June 17, 2011

Geography of Risk: Helping HNW Families Trim Costs, Boost Protection

 

Picture a wealthy family with a luxury penthouse in Manhattan, a beachfront compound in Palm Beach, a golfing getaway in Augusta, a ski lodge in Aspen, a ranch near Jackson Hole and a waterfront home in Tiburon--each worth millions or tens of millions of dollars.  If it seems like a dream, then you may not appreciate the nightmare insuring such properties can be for your wealthy clients.

Many wealth families and their family office managers discover that insuring each home requires navigating special conditions imposed by different state regulations and contending with different insurance company preferences. Florida can be a world unto itself for windstorm protection due to the threat of hurricanes, with a variety of special deductibles, insurance companies that charge exorbitant rates or simply refuse to accept new homes in beautiful but high-risk coastal areas, and state-run insurance pools that may not offer the desired quality of coverage and service. In California, the threat of earthquakes and wildfires can lead to similar complications.

Fortunately, wealthy families with widely dispersed properties have an important advantage that, if used correctly, can help them reduce insurance costs, improve protection and avoid the maze of state-by-state variations: geographic spread of risk.  How does this work?  First, let’s consider the traditional approach to insuring these homes. The family or family office manager works with an insurance agent to insure each home individually.  They buy enough insurance to cover the replacement value of each home.  If the family has six homes with an aggregate replacement value of $30 million, the client would purchase $30 million in coverage. That means that the family, or more likely the family office manager, would have to spend considerable time understanding all the nuances of local coverage.

But how likely is it that all six homes will burn down or be destroyed by a natural catastrophe at the same time?  It’s virtually impossible. Even the worst hurricane or earthquake couldn’t destroy all the homes; they’re too far apart. Thus the geographic spread of risk allows another approach to insuring the homes: treat them as a group.  Determine what the maximum possible loss to all the homes from a single event could be, and use that amount to set a blanket coverage limit. Instead of needing $30 million in coverage, the family may need only $20 million. This approach can even be used to a lesser degree when families own multiple homes in one or two states.

Moreover, the blanket property approach allows the family and insurance agent to create a customized policy with the insurance company that offers consistent coverage terms across the states, so there is less chance for confusion. Coverage terms can be written a la carte, allowing wealthy clients to capitalize on another advantage they have—the ability to accept high levels of risk, perhaps in the millions of dollars. Unique deductible amounts and special limits for perils such as flood, wind and mold can be structured to achieve often substantial savings. We’ve seen families reduce their costs by 50% using the blanket property approach.

Because a blanket property policy is so flexible and unique, it takes a fair amount of due diligence upfront. Wealthy families and family office managers should make sure they have partnered with a sophisticated insurance agent or broker (see my previous article for AdvisorOne about choosing one) if they are interested in this approach.  The long-term benefits of simplification, customized protection, and cost savings should far outweigh the initial work.

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