Risk is a four-let­ter word

Pro­tect­ing your­self can help you pro­tect your clients

Accounting Today - - Assurance - By John P. Napoli­tano See RISK on 21

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 some- thing 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

John P. Napoli­tano, CFP, CPA, PFS, MST, is CEO of U.S. Wealth Man­age­ment (www.uswealth­napoli­tano.com) in Brain­tree, Mass. Reach him at Johnpnapoli­tano on Linkedin or (781) 849-9200.

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