operating officer of Chubb Personal Insurance. He can be reached at amcelwee@chubb.com.

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