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Beware of Hidden Insurance Risks for Small-Business Clients

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Successful small business owners can be among a financial advisor’s best clients. Not only do these professionals often enjoy high incomes that fund sizeable personal investment portfolios, they also may rely on their advisor to provide other investment-related services, such as retirement plan advice.

While a small business owner’s personal holdings and business assets often are separated by the legal walls of the business’s limited-liability status, there is no doubt that owners often think of their personal and business wealth as one big pool.

This mindset, and the potential for a large personal property or casualty loss to prompt a business owner to tap company assets, creates the potential for an unexpected change of circumstances to a client’s wealth — and to an advisor’s assets under management.

Consider the example of Brian Herndon, a fictional but typical 58 year-old entrepreneur who owns a successful metal fabricating business in suburban Chicago.

A candle left burning on a counter in the Herndon’s recently renovated kitchen for some reason emitted an ember that caused a hanging potholder to catch fire. The fire spread quickly and destroyed the kitchen’s custom cabinetry, high-end appliances and flooring. Damages totaled $350,000.

Unfortunately, the Herndon family hadn’t updated their homeowners insurance after completing the kitchen renovation, leaving their coverage inadequate and saddling them with $150,000 in expenses they had to cover out of pocket.

Like many small business owners, the vast bulk of Mr. Herndon’s wealth was tied up in his business. The Herndons’ personal financial wealth was relatively small and held in qualified retirement accounts, which Mr. Herndon and wife didn’t want to tap to avoid paying the 10% early withdrawal penalty.

Instead, he decided to borrow cash from the business to cover the expense — also a complicated maneuver that should be undertaken only with the help of a tax expert to avoid IRS penalties.

Borrowing funds from the business proved costly in its own way. It depleted working capital, which the business had to borrow from its bank. That not only raised costs and reduced margins, but also lowered the value of the business, which Mr. Herndon was hoping to sell when he reached 60.

Also affecting retirement was the reduction in Mr. Herndon’s qualified plan contributions that had to be earmarked to repay the loan.

All this current and potential future damage to the Herndon family’s personal and business wealth could have been avoided by having adequate homeowners insurance and an umbrella policy. Of course, financial advisors rarely are property and casualty insurance experts and quite understandably do not provide such advice.

But an advisor can help his or her clients with P&C issues — and protect assets under management — by developing ties to trusted and qualified independent insurance agents.

Because many affluent clients often have coverage that is inadequate or entirely absent, annual reviews by a qualified agent suggested by a trusted advisor can eliminate major risks to a client’s business and personal wealth and their plans for the future.

As too many business owner advisory clients often discover, property and casualty risks come not only from familiar misfortunes such as fires and burglaries, but from threats that probably never cross their minds.

These include cybercrime losses owing to identity theft or to damage resulting from hacking into devices such as home security systems; flood damage, for which only about 12% of Americans have insurance coverage; and accidents, which often lead to litigation and settlements that are in excess of homeowners policy limits and can lead to large out-of-pocket costs unless an umbrella policy is in place.

A recent study by the management consulting firm of Oliver Wyman found that 77% of advisors’ clients would appreciate their advisor providing access to P&C guidance and counsel. There is little doubt that for small business owners with so much of their wealth at stake, that level of appreciation is likely far greater.

If you have any questions about this topic, please email me at [email protected].

Fran O’Brien is Division President, North America Personal Risk Services, Chubb. She can be reached at [email protected].


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