In the context of a PFP engagement, planners must approach risk management broadly. I’ll define risks in terms of engagement risk and specific risks.
Let’s start by defining your engagement with a client and understanding your role. If you’re in a tax engagement with a client, and notice that they have exposure in terms of a high-risk property that is jointly owned with another person, do you have a responsibility to say anything? In the terms of a pure tax engagement, it’s likely that your responsibility ends at accurately reporting the results of the rental property on the Schedule E of the client. But what about the risk of owning joint property with another? In general, as a tax preparer, it isn’t your responsibility to cite that risk, but what if your firm does indeed have a PFP division? Does your firm perform any advisory service for that client? If so, is it clearly laid out in an engagement letter, or is it merely consulting hours for which you render a bill for payment?
For my money, even a tax preparer who performs tax returns should have the smarts and decency to mention something to the client. Unincorporated entities may have unlimited liability to the owner(s) of that business. That would certainly apply to this rental property and I feel that a thoughtful tax preparer would at least bring this fact to the client’s attention. For the firm with a wealth management division, not addressing the gap in your client’s plan is borderline negligence and malpractice.
Are you, or not?
I believe the first large area of risk for the financial planner are the broad engagement risks. In short, the question is: Are you, or aren’t you the client’s financial planner? And as their financial planner, why wouldn’t you be required to follow the fiduciary standards and practice guidelines set out by the Securities and Exchange Commission, the Financial Planning Board of Standards or the PFS standards of care? Any of these would easily conclude that risk management is indeed a vast part of financial planning and that you missed this one entirely.
You may not feel that you are that particular client’s financial planner, but sometimes in a matter of a lawsuit or a complaint, what you think doesn’t matter. It matters what the client thinks. I suggest that all financial planning practitioners have a clear written engagement letter with clients that accurately describes the exact role you intend to serve.
Taking it a step further — suppose that your firm has a client for which you’ve assisted with an old 401(k) that was ignored. You may have identified a poorly managed asset and rescued it from the jaws of defeat by helping to assess and build a portfolio that suits your client perfectly. How does this have anything to do with the aforementioned risk associated with the poorly owned rental property and engagement risk? The answer lies in the gray area of who your client thinks that you are to them. If you are simply a money manager and everything from your engagement letter to your conversations lead a reasonable person to that conclusion, then again you may have escaped liability. But if that client thinks that you are indeed their financial planner, then I pose the question about your liability with respect to advising on the ownership structure of the rental property. My experience tells me that if your client thinks you are their financial planner and there is a problem with the rental property that may have been avoided or mitigated through a different ownership structure, then you may have some exposure.
Be the thorough planner
Using the aforementioned rental property example, let’s change the circumstance. Instead of that rental property being jointly owned with another person, let’s assume that your client hired an attorney and has an LLC with a written LLC agreement behind it as the owner of the property. Would it be enough for you to think that no further scrutiny is required? If you’ve read my articles before, you know the answer is of course not.
The thorough financial planner would take several more steps here. The start would be a review of the LLC agreement to see that the document itself does not expose the owners to any further risk. Most financial planners aren’t lawyers, but I believe that the planning engagement would include your review of the document. If you aren’t comfortable with the risk buck stopping with you, then your written planning advice should suggest that the client engage their lawyer or another attorney to review the document from an asset protection perspective.
After the entity review, the insurance policy on the rental property also must be analyzed. Once again, it isn’t assumed that you’re an insurance expert, but it is a base requirement for you to ascertain that the purchased coverage does indeed protect your client and the property. For this, as with the review of legal documents, you may engage the assistance of a property and casualty expert to ensure the policy in place is adequate.
A similar review is likely needed for all of your client’s personal property and casualty coverage. Some things will stick out like a sore thumb. Lacking umbrella liability insurance, for example, is very obvious and easy for even a lousy financial planner to spot. But what about a conversation regarding how much umbrella or catastrophic liability insurance may be needed? A deeper dive should also be taken with respect to their underlying coverage. If you aren’t eligible to do this review or give the advice, once again your planning memo needs to be clear, and as a firm you may need to engage the assistance of a risk professional to do what you cannot.
Some of the non-core insurance products that your client may own would also require your sharp eye.
Life insurance also bears a similar risk for the unwary planner. Doing a capital needs analysis and advising your client that they have enough life insurance may suffice for today, but have you examined the value and longevity of the policy? For example, a 10-year term life policy may work today, but if your planning analysis shows the coverage to be optimal for a 20-year period, is that policy truly the best option?
For permanent life insurance, have you asked for in-force illustrations to ensure the policy is on track to deliver as anticipated? If you don’t do that, and the policy lapses for value or somehow doesn’t last as long as needed, you may have exposure. Though you didn’t sell the policy under review, as the planner, it is your responsibility to assess the amount and adequacy of that coverage. A similar analysis should be performed for any group coverage that is a significant part of your client’s financial plan.
Long-term care insurance is one of the toughest areas to assess today. For an existing policy, the analysis is easy. But when it comes to making a recommendation to your client about acquiring the coverage — this is hard. The huge cost of these policies today is part of the issue.
To properly assess the LTC situation, you must lay out the facts in black and white. There are four situations possible with respect to long-term illnesses. You have a health event and either have coverage or you don’t have coverage, or you don’t have a long-term health event and you do have coverage. Any of these possibilities can be forecast to illustrate the consequences of the long-term illness and/or the cost of coverage without ever having to use the coverage.
Risk is often a subject frequently covered with insurance. While there are many great insurance agents in the world, I think that many would agree that the profession is also full of salespeople whose mission is to sell as much insurance as they can, without any fiduciary responsibility. Embrace risk, and your role to be that independent fiduciary assessing your clients’ needs and plans, and you’re almost guaranteed to enhance their experience.
