Most people have an inadequate understanding of the role of liability insurance in asset protection planning.
That role is very important role. In fact, liability insurance is the first and primary line of defense in the asset protection cache of weapons for the protection of assets.
Many litigation cases show that the existence or non-existence of liability insurance has made the difference between whether an asset protection plan survives attack or not, or if the plan is challenged at all. The reasons for this are practical and technical.
When one of our clients seeks asset protection planning, we follow the following steps:
- Learn about the client’s liability exposures,
- both for the person (and family) and
- for the client’s business.
- Inquire into what liability insurance the client has in place for those exposures, including learning the scope of the coverages and the policy limits.
- Inquire as to whether the client has personal or business umbrella insurance, and the limits of those policies. If the client has significant liability exposures that could be covered by insurance, but are not currently covered, we suggest to the client that before any asset protection planning is undertaken that the client meet with his or her insurance broker and see if such insurance can be procured, or policy limited increased, etc., as the case may be.
There are sound reasons for doing this sort of exploration before the client embarks on any asset protection planning.
The technical reason is the easiest to explain:
In some cases, insurance coverage may count towards solvency. Asset protection planning inherently involves consideration of fraudulent transfer issues which often focus on insolvency, and the existence of insurance coverage may go to the issue of whether the client or the client’s business was insolvent. Thus, before the client makes any transfers for asset protection planning purposes, the client should have as much insurance in place as can reasonably be procured, since the greater the insurance coverage the less likely the client may be determined to be insolvent.
The practical reason for making sure that adequate insurance is in place is that if a particular claim is covered by insurance, then the asset protection plan may never be activated in the first place. Even if a claim exceeds policy limits, in most cases there will still be a settlement within policy limits because of the risk of litigation.
Observation: Usually, trial lawyers representing plaintiffs will accept a check for a large policy limit in exchange for a settlement in full. That’s what trial lawyers are known for: Negotiating with insurance companies for the limits of coverage (assuming it is adequate), and then moving on to their next case. Attempting post-judgment enforcement is avoided. Frankly, the vast majority of trial lawyers do not know where to even begin trying to collect on a case where the insurance company has not paid off, so in the rare cases where that happens, they go out and find creditor’s rights counsel (which they’d rather not do because it usually means that their own fees will be reduced).
What is Insurance?
Insurance is, at it very essence, a vehicle for risk transfer.
For a fee in the form of premiums, the client shifts the risk of something or other happening to the insurance company. If the risk actually materializes, then it is the insurance company which stands liable for the risk and not the client. The client gets to stand back and say, “Here’s a check for my deductible, now it’s your problem.” When a significant covered claim has arisen, there’s nothing better than that — far better than perhaps years of expensive litigation as to whether the plaintiff can somehow pierce the asset protection plan: the reality is, there simply is no such thing as a bulletproof asset protection plan.
In reviewing a client’s coverages, the two things to look most closely are the following:
- the scope of the coverage, i.e., what claims are covered or not covered, and
- the limits of the policy.
As to coverages, what I usually find is that the client thinks that they have insurance against all their exposures, but in fact there are gaps in their policies. Not only that, but only personal injury and property damage claims will be covered by the insurance. Contract and other types of creditor claims are not covered by insurance. For those types of claims, that is where asset protection planning strategies become important.
For instance, in California so-called “wage and hourly” lawsuits are widespread, these being class-action lawsuits brought by former employees alleging that they didn’t get their full 60 minutes for lunch, or something similar. This doesn’t sound like much, but you get a few hundred employees going back four years and it can be a backbreaker for a business — most of these claims go into the many millions. Business owners think that their general liability insurance policy protects against such claims, but it does not. Rather, a special insurance policy, or a rider to an existing policy, is usually required to pick up these sorts of claims.
The other thing we look at is the limits of policies and whether they are adequate for most anticipated claims. What I usually find is that a client will have both a low deductible amount and a relatively low policy limit. Usually, it should be the other way around.
Here it is important to understand that insurance is priced on a so-called “first dollar” basis, meaning that the first dollar of coverage is the most expensive. The lower the deductible, the higher the cost of the insurance. Clients can reduce the cost of their insurance by raising their deductible.
Conversely, when it comes to policy limits, increasing the limit does typically not carry a large cost. In fact, it is often possible to substantially increase the limits of the policy relatively cheaply. The higher the policy limits, the less likely that the client will suffer a so-called “excess judgment”, being a judgment in excess of policy limits. Also, the higher the policy limits, the greater the likelihood that the case will settle within those limits.
What usually makes sense for a client is to increase the deductible and use the extra money to buy a higher policy limit. Consider a situation where if the deductible is raised from $2,000 to $10,000 then the policy limits can be increased by $3 million. If something really bad happens, then the client will be out-of-pocket an extra $8,000. Not a small amount, but probably something they will simply forget in a week or two. Conversely, if the claim exceeded their smaller policy but would have been resolved by the larger policy limits, then you are talking about a situation involving millions in uncovered liability which could make the client miserable for some considerable time.
Note that many larger business use captive insurance companies for the very purpose of covering greatly increased deductibles and thus allowing the business to afford raises to their coverage limits. There is nothing that prevents individuals from using this same tactic and self-insuring their own deductibles, but without not necessarily using a captive.
The single most common situation that I see is that of the client who has no personal or business umbrella insurance, usually because they’ve just never thought about it and their insurance agent has never bothered to mention it to them. Oh sure, umbrella insurance is more full of exclusions than holes in Swiss cheese, but umbrella insurance does tend to cover the very sorts of unforeseeable accidents which ultimately result in asset protection plans being challenged.
Many times, Clients would not have been debtors at all had they spent a few hundred bucks a year for an umbrella policy. The vast majority of these were simple auto accident cases, where the unfortunate but negligent debtor had very low policy limits such as $50,000 or something, but the accident put somebody or several somebodies into the ICU for a lengthy period of time and suddenly just the medical costs alone were north of $500,000. In that case, the insurance company will send its check for the $50,000 to the plaintiff’s attorney, and post its insured a bland letter which basically says, “You’re now on your own.” One day, everything is fine, and the next day they are talking about how easy it will be for the plaintiffs to sell off their home. If nothing else, umbrella insurance treats that very common malady.
Who is reponsible for making the insurance coverage and limits decision
I must make the point that it is not the planner’s responsibility to figure out these insurance issues.
That is between the client and the insurance broker. What I can and should do is to identify the issues, and have the client resolve them before the asset protection planning process begins in earnest
Foolishly, some planners who think that they know something about asset protection planning will actually tell their clients something like, “Once you have your asset protection plan in place, you can give up your insurance coverage because you will not need it anymore.” This is a hidden sales pitch here, because the planner is trying to make the client think that the money that they save on insurance will offset the cost of their asset protection plan (which will, of course, usually just be some junk planning). This is just crazy, for all the reasons set forth above, and a very good indication that such a planner doesn’t have the first clue what they are doing.