Risk Management and Asset Protection

Question 1

What are the common types of insurance coverage?

Answer 1

• Automobile
• Homeowner
• Umbrella liability
• Professional liability
• General business liability
• Business interruption
• Life (dying too soon)
• Superannuation (living too long)
• Disability
• Medical
• Long-term Care

Question 2

Describe self-insuring as a strategy

Answer 2

Self-insuring is putting aside money for possible losses as opposed to purchasing insurance. From an organization perspective, if the organization pays for its own losses then no risk finance transfer to another distinct party occurs. May also be called self-funding or retention
An analysis of what an individual or organization can afford needs to be done in order to implement this strategy

Question 3

Illustrate the role of a variety of legal entities in an asset protection strategy

Answer 3

Diversification of entities and tools within a client’s portfolio is important to ensure that if one category tool goes down or unprotected, the client has other buckets of assets that are protected
It’s a tiered matrix strategy where once the tools in one layer are fully utilized, the advisor then moves onto the next layer of tools to protect assets

Question 4

What are the creditor protection features of insurance?

Answer 4

They get the benefit of strong asset protection and a strong lobby in Congress. There is no income tax on the gains inside the product while the product is in place. The cash value in those products is completely protected from creditors. In annuity, the cash is protected from creditors, but it does get taxed on distributions

Question 5

What are the creditor protection features of real estate?

Answer 5

It varies state by state, some have value-based exemptions, some have acreage exemptions
With value-based exemptions, the amount of equity that’s in the home is protected from creditors

Question 6

What are the creditor protection features of retirement funds?

Answer 6

Protected on a state level if it’s covered by ERISA
IRAs covered under ERISA

Question 7

What are the creditor protection features of college savings accounts?

Answer 7

529 have high contribution limits, and the money grows tax free while it’s in the account. If they use them for education purposes, they can withdraw from those accounts tax free. They can also take the assets out and not use for education with some tax payments and penalties, but the cost of the penalties may be cheaper than life insurance and annuities costs

Question 8

What are the creditor protection features of trust assets?

Answer 8

• Can create a spendthrift trust that benefits an individual and it’s protected from creditors as long as the beneficiary is not the settlor
• Assets that are in a trust that doesn’t have reversionary interest and control in the assets is completely protected from creditors
• If assets are distributed to the grantor (but they don’t have control over how much and if corpus can be used for distributions), then the assets may be available for creditors to take

Question 9

What are the creditor protection features of corporate and partnership assets?

Answer 9

Business structures will protect the business owner from the creditors in the business. Need to look at protection for the business owner from a third party creditor
Corporations are share based
Partnerships used to have an aggregate share structure where the company couldn’t be divided equally, so charging orders, orders to have distributions pay creditors first, were created. Now, partnerships are set up more like entities
LLCs are a hybrid of corporations and partnerships

Question 10

Describe the structures and jurisdictions of off shore trusts

Answer 10

People seek asset protection by creating trusts in foreign jurisdictions to place assets out of reach of US courts and their creditors because many foreign jurisdictions do not honor US judgments involving the rights and claims of creditors. If there is a US claim, they have to file another one in the country the trust resides in and creates substantial legal barriers for creditors

Question 11

What are the advantages and disadvantages of off shore trusts?

Answer 11

The assets are protected by foreign jurisdictions and the assets are difficult to get to by a creditor. Often, it leads to creditors settling for a lesser amount
They are very complicated, often expensive to establish. It requires knowing the tax laws of the foreign country, making sure there aren’t any language barriers, and the institution to be used needs to be well-trusted by the client and the financial planner

Question 12

Asset Protection: Problems, Issues, and Opportunities

Answer 12

It is important to consider how to protect one’s assets, and more often than not, individuals use traditional forms of asset protection, and those typically don’t protect the entirety of a person’s net worth (if they’re HNW). Now, it is easy to sue people and to take claim of a person’s assets, so safeguarding them in various assets and vehicles will give creditors and litigants less of an opportunity to take assets from the person.
Transferring assets to spouses, moving assets in protective investment options, and moving assets in various trusts will help safeguard from creditors

Question 13

How can domestic trusts be used as an asset protection tool?

Answer 13

They provide protection of the assets within the trusts from creditors, while still giving the grantor access to the assets potentially (if it’s a DAPT).
The grantor can receive distributions from the trust if the trustee (a separate person/entity) grants permission, and those distributions cannot be claimed by creditors

Question 14

What are the characteristics of self-settled trusts?

Answer 14

Self-settled trusts allow the person that establishes the trust to be the beneficiary of the trust

Question 15

What are the characteristics of grantor trusts?

Answer 15

The grantor still retains ownership of the assets and will have to pay taxes on the income produced from the trust

Question 16

What are the characteristics of dynastic trusts?

Answer 16

Dynastic trusts are created by the grantor intended to benefit multiple generations of the grantor’s family and take advantage of both the lifetime gift tax and the GST tax exemption
Duration can last forever

Question 17

What are the characteristics of domestic asset protection trusts?

Answer 17

A DAPT is an irrevocable self-settled trust where the grantor is designated as a permissible beneficiary and allowed to access the funds in the trust account
The trust should have an independent trustee
Creditors of the grantor should not be able to reach the assets in the trust
A limited number of states allow them

Question 18

What are the advantages, disadvantages, and legality of trusts?

Answer 18

• Various types, DAPT, self-settled trusts, dynastic trusts, spendthrift trust
• Advantages - Provide opportunity to send an income stream to individuals while keeping the principal asset protected from creditors. Utilize trustee to remove grantor rights from the trust but still have access to an income stream
• Disadvantages - If the grantor of the trust has any form of control over the assets and the distribution of the funds, then the creditors may have access to it. Once income is sent to the individual, creditors may have access to that income stream
• Legality - If irrevocable or the grantor does not have unlimited access to the funds in the trust, creditor is unable to access the funds within the trust
  (?)

Question 19

What are the advantages, disadvantages, and legality of entities?

Answer 19

• Corporations
  *Limited partnerships
• LLCs
• Spousal transfer
• Joint property and tenancy by entirety
• Retirement accounts
  (?)

Question 20

What are the advantages, disadvantages, and legality of 529 plans?

Answer 20

• Advantages - Have high contribution limitations. Can be used for education for any family member. Income in the 529 is tax free
• Disadvantages - If the money is taken out of the plan and it is not used for education purposes, the distribution is subject to income tax and a 10% penalty
• Legality - Protected from creditors. One of the only ways an individual can have assets in their name with complete and total control and have protection from creditors

Question 21

What is fraudulent conveyance?

Answer 21

Fraudulent conveyance is the illegal or unfair transfer of property to another party via a bankruptcy trustee
The transfer of assets in the face of or in anticipation of a creditor problem will be disregarded by the courts, and the creditor will be allowed to enforce its judgment against the transferee of the debtor’s property

Question 22

What are the challenges of asset protection in marriage, death, and divorce?

Answer 22

• With marriage, have to make sure that the assets are protected from creditors for both
• Difficult to try and protect assets from a spouse while in the process of getting divorced
• Need to make sure that for estate transfer, that creditors don’t have access to the assets after death. Utilize trusts and other transfer tools to ensure this
  (?)

Question 23

What are the issues in the protection of digital assets?

Answer 23

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Question 24

What is indemnity?

Answer 24

An insured shall not be compensated by an insurer in an amount greater than the economic loss. To be made whole

Question 25

What is actual cash value?

Answer 25

The actual cash value of lost or damaged property is the maximum amount that will be paid to indemnify an insured

Question 26

Insurable interest

Answer 26

For a person to purchase insurance and be able to collect on a claim, there must be something that the policyholder or beneficiary will lose if there is property loss, injury to others, or if the insured dies or becomes disabled due to accident or sickness

Question 27

Coinsurance

Answer 27

A clause in an insurance contract requiring the policyholder to purchase insurance in an amount at least equal to a specific percentage of the value of the property

Question 28

Other insurance clause

Answer 28

Such a provision spells out the way that a loss will be apportioned between that policy and any other insurance the insured has available to cover the same loss

Question 29

Negligence

Answer 29

For liability insurance purposes, negligence is typically defined as the failure to use such care as a reasonably prudent and careful person would use under such circumstances

Question 30

Contributory negligence

Answer 30

A form of defense against a claim of negligence. The defendant claims that the plaintiff (injured party) contributed to the loss by acting in a manner that was itself negligent

Question 31

Comparative negligence

Answer 31

Assigning responsibility for a loss is intended to provide a balance between the extremes of strict negligence and contributory negligence

Question 32

Assumption of risk

Answer 32

Participants in certain activities known to have an inherent element of danger have, by participating, assumed the risk, relieving other participants or sponsors the activity of any special duty to protect them

Question 33

What is asset protection planning?

Answer 33

The process of organizing one’s assets and affairs in advance so as to safeguard against risks to which the assets otherwise would be subject`

Question 34

What is commercial general liability coverage?

Answer 34

• CGL is an insurance policy that provides coverage for the insured’ liability from its business operations, and is the cornerstone of an organization’s liability insurance program
• Insured business chooses to transfer some of its risk exposures to an insurance company. If the insured has to pay for injury or damage to another person or company, the CGL form requires the insurance company to pay the insured’s legal obligations up to the policy limit
• Advantages - Most of the entity risk exposures are transferred. Insured company doesn’t have to worry about and plan for certain types of losses. Premium paid for the form is a legitimate business expense that can be deducted from tax liabilities. Insured can rely on insurance company to handle all the legal work and other paper work after a claim or lawsuit is filed
• Disadvantages - Premium spent on insurance is money that the insured doesn’t have for business plans. If insurer (insurance company) doesn’t handle the claim property or is not willing to settle a claim quickly, the insured can receive bad publicity. Insured cedes total control over claim management and settlement to the insurance company. If insurance company becomes insolvent, the burden of management and settlement of the claim or lawsuit falls back on the insured

Question 35

Term life insurance

Answer 35

• Simplest form
• Beneficiary only with life insurance protection, usually lowest cost, non-renewable term
• Advantageous when insurance need is limited to an identifiable period of time, especially if it doesn’t extend beyond 15-20 years

Question 36

Whole life insurance

Answer 36

• Traditional cash value policy with level premium payments designed to remain in force over the entire life of the insured individual
• Appropriate for meeting insurance needs for entire life
• Includes a savings or cash value reserve element. Insurer adds premiums the insured pays in excess of the mortality and the administrative costs of the policy to the accumulating cash value of the policy. Cash value earns interest that also accumulates in the policy
• Typically have fixed and guaranteed schedules of cash values that the policy owner can borrow against for any reason, or which the policy owners can take in cash upon the surrender of the contract
• Provide guaranteed maximum mortality charges and guaranteed minimum interest rates
• Annual premium is generally high

Question 37

Universal life insurance

Answer 37

• Form of cash value policy
• More flexibility for the policy owner. Policyowner can increase or decrease premiums from year to year, or skip premium payments in some years. The concern is maintaining a sufficient cash value to cover the future mortality and administrative costs without imposing huge prospective premium requirements
• Policyholders may change the death benefit levels of the policies within limits
• Policyholders have access to the cash value of their policies either through policy loans or direct withdrawals
• Policy owner may choose a level death benefit or increasing death benefit. Increasing death benefit typically has a higher premium
• Provides for maximum mortality charges and minimum earnings rates

Question 38

Variable life insurance

Answer 38

• Has a fixed premium and a minimum guaranteed death benefit
• Risk and reward of investment decisions is shifted to the policyholder. Insurer maintains the cash reserve of variable policy in a segregated investment account, and the policyholder determines how the reserve funds will be invested. Typically in the form of mutual funds and include a variety of equity, bond, balanced, and money market funds

Question 39

Variable universal life insurance

Answer 39

• Combines the critical attributes of both variable life and universal life
• Provide for flexibility in the payment of premiums and limited flexibility to alter the death benefit
• Policyowner may choose between level and increasing death benefit
• Investments are maintained in a separate account and are managed by the policyowner
• VUL provides for no minimum cash value, no minimum earnings rate, and no guaranteed minimum death benefit
• Popular for those that are willing to assume the risk in exchange for potential of a greater increase in cash value while maintaining the highest level of flexibility and control over the variable policy’s components

Question 40

Private placement variable life insurance

Answer 40

• Special type of variable life insurance geared toward need of wealthy individuals
• Policies typically require large premium ($1MM)
• Allow the policyholder to choose from approved money managers to mange investments in the policy account
• Charge lower investment management loads than imposed by standard variable policies

Question 41

Survivorship life insurance

Answer 41

• Second-to-die or joint life or last-survivor life insurance
• Payment of death benefits only after both insured individuals have died
• Because insurance company doesn’t have to make a death benefit payment until after the two deaths, policyowners use survivorship insurance as a tool to provide liquidity to pay estate taxes, or to create an estate for transfer to future generations, when the last of a couple dies
• Increased popularity after the unlimited marital deduction
• Typically a level premium cash value policy (whole life, universal, VUL) covering two lives, but almost any reasonable variation is possible
• Generally cheaper than comparable levels of insurance on either of the insured lives

Question 42

Homeowner insurance

Answer 42

1. Loss or damage to property: dwelling, other structures at the residence, personal property, loss of use
2. Liability claims: comprehensive liability coverage, medical payments to others
   * May need supplemental coverage for flood, landslide, earthquake
   * Other risks that are usually excluded that need coverage: mold, rust, rot, fungi
   * Approaches to coverage include normal perils coverage (perils not listed are covered) or all risks open perils coverage (only perils specifically excluded are not covered. Typically broader and more expensive)
   * Factors that impact cost: Physical damage coverage (80% of cost to rebuild). Amount of coverage for other structures (10%), personal property (50%), loss of use (20%). Deductible for property damages. Limit on liability coverage. Medical payments to others. Damage to property of others

Question 43

Automobile insurance

Answer 43

• Part A - Liability coverage
• Part B - Medical payments
• Part C - Uninsured/underinsured motorists
• Part D - Damage to the insured’s vehicle
• People generally covered in policy: named insured and any family member, any person using the covered vehicle with the insured’s permission, and any person or organization for a liability arising out of any covered person’s use of the covered vehicle on behalf of the insured person or organization

Question 44

Umbrella liability insurance

Answer 44

• Excess liability or personal catastrophe coverage, provides persoanl liability coverage protecting individuals and families from large personal liability claims
• Supplements underlying liability coverage provided in homeowner and auto insurance policies