Financial Planning

By Richard K. Fullmer

October 1, 2008

The year 2008 is shaping up to be a nasty year in which to retire. ...

Soon-to-be retirees who saw the market take huge bites out of their investment portfolios in just 11 months' time must surely be confused by the wide divergence of opinion on the appropriate exposure to equities going forward. ... So a natural question is: How should retirees configure their portfolios for the long term, while not exposing themselves to inappropriate risk?

...Retirees ... must consider two conflicting elements of risk—the risk of outliving the portfolio because it shrank in a down market and the risk of losing pace with long-term inflation.
It's time we turned conventional wisdom on its head. A common argument is that portfolios with conservative asset allocations may not provide sufficient investment returns in retirement. Even if true, this argument does not mandate that investors should be invested aggressively over the entire retirement period. ...

But this could mean taking the most investment risk precisely when it is most perilous to do so. Counter to conventional wisdom, longevity risk can be reduced, on average, by planning for a more conservative portfolio early in retirement and a more aggressive portfolio later. ...

The Volatility Bow Wave Effect
It is well documented that people are living longer. ... For retirees concerned about fully funding their golden years, the proper asset allocation depends not so much on their tolerance for investment risk, but their tolerance for longevity risk. What most retirees really care about is not going broke.

When a ship plows through water, it creates a bow wave, a V-shaped curl of raw power. [Naval] architects attempt to reduce a vessel's bow wave because it can sap energy and reduce fuel economy. ...

The volatility of investment returns is like a bow wave that can sap energy from a retiree's portfolio. ... Reducing the volatility of return at the beginning of a portfolio's distribution period by allocating assets more conservatively helps reduce the bow wave effect, enabling the portfolio to "plane over" rough periods in capital markets.

...Volatility is more bearable in the accumulation phase when the investor has more options available... It is much less bearable in the distribution—or decumulation—phase, when these options are not likely to be available. Further, the impact of volatility is lessened during the accumulation phase because the dollar-cost averaging (DCA) that occurs as a result of making periodic investments throughout the accumulation phase has beneficial effects to the investor.

Unfortunately, during the decumulation phase, the often-promoted benefits of DCA disappear and, in fact, work against the investor when cash is flowing out of the portfolio. ... It turns out that the sequence of investment returns is important in the decumulation phase. ... [It] may be that a more conservative portfolio is in order during the early retirement years, in order to get through the riskiest period. Later, it may be safe to move to a more aggressive portfolio.

Implementation
Such a strategy can be implemented in a number of different ways. For example, when an "income bridge" approach is used, one pool of money may be invested to fund the first 10 years of retirement and another pool of money to fund the years after that. Even more funding pools may be used under what could be called a laddering approach.

In either case, any particular pool could be allocated 100% to a single asset class, such as 100% cash or 100% equity, for that matter. However, the overall portfolio allocation should always take into account the client's tolerance for longevity risk and investment risk. It may serve advisors well to challenge conventional wisdom by reconfiguring their clients' portfolios to protect them against late-stage risks. Retirees have but one retirement to plan for, and there are no "do-overs." Reducing one's exposure to equities early in retirement may increase the likelihood of funding the golden years and preserving wealth.

Richard K. Fullmer, CFA, is a senior portfolio strategist for Russell Investments in Tacoma, Wash.

InvestmentNews

By Noelle E. Fox And Drew A. Denning
September 22, 2008, 6:01 AM EST

The following white paper, "Sustaining Income Through Retirement: Four Strategies for Retiring Clients," was published by Principal Financial Group in Des Moines, Iowa, and is reprinted with its permission.

Over the next 15 to 20 years, baby boomers are expected to reallocate nearly $8.4 trillion in retirement assets from investment products that support wealth accumulation to those that will support spending needs through retirement (Boston Consulting Group, 2006). Fortunately, today's retirees have access to a much wider range of strategies for turning personal savings into reliable streams of income than their predecessors had. But for most, awareness and a thorough appreciation of these strategies will occur only with the guidance of a financial professional.

...It has been well-reported throughout the media that baby boomers face an uncertain financial future as they transition from full-time employment into their retirement years.

As with prior generations, baby boomers face the twin retirement savings challenges of keeping up with inflation while protecting against losses due to volatile market swings. Baby boomers also face an increased risk of outliving their savings, thanks to increased longevity.

Moreover, as the uncertainty of having enough retirement income has escalated, so has a retiree's share of the financial responsibility for securing a comfortable lifestyle. Unlike the prior generation, fewer baby boomers can rely on employer-provided pension plans for sufficient retirement income and health care coverage (Department of Labor, Pension Benefit Guarantee Corp., Internal Revenue Service, Department of Commerce, Employee Benefits Research Institute, Bernstein and Mercer Human Resources Consulting estimates). Meanwhile, Social Security will provide proportionately less income replacement than it did for prior generations. ...

MAINTAINING INCOME 

...[In] the distribution phase of a retiree's life, the rate at which money is spent is the most important factor in maintaining sufficient retirement income for the rest of his or her life. ... As a rule of thumb, a retiree can withdraw 4% to 5%, adjusted annually for inflation, and still retain a high probability that his or her savings will last through a 25- to 30-year retirement.

While saving more and spending less are the key drivers in establishing and maintaining a secure retirement income, retirees may also improve their income flow by employing thoughtful asset allocation strategies and utilizing innovative retirement products throughout their retirement years (diversification/asset allocation is not a guarantee of future benefits). ...

FOUR INCOME STRATEGIES

...[We] will explore the differences among four strategies for turning retirement savings into a sustainable retirement income stream. By comparing the strengths and weaknesses of each option, financial professionals can help clients make an informed decision about which strategy best meets each client's needs.

The four retirement income strategies we will discuss are:

1. Mutual funds with automated income payments.

2. Variable annuities with guaranteed minimum withdrawal benefits.

3. Income annuities.

4. Combinations of mutual funds and income annuities.

Strategy 1. Mutual funds with automated income payments are designed to automatically provide a steady, inflation-adjusted monthly payment, much like some income annuities. But where an income annuity turns a lump sum investment into a stream of payments, a mutual fund with automated income payments still offers access to the underlying account balance. Also, the income distributed by these mutual funds is not guaranteed to be steady — predictable from year to year — or to keep pace with inflation.

... Once the mutual fund is depleted, the investor can no longer receive income from it. Also, while the potential for investment growth with a mutual fund is appealing, the investor receives no protection against market losses. This means the investor may outlive his or her retirement savings.

...Investment option fluctuations and longevity are important factors for an investor to consider when considering a mutual fund with automated income payments.

Types of mutual funds with automated income payments. Mutual funds with automated income payments come in two forms: endowment-style and self-liquidating. Each form works in a different way to help control the risk of an investor outliving his or her savings.

• Endowment-style mutual funds. These are designed to last throughout the investor's lifetime. The in-come payments are linked to account performance. Consequently, in the event of market volatility — be it a rapidly rising or falling stock or bond market — the amount of each distribution check could vary widely from year to year. The potential for such volatility makes it difficult for the investor to consistently budget his or her retirement expenses. So, while this strategy technically does provide longevity protection by providing some income for life, that income may not be sufficient to meet the retiree's needs.

• Self-liquidating mutual funds. These are designed to completely liquidate over a predetermined time horizon. The investor agrees to that time horizon when purchasing the mutual fund. Instead of spreading out assets to last a lifetime, these mutual funds are designed for the assets to last through the predetermined date. Income is tied to account performance, so income payments may be unpredictable. Typically, investors who select a self-liquidating mutual fund have other assets set aside to cover their fixed expenses in case they outlive the money in the self-liquidating mutual fund.

While mutual funds with automated income payments do fulfill a retiree's need to generate income, they lack the ability to provide full income for life and the income predictability of other retirement income strategies.

Strategy 2. A variable annuity contract with a guaranteed minimum withdrawal benefit rider is a distribution choice for retirees concerned about maintaining a minimum retirement income. As a variable annuity, the product allows the owner to stay invested in the market, similar to Strategy 1. And the GMWB rider provides a minimum level of income through guaranteed benefit payments.

By opting to receive income payments at a fixed percentage rate for life, a retiree is protected against outliving this particular income stream. The guaranteed portion also establishes an income "floor," which cushions the retiree against market risk. This means that, regardless of fluctuations in the value of the investment options that make up the variable annuity contract, the retiree will continue to receive a guaranteed minimum income payment for life. ...

While the guaranteed income may provide retirees with some assurance, it comes at a price — the GMWB fee. ...

Fees associated with the GMWB are the price retirees pay for the assurance of knowing they will always receive a minimum income (Guarantees are based upon the promises and claims-paying ability of the issuing insurance company). ...

Ideally, a retiree would like a reliable income that increases a little each year to offset the negative impact of inflation. However, any growth in the payments from the GMWB is dependent on account performance. To have any increase in the monthly payments, even just to make up for inflation, the account balance must grow enough from investment returns to exceed the benefit withdrawal base and prompt a step-up.

Annual fees can add up to more than 2.75%. Assuming inflation is 3%, the investment would have to earn a 5.75% return just to make up for the eroding impact of fees and inflation. In order to allow income to step up on a regular basis after withdrawals start, the annual return would need to be at least 10.75%, due to the 5% annual withdrawal. ..

. Absent a rising account value, the beneficial future step-ups will not occur, making it very difficult for the retiree's spending power to keep pace with inflation over the long term. ...

Investment options. Generally, the owner has a specific set of investment options or portfolios to choose from. ...

Strategy 3. Income annuities turn a lump sum of retirement savings into a regular stream of income. That income stream can be guaranteed for life, protecting a retiree against the risk of outliving his or her savings. Income annuities have no risk from market exposure and maximize spending for an individual. Retirees can also select additional features with this product that will address the risk of their income not keeping pace with inflation or not paying the remainder of their investment upon an early death.

With relatively low fees and fully guaranteed payments, income annuities are generally considered a cost-effective strategy. ...

Chief among the drawbacks owners encounter with income annuities is a loss of control. Once an annuity is purchased, the owner cannot surrender the contract for the cash value. ...

Other concerns can be addressed through the selection of additional features, but adding features will reduce the income payment received. Still, the cost may be worth it if those features address key owner concerns, such as:

• The risk of dying before the owner has received much value from the annuity. This risk can be reduced through a refund option, which entitles the beneficiaries of the owner's estate to either a lump sum or a payment stream equal to the remaining value of the initial premium.

• The risk of the owner's spouse not being covered after the owner's death. Owners can choose to base the annuity payments on their life expectancy and that of their spouse. This ensures that either spouse will continue to receive an income payment should the other spouse pass away.

• Inflation risk. This can be controlled by purchasing an annuity linked to the consumer price index. The annuity's payments increase with the government's regularly reported increases in the CPI. Another option that addresses inflation risk involves adding a fixed annual increase feature. This gives the owner an annual "raise" based on a predetermined rate.

Although income annuities can create cost-effective, inflation-protected income that is guaranteed for life, they are not a complete solution to retirement income. Retirees need some liquidity to pay for unexpected costs in retirement, especially those that arise in health care. Retirees also need flexibility in spending, as retirement could last more than 30 years and, over the course of time, spending needs are likely to change.

Strategy 4. The income annuity becomes a more effective solution when combined with other investment options, such as mutual funds. ... While the mutual fund provides market exposure, control, liquidity, and flexibility in spending, the annuity provides a baseline of guaranteed income.

... By combining traditional investments, a retiree can generate retirement income that adequately meets all of his or her retirement needs at a low cost. However, this solution is not for everyone. Consider the example of a retiree entering his or her drawdown phase with a significant portion of guaranteed income from a combination of pensions and Social Security. In such cases, retirees may be better equipped to face the unexpected costs in retirement by forgoing an annuity purchase and keeping their remaining savings liquid.

Also, income annuities are typically not appropriate for individuals in poor health, as longevity protection is not the primary concern.

CONCLUSION

After evaluating multiple alternatives, it is clear that no single product or withdrawal strategy is always the right answer for every retiree and every situation. ...

Noelle E. Fox is an investment and product analyst, and Drew A. Denning is vice president of income solutions in the retiree services group at The Principal Financial Group.

STRATEGIES To see the white paper and additional graphs, visit investmentnews.com/income.

New vehicle aimed at property owners with charitable intent

InvestmentNews

By Janet Morrissey
September 22, 2008, 6:01 AM EST

A number of broker-dealers have started offering a program that allows charity-minded clients to offload their real estate in a tax-friendly way while enjoying an income stream from the proceeds.

The program, offered since June by Life Income Funds of America in Englewood, Colo., is a pooled-income fund that allows real estate donations.

About 25 broker-dealers sell the program, including Commonwealth Financial Network of Waltham, Mass. ...

"I'm not saying this is the solution for every single client, but it's at least another option from just an outright [property] sale, a 1031 [like-kind exchange] or a charitable-remainder trust," said Gavin Morrissey, director of advance planning in Commonwealth's San Diego office. ...

DEMAND FROM ADVISERS

..."Demand is extremely high, especially with their baby boomer clients," he said. "[Baby boomers] typically have 30% to 40% of their net worth in real estate and only 15% to 25% in investments such as stocks, bonds, mutual funds, 401(k)s and things."

Life Income's product is intended for retirees and others who want monthly income but no longer want to manage their real estate holdings or face a capital gains tax from selling the properties.

"They don't want the tax implications of selling a property or the management hassles of putting it into a 1031 exchange program," Mark Quam, president and chief executive of Life Income and its distributor, Welton Street Investments LLC, also of Englewood, said.

Under his firm's program, a person can donate cash, securities and real estate to a pooled-income fund, which then sells the property and reinvests the proceeds in special funds. The donor gets a partial tax deduction for charity, avoids paying the capital gains tax from the property sale and gets a monthly or quarterly income distribution from the fund — which varies depending on the fund's performance — until the donor dies.

Under one option, after the donor's death, the remaining principle is donated to the philanthropist's charity.

The donor also has another option of donating all or even part of the property to the charitable fund and can designate up to two heirs to continue receiving monthly income payments after the donor's death.

There are other donor programs, such as the charitable-remainder trust, charitable-lead trust and the charitable-annuity trust, which often accept real estate donations as well. However, these trust programs are donor-advised funds that require costly lawyers and accountants to set up and maintain.

...Pooled-income funds also allow people to contribute a portion of a real estate property, while charitable trusts require that the entire property be donated.

"Charitable-remainder trusts are very expensive and cumbersome — lawyers and trustees are involved," Mr. Quam said.

Pooled-income funds eliminate the "expense and administrative hassles that come along with a charitable-remainder trust," Mr. Morrissey said.

Donors can direct their assets into one or more of Life Income's four funds, which currently offer yields ranging from 1.7% to 8.9%, he said.

The best candidates are those who don't have more than 50% debt on their properties, Mr. Quam said.

COST OF GIVING

Still, there are fees associated with a pooled-income fund, which vary from firm to firm. At Life In-come, the donor faces a 4% upfront fee and a 0.25% annual fee for five years in the firm's Series A funds, and a 2% upfront fee and a 0.5% annual fee for seven years in Series C Funds.

...Most other pooled-income funds don't accept real estate donations — at least not yet.

"The complexity of owning real estate and the risks associated with it, and problems associated with disposing of real estate — even in good times" — makes it a tricky investment for a charity, said Dave Ness, president of the Raymond James Charitable Endowment Fund in St. Petersburg, Fla., whose pooled-income funds don't allow real estate donations. "And the current real estate environment hasn't made disposing real estate any easier," he said. ...

E-mail Janet Morrissey at jmorrissey@investmentnews.com.

Growthink blogs

Written by Jay Turo on Thursday, October 2, 2008

We are living through one of the most tumultuous periods in the history of the financial markets.  It is rattling even the most steadfast and optimistic of investors.   ...  

A few takeaways:

Big is Not Safer Than Small.   Whatever the results of the government mortgage bailout, ... for equity holders of the big banks and mortgage and insurance players caught up in the mess ... it is misery.   ...   Investors for a long time will have serious hangovers and reservations regarding investing in these entities in any form – stock, debt, and/or derivatives.   Quite simply, the whole sector is tainted.

Cash Is Not Safe. Never in U.S. economic history have there been as many question marks as there are now around the security of cash...  

The question marks are threefold:

1. The underlying entities holding cash are more sick than not, ... your deposits are exposed.
2. The FDIC backstop/guarantee – ... is getting spread thin across an unprecedented number of defaults and in too tight a time frame.
3. Inflation.  ...[As] expenditures for bailouts, wars, ... mushroom ... the inevitable outcome has to be the government simply printing more and more money.   Thus inflation.

So cash, our old friend – whether in the bank or under our mattress – is both under parking risk of default (a low risk for sure but much more so than just a few weeks ago) and under systemic, significant inflation risk.  .

Executives Good, Traders Bad. In 2007, venture capital firms invested approximately $26 billion in startup and emerging companies.   ...   In Washington, the nation's political leaders are committing more than 25 times this amount, effectively, in bailing out the residential mortgage market.

Now don't get me wrong, the housing and foreclosure crisis is real and painful in this country.  But let's take a step back and think about priorities for a second:

• Would it be better to have more non-fossil fuel startups and technologies and fewer McMansions? Would we rather have more medical researchers and scientists or Wall Street derivatives traders?
• Who should be rewarded: the executives and visionaries working to build real operating companies, or the Wall Street whiz kids that made billions trading leveraged “house of cards” sub-prime mortgage portfolios?
• Quite simply, do we want to be a nation and a society that rewards entrepreneurship and business-building or one that rewards financial instrument manipulation?

Thinking about it for only a minute, the answer is obvious.   It is even more obvious to the biggest investors in this toxic debt: the Chinese, the Koreans, the Japanese, the Russians, and the Arabs.   ...

So where is this foreign capital now going to go?  Well, most of it will now in all likelihood stay home, or be invested in emerging/developing economies.  ...[While] the U.S. investment climate looks very, very unattractive compared to what it once was it is still by far the best place in the world to invest in startups, to invest in entrepreneurs, and to invest in operating companies.  ... While most Americans – terrified by the hysterical financial media that the end of days are near – are increasingly blind to this fact, the more detached foreign investment players know the real deal.  There are ... great American operating companies all in our midst.  Some are publicly traded, most are not.  In the coming years, watch for a return to this kind of back-to-basics business-building/value creation investing.  It can’t come soon enough.

PPLI offers tax-advantaged hedge-fund investing and other benefits

Investment Advisor Magazine

By Lewis Schiff
View Lewis's most recent musings in his blog

From the July 2008 Issue of Investment Advisor Magazine

... Private Placement Life Insurance is a powerful solution that’s also powerfully intricate. ... PPLI solutions support wealth transfer, wealth creation, and philanthropic needs, by using the death benefit in tax-advantaged ways.

For several years, Robert W. Chesner, Jr., an attorney with Giordani Schurig Beckett Tackett LLP, Austin, Texas, has used PPLI with a variety of affluent clients. ... For this kind of client ... investing in the same or similar portfolio within a PPLI offers a major advantage by eliminating the federal income tax.

Tax-free growth
Leslie C. Giordani and Michael H. Ripp, Jr., also attorneys with Giordani Schurig Beckett Tackett LLP, have demonstrated the advantages of accumulating returns inside a PPLI versus a taxed investment (“Private Placement Life Insurance Planning (Part 1),” ALI-ABA Estate Planning Course Materials Journal, 2006). In their hypothetical example, they show the side-by-side scenarios for a PPLI policy insuring a 45-year-old man with a $2.5 million annual premium for five years and a 10% rate of return net of investment management fees (taxed as ordinary income.) A hypothetical combined federal and state rate of 40% was used (see table, below).

Even after the first year, the PPLI cash value exceeds that of the taxed investment—plus the client’s death benefit.

In addition to the features of a traditional policy, a PPLI policy provides:

• Fee transparency to the client, unlike the “hidden” commissions of a traditional policy;
• Investment options, such as hedge funds and private equity;
• Very low cost for insurance and other policy fees (insurance, mortality and expense charges, commonly average around 1% or less over the life of the contract);
• More efficient cash value compounding with the low cost of insurance, the potential performance of alternative investments, and no commissions reducing contributions to the cash value account—especially in the first year.

The interest in PPLI for asset protection has also increased. Asset protection in offshore insurance vehicles offers many additional advantages for high-net-worth clients. ...[If] the offshore trust owns the PPLI, then those assets grow free of any federal income tax—and free of predators after the client’s estate. At the death of the insured, those assets can distribute in a tax advantaged way to the next generation.

Paying premiums
PPLI policy premiums start from a low of $1 million ($250,000/year over four years, for example) to a more typical $5-10 million (paid in the early years of the policy or as a single premium). ... To make the investment side of all PPLI policies efficient, early aggressive funding works best. The premiums usually represent less than one half of a client’s net worth and are typically in the 10-40% range.

... To fund a PPLI policy, Chesner and Giordani favor using a private split dollar structure, which acts as intra-family loan. The attorneys on the advanced planning team set up two ownership entities in the form of trusts. The first one exists completely outside of the patriarch or matriarch’s estate (and perhaps offshore) for income-tax and estate-tax purposes. It owns the policy.

The patriarch, for example, owns the second trust, which can be included for income tax purposes. ... The real advantage of this arrangement is that the significant growth of the PPLI cash value and death benefit (minus the premiums and interest) occurs outside of the estate and free of income and estate taxes.

“You can start moving the needle to really help mitigate the transfer tax,” says Chesner. “It depends on how much insurance the client buys”

Setting up a PPLI Policy
After the client education stage, advanced planning teams focus on five areas:

• Insurance underwriting—In the overall scheme of a PPLI policy, the cost of insurance is relatively inexpensive if the insured is in good health and doesn’t bring underwriting baggage. ...
• Financial underwriting—... Large PPLI face amount policies take longer to place than average-sized policies.
• Investment research and selection—... A PPLI is usually embedded within a comprehensive financial plan, complete with growth scenarios and cash flow projections.
• Funding the policy—Substantial tax and planning questions lead to solutions such as private split dollar and other solutions.
• Domestic vs. offshore ownership—The advanced planning group will need to analyze the benefits of domestic vs. offshore ownership—and the best ownership entity.

Obviously PPLI is not for everyone, but for those clients who are concerned about estate taxes and have sufficient assets to protect, it’s an option worth exploring.

---

Lewis Schiff is the principal of Advanced Planning Group, a family office network for advisors. His latest book, The Middle-Class Millionaire, was published in January 2008. He can be reached at lewisschiff@advancedplanning.org.

By Elizabeth D. Festa

From the August 2008 Issue of Investment Advisor Magazine

Michael Salley ... [left] a long career as a wirehouse rep at Merrill Lynch and Prudential Securities ...to start Salley Wealth Advisors Group, LLC, in Summerville, South Carolina ...

... Americans are living longer and longer, and for Salley, “the question is not the return on investment, but how do I manage my clients’ assets to make sure that I don’t outlive them.”

Thus, Salley likes to use a group annuity when it comes to a 401(k) plan. “I use the variable annuity quite extensively with retirement plan assets because it is the only thing I can show my clients that has a guarantee against market risk,” he says. ... Baby boomers with very large IRA and 401(k) balances get Salley’s explanation that they have their boat insured, they have their house insured, so why not insure their 401(k) plan with an annuity? An annuity within the 401(k) makes sure there is a guaranteed income stream despite what the market does.

Salley ... also says the new guaranteed living benefits are a tremendous tool for the investing public, “especially during these extremely volatile times,” and he likes that they can be extended to the spouse as well.

With continued globalization, a large percentage of stock market opportunities are outside the U.S. and there is a lot of uncertainty, so using an annuity in a qualified plan because of the safety and the benefits means the results for clients are actually guaranteed, he says.

An insurance company’s key concern is to stay invested—the assets are preserved for the family and the annuity owner, Salley claims. ...

Major insurance companies now use a multi-manager investment platform that gives access to some of the brightest portfolio managers on Wall Street. Many contracts offer over 50 options to choose from in addition to a menu of asset allocation portfolios, Salley says.

... Now annuities are available with 18 different mutual fund companies on the investment platform so there is a wide choice of investments, he notes. ...

---

Elizabeth D. Festa is a freelance business writer based in Washington, D.C. She can be reached by e-mail at elizabeth.d.festa@comcast.net

If your clients have to surrender a settlement to reimburse their insurer or employer, will their assets support their needs?

Investment Advisor Magazine May, 2008

By Marlene Y. Satter

This is a story about a threat to your clients of which you may not be aware, but that you can do something about. It starts with a woman named Deborah Shank who stocked shelves at a Missouri Wal-Mart. She was seriously injured in an automobile accident, was permanently disabled, and now lives in a nursing home. ...

Shank was one of the “lucky” Wal-Mart employees in that she did have medical insurance, and indeed the policy paid out close to a half million dollars in medical bills. But when Shank’s husband negotiated a settlement from the employer of the truck driver who hit her minivan broadside, Wal-Mart sought to recover that money in a process becoming increasingly more common: subrogation. The court stood with Wal-Mart, and Shank has lost every penny of the settlement that was meant to pay for her long-term care, even though the money was placed in a special needs trust. ...

When contacted about the Shank case, Wal-Mart Corporate Communications Director Daphne Moore wrote that the company was “sorry for any additional stress this has put on the Shank family,” and that “Our current plan doesn’t give us much flexibility, so we began reviewing the guidelines for the trust that pays medical costs for our associates and their family members.” Moreover, Moore wrote that Wal-Mart has “decided to modify our plan to allow us more discretion for individual cases,” said the company was “in the final stages of working out the details,” and pledged it “will not seek any reimbursement for the money already spent on Ms. Shank’s care, and we will work with the family to ensure the remaining amounts in the trust can be used for her ongoing care.”

It Can’t Happen Here
... Subrogation is written into many health carriers’ policies...

What is subrogation? It is the practice of recovery by an insurance company of money paid out on behalf of someone who subsequently receives an award or settlement. According to attorney and planner Howard Roitman, of Howard Roitman and Associates in Las Vegas, ... generally most employers, particularly large ones, operate their insurance plans as self-funded, with an administrator or with an insurance company to administer benefits. ...Roitman adds that in the plans’ documentation “they all, or generally all, say that if you get recovery, we acquire a lien on any prospective recovery.”

...Federal law allows plans to be reimbursed for what they have paid out, depending on how they are structured; state laws vary, but some states in addition to Nevada allow reimbursement only after the individual has been compensated for her loss. ...

How It Can Happen
Andrew Tignanelli, an advisor and president of The Financial Consulate, Inc. in Lutherville, Maryland, lays out the following scenario: Your client is driving down the road when he’s hit by another car and seriously injured. Not only has the accident totaled your client’s car, but he’s flown to a shock trauma treatment center and then spends over a year in rehabilitation. When he comes out, he not only bears numerous scars but also has lost various abilities. And he wants to recover what he’s lost.

Calculating the total can add up to serious money. Hefty medical bills of perhaps half a million dollars ... he’s a shell of his former self, having lost more than a year’s income and his business to boot. At $200,000 a year in income and a business worth substantially more, and perhaps a marriage that suffered along with your client, the total is rising. When you add pain and suffering into the mix, the total gets even higher.

Once that total is reached, the lawyers negotiate—assuming that the person who hit your client was insured ... Perhaps an agreement is made to settle for $1 million... That is when you find out that your client’s medical insurance has an “absolute right to subrogate against someone who causes medical damage to you that requires them to pay out medical payments to you.” If any part of that settlement is for medical expenses, the insurer can take it away again.

Where Advisors Come In
According to Tignanelli, an advisor can help in a situation like this in two ways. First, she can help the client to understand what the settlement will be, and second, perhaps she can help negotiate the settlement, working with the attorney to get the best possible outcome. “Maybe getting [the case] settled is not in the best interests of the client,” he adds, pointing out that structured settlements can work more in favor of the client than a lump sum. ...

Show Me the Money
...So what is a structured settlement? It’s an agreement by the insurance company and the plaintiff to a payout over a period of time as opposed to a lump sum payment. ...

... Medicare, Medicaid, and worker’s compensation “will lien against settlements,” [Tignanelli] warns. They “have a legal right to put their hands out” and it is the plaintiff’s attorney’s responsibility to be sure the settlement is large enough to allow this. ...

Getting Around the Situation
Rick Shapiro, of Investment & Financial Counselors in West Hartford, Connecticut, further suggests, as do Tignanelli and Roitman, to insure against such a situation by, literally, insuring. Roitman suggests uninsured motorist coverage, or UIM, “preferably some kind of umbrella policy that runs $2 million to $5 million; the key being that much UIM coverage, not just liability coverage.” He also suggests taking the maximum amount of medical payments coverage available from auto insurance, and getting supplemental health insurance coverage.

Shapiro further says that clients should carry both disability and long-term care insurance, ...

The final word on protection, of course, is your client’s. It’s up to you to educate him and make sure he understands the risks and the high cost of ignorance.

---

Marlene Y. Satter, a freelance business writer based in New Jersey, can be reached at harpwriter@verizon.net.

Journal of Financial Planning November, 2007

by Richard F. Stolz

...Why are so many consumers underinsured? What are the gaps in P&C coverage that financial planners need to be on the lookout for and what coverage is appropriate, both for the average client and the affluent client? How should planners go about being sure those gaps are being properly filled? How will the client pay for additional coverage? And what is the planner’s role in all this if they don’t sell P&C coverage?...

Common P&C Gaps

...The most pressing risk management issues for the vast majority of clients, say planners and P&C specialists, revolve around getting the right auto and homeowners policies in place.
“According to the Professional Insurance Agents of Wisconsin, practically two out of three homeowners are underinsured,” asserts David Shaffer, a P&C professional based in Walnut Creek, California.
“One of the classic things we see from clients coming in,” adds Kevin Gahagan, CFP®, of Mosaic Financial Partners Inc. in San Francisco, California, “is they’re underinsured for catastrophic risks to their home, when you look at the cost of replacement coverage.”
“Most policies provide rising coverage for inflation,” Gahagan adds, but they often fail to keep pace with construction costs—at least where his clients live.
...Additional caveats and pointers on securing adequate homeowners insurance protection include

• Appraisals. If a home is particularly valuable or has special decorative or architectural features, have it appraised by an appraiser approved by the insurance company, rather than simply relying on standard replacement-cost formulas tied to square footage or neighborhood real estate prices. ...
• Contract language. Pay attention to contract language specifying whether a damaged or destroyed home will be fixed with “similar” or “like-kind” materials. ...
• “Extended coverage” provisions. “... It’s supposed to provide an additional benefit under extraordinary circumstances, such as a surge in construction costs that could occur in the wake of a natural disaster in which the demand for construction services spikes. ...“The consumer is expected to maintain the appropriate level of core coverage,” he says.
• Personal property replacement. “Some carriers may offer some kind of cash settlement—they’ll just write you a check for lost property,” says Gahagan. “Others will just reimburse you if you go out and buy the lost items. That’s very different.”
• Miscellaneous limits. On high-end homeowners policies, you won’t find as many limits on reimbursement for damage caused by such hazards as backed-up sewer lines, says Tod Aronson, a seasoned (and third generation) P&C professional with E.R. Munro & Co. in Pittsburgh, Pennsylvania. ...

In addition, Clark D. Randall, CFP®, of Lincoln Financial Advisors, in Dallas, Texas has compiled the following short list of common gaps in clients’ P&C coverage that result more from taking short-cuts or from simple oversight, than from any technical issues buried in insurance contract language.

• The general contents of the home are covered as a percentage of the home’s value. “This is arbitrary and should be reviewed for accuracy; the homeowner should have his contents documented,” Randall says.
• Valuables—jewelry, antiques, and so forth—have not been scheduled and are not adequately covered.
• Improper coverage for a home that has been retitled into a trust.
• Lack of proper coverage for jet skis and ATVs.
• No coverage for flooding. (Flood damage doesn’t only hit homes situated in coastal areas or on riverbanks, and coverage is more widely available than many believe.)
• Lack of proper coordination between a base auto or homeowners policy and an umbrella policy that leaves a significant coverage gap.

Nanny Hazards

...Clients typically treat them as independent contractors and not employees—potentially a very costly mistake, Randall says.
But is the nanny really an employee?
“If she’s there every day, and you’re telling her when to get there, what to do, she reports to you, and you can fire her, then you need to consider her a W-2 employee,” Randall says. ...

Special Risks

Of course, the property-casualty industry can plug more esoteric exposure gaps for clients with special needs, low risk tolerance, or both. ...
Other specialized policies of possible interest to high net worth clients cover the risk of having to pay a ransom to gain release from kidnappers, ancillary losses related to burglaries, damage and personal injuries sustained at large parties and events, and litigation associated with service as a director on a corporate or charitable organization board, among others....

A Drain on Investments?

.... An illustration offered by David Shaffer, the P&C broker in Walnut Creek, makes the point: Raising the deductible on a particular $500,000 homeowners policy from $500 to $1,000 essentially buys an additional $100,000 in coverage. Similarly, raising the deductible from $500 to $5,000 results in a 5 percent drop in premium, and a 40 percent increase in maximum coverage, to $700,000....
Richard F. Stolz is founder of Publishing Services & Strategies, a communications consulting and marketing services provider based in Rockville, Maryland. He has been writing about personal and corporate finance topics for 25 years.

Financial Advisor Magazine October, 2007

By David J. Drucker
    It used to be that “all perils” coverage was superior to “named perils” coverage. In the former case, all perils are covered unless specifically excluded. In the latter case, only named perils are covered. What’s transpired over the last decade is that major insurers now exclude so many perils—such as previously covered interior water damage or broken pipes—that there is little difference between the two policy forms.

In The Beginning
    Says Peter Lindholm of the insurance agency bearing his name in Albuquerque, N.M., “In the beginning, so-called ‘all-risk’ policies had no exclusions except for damages attributable to war. Even acts of God weren’t excluded. Today, homeowners policies exclude coverage for child molestation unless the homeowner purchases an endorsement. Back about ten years ago, when this risk wasn’t excluded, attorneys realized they could get a piece of the $100,000 or $300,000 personal liability protection each homeowner had in his policy by encouraging child molestation claims. All the homeowner had to do was say to his neighbor, ‘Hey, I don’t like the way you’re looking at my daughter,’ and insurance companies were forced to pay up.”

   Another cause was the mold damage controversy of 2000 that led the state of Texas to require homeowners policies radically different from those offered in all the other states (a sort of homeowners insurance equivalent of California’s unique auto emission control standards). “After policies issued in Texas had long ago excluded mold damage, Judge John Dietz overruled that practice in a high-profile case forcing insurers to cover mold damage claims, raising the average claim from $3,000 or $4,000 up to $15,000 to $20,000. It also gave rise to a whole new industry: mold restoration companies. These companies would encourage homeowners to look for mold in ductwork or mold damage to carpets and furniture, advising them that their insurance would cover the cost of restoring those items.” 

   Of course, Hurricane Katrina provides a more recent example of the same phenomenon. State Farm, insuring many of New Orleans’ damaged homes, denied coverage for water damage caused by the city’s broken levees; yet U.S. District Court Judge L.T. Senter overruled the company in January 2007, saying State Farm hadn’t proved that the damage to the levees wasn’t caused by the hurricane or wind—a covered peril.

    But regardless of where you stand on these rulings, it’s important to realize that, through a series of legal and economic maneuverings, insurers have been put to the test and their efforts to remain profitable have squeezed homeowners in ways that blindside most.

What We Don’t Know Can Hurt Us
    Frank Presson of Presson Financial Associates LLC in Tucson, Ariz., says of the condominium he owns upstate in the Flagstaff area, “The owner of the unit above me didn’t have his utilities turned on when the temperature dropped into the single digits while he was away last November. His sprinkler system froze and flooded four units, mine being the worst, suffering $44,000 of damage.” The neighbor’s insurer covered his liability to Presson and the other neighbors but wouldn’t cover his own losses. Why?  “The company considered his not having turned on his utilities an act of negligence,” says Presson.
    In other cases, the property and casualty industry has allegedly denied fire claims where homeowners failed to clear brush over large areas of their property or install fireproof roofs; failed to pay storm-related claims where homeowners did not install permanent storm shutters; and some carriers in hurricane-prone eastern states are declining to insure any home not built to 2001 building codes for high-wind resistance.

The System Is Broken
    Bottom line—the system is broken. Homeowners policies with lists of exclusions spilling over onto additional policy pages have become the norm. Determining the causes of and responsibility for covered losses has become a subjective endeavor. Insurers say they’ve become unduly pressured by erratic court rulings and governmental pressures, forcing them to abandon heretofore profitable markets. Homeowners have become highly skeptical as they pay dramatically rising premiums for increasingly less comprehensive coverage.

   Is anyone paying attention to this mess? Kevin M. McCarty is. As commissioner of the Office of Insurance Regulation for the state of Florida, McCarty’s well aware of the evolutionary path homeowners insurance has taken. “We’ve come full circle,” says McCarty. “In the beginning, homeowners insurance was just for fire coverage. Then liability was added, as well as theft and other extended coverages. These policies finally evolved into all-perils coverage. Then, with hurricanes and other natural disasters becoming more common, insurers have engaged in much stricter underwriting and dramatically changed their policies so that most policyholders—even sophisticated people—would be surprised to find they don’t have the coverages they used to have.”

   McCarty, long a defender of seniors and minorities, understands both sides of the issue. “Companies are looking at how they calibrate their book of business, particularly after their experiences of the last few years. To preserve their return on investment, they’re having to shift away from insuring older buildings and coastal properties.”

    But isn’t that what the actuarial process is all about—anticipating losses based on past experience and setting premiums accordingly? Yes, but sporadic disasters undermine this process. “The worst storm in the Gulf area prior to Katrina and Rita was Camille back in 1969; [before Katrina], most people just thought they no longer needed flood insurance,” says McCarty.

    What he says is needed is a model all-perils policy, available in every state, that truly is for all perils, so policyholders and insurers don’t have to establish what peril their damage was caused by. “When a house is completely wiped out, it’s hard to determine if the wind blew the house down before the water came along to damage it further,” McCarthy says. Such a policy would exist in the context of a strategic national catastrophe plan, he says, that would require local governments to prepare a plan for disaster, establish a prefunding mechanism for uninsured losses and require uniform building codes. Adds McCarty, “There is no uniformity of disaster preparedness among the states. Instead, the federal government just opens its checkbook when disasters come along.”

Educate, Educate, Educate
    As a member of the National Association of Insurance Commissioners, McCarty and other state commissioners do public outreach and consumer alerts to get people to ask questions of their insurance agents so they can be better versed about what’s in their policies. “But Florida takes it one step further,” says McCarty. “We’ve developed a consumer checklist that consumers and advisors all over the country can use.”  (For your copy, visit http://www.floir.com/pcfr/HO ChecklistRule.htm).

    Ultimately it’s sobering to realize that the property/casualty industry, selling homeowners insurance as an essential piece of every client’s financial plan, is just as impaired as the health-care industry or Social Security. The U.S. has tough challenges ahead in repairing these systems, so critical to its citizens’ financial well-being. Financial advisors can and should play a more active role, recognizing that, for most Americans, their home is the most valuable asset they have. “If they don’t build a moat around the castle,” says Commissioner McCarty, “they’re in a position to lose much of their financial security.” 

An independent financial advisor since 1981, David J. Drucker, M.B.A., CFP, lost a fight with Farmers Insurance, which paid nothing on his claim for extreme damage to his home caused by snow and ice in December 2006.

Financial Planning Magazine

Get your clients the full-service homeowners policies they don't know they need.

By Jeanne Lee
August 1, 2007-   When it comes to insuring their luxury mansions and multimillion- dollar beach houses against floods, fires and other catastrophes, wealthy homeowners often have a kind of financial blind spot. Even otherwise savvy clients may default to the same basic homeowners policy year after year, perhaps increasing the dollar limit as their net worth expands, but neglecting to evaluate the quality or depth of coverage. 

  Two-thirds of people living in homes worth $1 million or more are insured through a mass-market insurance carrier, according to Chubb Group, which focuses exclusively on the high end of the market.  

    Property and casualty (P&C) coverage is becoming more critical as today’s baby boomer clients get past the stage of accumulating wealth and focus more on wealth preservation. “The affluent client needs access to the high-end insurance agent and doesn’t know where to find one,” says Gary Rathbun, chief executive officer of Private Wealth Consultants in Toledo, Ohio. “I don’t sell P&C insurance, but we need to have those relationships—it’s just part of the service we provide. It’s important to really spend time on inter-viewing and partnering with the right [P&C] firms—and the networking is not something that you’ll get paid for. But it will pay off for your client.”

  THIS OLD HOUSE

  Although affluent clients may not realize it, their complex insurance needs—if they have multiple homes filled with expensive art and furnishings—go far beyond a rider to cover great-grand-mother’s silver. To start, there’s the issue of how to properly determine replacement cost for a custom-built house that may have unique architectural features, uncommon materials or one-of-a-kind craftsmanship. “We find that reconstruction costs are often set too low,” says Cary Hager, an independent insurance agent with Insurance Office of Central Ohio in New Albany, who specializes in high-net-worth clients. “Many agents are not accustomed to how stonework, say, or certain types of crown moldings add significantly to the cost per square foot.” 

    Appraisers also take stock of the contents of the home, to make sure that antiques, jewelry, art or expensive collections are covered. “I’ve found $50,000 hand-tied silk rugs that the owner inherited, and never realized were an insurable asset,” says Hager. “I call it the Antiques Roadshow moment.” 

  The appraisers may offer tips to help prevent losses, such as making sure that valuable paintings are never hung over working fireplaces. 

  TESTED BY DISASTER

  Many meteorological experts are predicting that environmental factors will make our weather more violent. This means expensive coastal property could become even more vulnerable to storms. Insurers are learning to be proactive.   

  Many insurers shy away from coastal risk. While the federal government runs a flood insurance program that will write up to $250,000 per house, high-net-worth clients obviously need more coverage. 

    Planners need to make sure that the language in clients’ contract specifies in-kind and quality replacements. “This could mean the difference between getting a mahogany door, or just a door,” at claim time,says Maureen Hackett, vice president of AIG’s private client group. They also need a guaranteed replacement endorsement, which covers the difference if rebuilding will cost more than the value of the insurance policy.

   The gap between market value and replacement cost can be especially pronounced in the case of a period house with historical value. For instance, owners spent $3.5 million to rebuild a house in Salem, N.Y., that had been designed by the famous architect Stanford White—even though the house had been estimated to have a market value of only $1.5 million. The Chubb policy paid to replicate the original architectural style in period-appropriate materials because it contained an endorsement known as “law and ordinance coverage,” which provides extra funds to make sure the new structure will meet modern building codes. “If you don’t have that built into your policy and you have a historic dwelling, you’re on the hook for the additional costs,” says Mark Schussel, vice president and director of public relations at Chubb. 

   When disaster strikes, deluxe carriers make accommodations that would be out of the question with a standard-issue contract, including generous allow-ances for living expenses while a house is being rebuilt. In the case of the Stanford White house, Chubb provided $10,000 per month toward the rental of a comparable house nearby during the months of reconstruction. 

NEW RIDERS

  In the past two years, carriers have rolled out more specialized coverage for the affluent market. Clients who frequently travel overseas may be interested in Chubb’s Signature Passport endorsement, which provides up to $250,000 for emergency medical transport. “If you are in equatorial Africa on safari and are badly injured, they can get you to France, England or all the way home,” Hager says. 

   Another risk clients may overlook is the potential for a lawsuit by a nanny, personal assistant or other domestic employee for sexual harassment, wrongful termination or discrimination. 

  Finding the proper homeowners insurance for a high-net-worth individual may require the joint efforts of a financial planner and an insurance specialist, if for example, an affluent client puts his or her home into a trust. 

  “Now that the trust is the owner of the home, jewelry and art which was covered by the homeowners policy may no longer be covered,” says Elizabeth Jetton of Mercer Advisors in Atlanta, and a past president of the Financial Planning Asociation. “If I have a high-net-worth client with a very complicated potential loss situation, I would absolutely sit down with an independent insurance agent, because I am the advocate for the total financial picture for that client.”

(c) 2007 Financial Planning and SourceMedia, Inc. All Rights Reserved.
http://www.Financial-Planning.com http://www.sourcemedia.com

By Hannah Shaw Grove and Russ Alan Prince

July, 2007 Financial Advisor Magazine

Knowing what to do is one thing; knowing how to do it—and to keep it done—is where the advisor shines.
    Operationally, the wealth protection process is comprised of the following six phases, but should not be treated as an incontrovertible process. If utilized as a broad conceptual model, it can guide the wealth manager and the client as protection objectives are established and met. The six phases are:
    • Phase 1: The At Risk Assessment
    • Phase 2: Evaluate Alternative Solutions
    • Phase 3: Select Solutions
    • Phase 4: The Action Plan   
    • Phase 5: Implementation
    • Phase 6: Follow Through 
    As with many wealth management offerings, wealth protection will invariably require the use of outside experts throughout the process.

Phase 1: The At Risk Assessment
    During this phase the basic protection concerns and needs of affluent clients are identified. Success in each of the subsequent phases of the wealth protection process is reliant on the risk assessment being as complete, thorough and accurate as possible.

Phase 2: Evaluate
Alternative Solutions
    Both asset protection and physical security will have an array of solutions and these must be considered and screened in the context of the individual or household they have been proposed for. An important method for evaluating wealth protection solutions is the following conceptual algorithm—the net value of a security solution:

Net Value of a Security Solution = 
Intensity x Duration
Lifestyle Issues x Financial Issues
    Every wealth protection solution has four variables that can be modified within set parameters. One is intensity: How concentrated should the security solution be? Another variable is duration: How long will the solution be active? The denominators are lifestyle considerations—the extent to which a wealth protection solution is an impediment to your client’s lifestyle—and financial considerations, or the costs of using a particular wealth protection solution.

Phase 3: Select Solutions
    Once the most appropriate and effective solutions have been identified, it is time for the wealth manager and the client to select those that best fit their needs and overall wealth protection goals. Using hypothetical scenarios can often help a client identify those issues that are of greatest personal concern and those areas with the greatest risk exposure.
    Some of the questions wealth managers can use during this phase include:
    • What if someone kidnapped your daughter?
    • What if you were being followed everywhere by an obsessive fan?
    • What if a teenager claimed to be your illegal offspring?
    • What if someone is listening in on all your phone calls and is reading all your e-mails?
    • What if a stranger knows how much money you have and where it all is?
    • What if someone steals your identity and empties all your accounts?
    • What if someone filed a frivolous but very real lawsuit against you for $50 million?
    • What if you found your private jet trashed the next time you boarded it?
    While these types of scenarios are unlikely, they are still possible. The following algorithm can be useful when evaluating a potential incident and its solution, as it can help affluent clients perceive each within the confines of their personal circumstances.

Need for a Wealth Protection Solution =
Probability of Incident x Severity of Incident
    Once complete, the wealth manager and the client should work together to rank the incidents by the degree of negative impact. And finally, as a generalist, the wealth manager should maintain focus on the client’s overall goals and not be persuaded by the zeal or enthusiasm of a specialist to adopt a strategy that is not the right fit.

Phase 4: The Action Plan
   Once the advisor, specialists and client agree, each solution is customized for the client and a detailed proposal and blueprint for implementation is drafted. The overriding goal of the action plan is to give the client a clear sense of the steps required to secure their financial and personal property.

Phase 5: Implementation
   The action plan can serve as a To Do list of sorts, and next steps are relatively straightforward. This phase always requires a significant amount of work on the part of the specialists and the wealth manager, and is often where the process is derailed by unanticipated issues or mired in legal and contractual paperwork. A successful implementation will require ongoing involvement and commitment from the client and all the professionals.

Phase 6: Following Through
    Both our statistical studies and our anecdotal experiences confirm that many wealth managers and their clients make a critical mistake after the implementation phase by not following through on the plan to evaluate or modify its components. Effective follow-through includes these regular activities:
    • Environmental scanning. Work with the protection specialists to stay abreast of any changes impacting both wealth protection disciplines and to what extent your clients’ plans are affected.
    • Client-driven contact. Changes in the client’s life, whether marital, lifestyle or geographical, can have a material impact on a wealth protection plan. When this occurs, the wealth manager should update the client profile and reevaluate the efficacy of the plan.
    • Ongoing and periodic reviews. Wealth managers meet with clients on a regular basis and wealth protection requires the same level of attention. Periodic meetings provide a forum for feedback and a chance to observe various protection strategies as part of the overall wealth management experience.
    Adopting a systematic approach to wealth protection can help make a serious and sometimes unpleasant task proceed more smoothly for all parties involved and ensure that the result is a plan that delivers protection and peace of mind for the wealthy client.

Hannah Shaw Grove is the author of five books on private wealth and advisory practice management. Russ Alan Prince is president of the consulting firm Prince & Associates.