Expert Commentary

Estate Planning Strategies That Cause Major Insurance Coverage Gaps

Property and casualty (P&C) insurance is often overlooked during the estate planning process. This lack of attention to related insurance policies during this process may lead to significant coverage gaps that could derail the purpose of the estate plan if an uncovered loss occurs.


Personal Risk Management
April 2019

Consider a couple who transfers the title for their home into a trust as part of their estate plan. When the title is transferred out of the couple's names and into the trust, the couple relinquishes their ownership of the property. This transfer of title can have a disastrous effect on how the home insurance coverage responds to a loss. This is a clear example of where estate planning and P&C insurance are intertwined and why consideration must be given to P&C insurance when implementing strategies like this.

The above example is just one of many links between estate planning and P&C insurance that individuals, advisers, and family offices need to be aware of. The consequences of estate planning without considering P&C insurance can be devastating to a family should a loss occur that is not properly covered.

The balance of this article will discuss several estate planning strategies and situations that have a meaningful connection to P&C insurance. It will also provide high-level insights regarding how to address each strategy and situation within a well-structured P&C insurance program.

Retitling Real Property to an Estate Planning Entity

There are several types of legal entities that are used in estate planning. Some of the most commonly used entities include limited liability companies (LLCs), trusts, and family limited partnerships. These legal entities are effective tools for reducing estate taxes and limiting liability, but without consideration for the P&C insurance, they may unintentionally result in an uncovered loss.

Suppose a rental property is owned by an LLC, and tenants injure themselves when the deck railing gives way and sue the LLC for negligence. The LLC will need to hire an attorney to defend it in the lawsuit and may also need to pay a settlement. If the LLC does not have the proper liability coverage in place, the LLC will have to pay the costs of this lawsuit out of its operating budget.

Anytime the ownership of a physical asset, such as a personal residence, is changed for estate planning purposes, a corresponding update to the P&C insurance must be made.

An organizational chart of all entities involved with an estate plan can be very helpful to a P&C insurance adviser in designing an insurance program. This will show all estate planning entities along with the assets held by the entity. Lastly, it is not only important to account for the legal entity on the insurance policy, but it is also important to account for trustees, members, and partners related to the entity, as they will also need coverage in the event of a loss.

Coverage Concerns with Private Museums

Wealthy collectors are known to loan or donate their art to museums to share their incredible collections with the public. Another reason this is done is to achieve significant tax benefits. Some individuals and families who own significant collections valued in the millions of dollars may even create their own private museums to garner tax benefits. One example of a private museum is the Brant Foundation Art Study Center, located in Greenwich, Connecticut.

There are significant tax advantages to creating a private museum, but there are also significant risks. Private museums carry the risk of being sued by visitors who may be injured on the property. They also own valuable property that is at risk of being damaged by visitors, stolen by thieves, or destroyed by acts of nature.

Private museums located at the owners' personal residences need special attention because the P&C insurance is often overlooked. Owners may assume that their personal homeowners and valuable articles insurance policies will cover them and the art because the museum is located on their property, but that is not the case. The private museum brings increased liability risks from visitors' foot traffic as well as increased risk of damage to the valuable collections due to them being on public display. In addition, the art and the buildings used by the private museum may have been transferred to a new entity thereby necessitating the restructuring of the insurance policies associated with those assets.

Conducting a P&C insurance analysis with a qualified insurance specialist prior to the formation of the private museum will help ensure it is well protected from risk.

Art Collections and Estate Planning

Wealthy individuals collect art because they have a passion for it or because they see it as an investment. In either case, the sale of a work of art can produce a significant capital gains tax when the market value of the art appreciates from its original purchase price. The amount of the capital gains tax varies from state to state but can be as high as 45 percent.1 This is a significant expense that collectors may seek to mitigate through the use of complex estate planning strategies.

When a collector decides to sell or donate a work of art, an estate planning attorney may recommend the use of a charitable remainder trust (CRT), a family trust, or a private foundation. These estate planning vehicles can help reduce or defer the tax on capital gains the collector would owe after the sale of the art. If this strategy is implemented, the art will be transferred into the CRT, family trust, or private foundation, effectively transferring the ownership of the artwork from the individual to the estate planning vehicle.

In this situation, it is critical that the P&C insurance that provides coverage for the artwork is updated to account for the change in ownership. Even though the art may not have been moved physically, the change in ownership alters how the insurance policy might respond to a loss. In addition, there might be other implications to consider that the insurance company would want to weigh in on, such as whether or not the artwork will be loaned to a museum.

Estate Planning for Blended Families

A blended family is one that consists of a couple and their children from their current and all previous relationships. Estate planning for blended families can be very complicated due to the combination of assets from separate families and the emotions that may exist among the new family members.

Once a blended family is created, it is important for the couple to revisit their estate plan to update beneficiaries, wills, and other important documents to avoid having the estate distributed improperly and to mitigate estate taxes. During this process, an estate attorney may recommend the formation of a trust to hold family assets and distribute them according to the remarried couple's wishes over time.

Two types of trusts that are being used more and more in blended family situations are AB trusts and ABC trusts.2 When one of these strategies is used, the couple's P&C insurance policies will need to be updated to account for any change in ownership of physical assets, such as homes.

An insurance specialist who is familiar with these situations will be able to help guide the couple through the appropriate changes to their policies.

Wealth Management and Embezzlement Risk

The majority of investment professionals are honest and trustworthy, but there are some who devise schemes to embezzle money from their clients. Bernie Madoff is an infamous example of a dishonest investment professional who took advantage of his client's trust and embezzled millions of dollars from them.

Protecting wealth is a primary goal of the estate planning process, and embezzlement risk should not be overlooked during the process. The Madoff Ponzi scheme is a great reminder of how vulnerable investors are to the nefarious behaviors of the people entrusted with protecting and growing their wealth. Clients may trust their investment professional, but they should still be aware of the possibility that they may steal from them. Embezzlement insurance should be considered during the estate planning process as a hedge against the threat of embezzlement by an investment professional.

International Estate Planning and Real Property Risk

There are many factors to consider with inbound foreign investment in real property in the United States, and P&C insurance is among them. Whether the real property is purchased by a non-US person or estate planning entity, the insurance coverage must reflect the proper ownership structure. In addition, it is important for the insurance adviser to understand the short- or long-term plan for the real property, as this could affect the type of coverage that is placed.

Another aspect of international estate planning is setting up foreign trusts to own property outside of the United States. Just as estate planning entities in the United States need special consideration and coverage, they will also need special attention when they are outside the United States.

Self-Insurance and Estate Planning

There are many situations when individuals and families choose not to purchase insurance. This strategy is known as self-insurance. One of the most common examples of self-insurance is the decision not to purchase flood insurance on a home. Others include forgoing hurricane coverage for coastal properties and earthquake coverage in California.

A common strategy used in estate planning is to set up an irrevocable life insurance trust and fund it with a life insurance policy to help pay the estate taxes owed upon the death of the person the trust was created for. A home that is self-insured that sustains a catastrophic loss after the owner's death is the equivalent of having to pay estate taxes without the life insurance in place. Instead of having insurance to pay for the damages, the heirs will be burdened with covering the cost of damages to the asset from the estate or out of their own pockets.

Therefore, if self-insurance is incorporated into a risk management plan for an individual or family, there should be a record of this in the estate plan to ensure that relevant family members are aware of this.

Conclusion

The best way to ensure the links between estate planning and P&C insurance are addressed is to engage a P&C insurance specialist in the conversation. An insurance specialist will understand the strategies being used on the estate planning side and know how to address them in the P&C insurance program.


1 Janet Novack, "New IRS Rule Opens Tax Saving Strategy to Art Collectors," Forbes, September 21, 2016.

2 Craig Smalley, "Estate Planning for Blended Families," American Institute of Certified Public Accountants, June 8, 2017.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

Like This Article?

IRMI Update

Dive into thought-provoking industry commentary every other week, including links to free articles from industry experts. Discover practical risk management tips, insight on important case law and be the first to receive important news regarding IRMI products and events.

Learn More