Insurance as an alternative asset planning tool

The following is an opinion piece provided by Henry Brandts-Giesen, Partner at Kensington Swan. The opinions expressed within the article are not necessarily those of Insurance Business.

There seems to finally be an increasing awareness in New Zealand that setting up of a family trust is not always appropriate or desirable. Unfortunately, a whole generation of families in New Zealand have been advised to set up trusts without much interrogation of the rationale for doing so.

This is all rather curious for a number of reasons including:

• Often the assets held by the trust are encumbered with debt and security to banks or there are substantial settlor and beneficiary current accounts. And so there is not much wealth that is actually being protected by the trust.
• Often the trust has no income, and, even if it does, there are no material tax advantages in New Zealand to having income producing assets in a trust. If indirect ownership is desirable then a limited partnership or company may well be more tax efficient. In any event, New Zealand is a relatively benign fiscal environment compared to most developed countries (we have no inheritance, estate or wealth taxes). I would not be at all surprised if at some point in time elevating the rate of tax on trusts or beneficiary current accounts is considered an option for generating revenue in lieu of capital gains tax.
• Our succession laws are mature and relatively certain. They allow almost unrestricted freedom to benefit whoever we want under our wills. There are some requirements to provide for people to whom we have a moral duty but nothing like the forced heirship regimes that exist in many European and Middle Eastern countries.
• Our laws generally prevent claims being made against individuals for personal injuries caused by negligence. So, if we hit a cyclist while driving, our nationalised accident compensation regime is usually engaged to compensate the victim. The same regime applies if a surgeon makes an error on the operating table. In the US, a legal action for personal injury or medical misadventure would almost certainly follow such events.
• Tax authorities and government agencies nowadays typically look through trusts to the people who set them up and benefit from them. Increasingly the same approach is being taken by courts in cases involving the dissolution of relationships and recovery of debts.
• We have a very shallow pool of genuine trust law and governance experts and a virtually unregulated fiduciary services sector.

Another, often overlooked, reason why it is somewhat peculiar that New Zealanders use trusts so often to protect assets is that we have a well-functioning and relatively sophisticated insurance industry.

Asset protection

A common reason for people setting up trusts is that they are concerned about risks arising from their professional or business activities. Particularly in the case of professionals, I have often found this strategy to be slightly misconceived because it presupposes that the person setting up the trust would go bankrupt rather than pony up to pay a liability which (for the most part at least) would be covered by professional indemnity insurance. I think that would be a rare breed of professional and it is not something I have witnessed in practice.

In any event, transferring the asset in question (e.g. a house) to a spouse prior to taking on the risk is arguably a more robust strategy than to transfer it to a trust over which the professional has control, as so often happens in New Zealand’s “owner-operator” trusts ecosystem.

There is, of course, often value in having assets in a trust for the sole reason that it creates complexity and complexity can help negotiate better settlements with creditors. However, that is a cynical strategy and complexity can also have unintended consequences in other aspects of a person’s asset plan. As a general principal I prefer to keep the lives of my clients as simple as possible.

One way to achieve some of the same benefits of a trust but avoid the complexity is to look to products on the insurance market.

Most readers will be familiar with the concept of insuring against professional liability. There are many options available and, while the premia are a significant cost and the excess can be quite high, most professional services firms would not contemplate (or be permitted by their supervising authority) to go without professional indemnity insurance.

As a general proposition, professional indemnity insurance does what it is intended to do. On the other hand, certain professions and industries can be more difficult than others to insure. Sometimes wealthy families have complex assets that may not be covered by standard fire and general policies and require bespoke insurance cover.

Self-insurance

In certain cases, self-insurance may be an option. This is where a family or business that is liable for some risk, such as medical costs, does not take out any third-party insurance, but rather chooses to bear the risk itself.

In the US, the concept applies especially to health insurance and may involve, for example, an employer providing certain benefits – generally health benefits or disability benefits – to employees and funding claims from a specified pool of assets rather than through an insurance company, as the term is traditionally used. In self-funded healthcare, the employer ultimately retains the full risk of paying claims, in contrast to traditional insurance, where all risk is transferred to the insurer.

Captive insurance

Another option is for the very well-funded business or family (or a syndicate of them) to set up a captive insurance vehicle. This is essentially an insurance company that is wholly owned and controlled by its insureds. Its primary purpose is to insure the risks of its owners, and its insureds benefit from the captive insurer’s underwriting profits.

Private placement insurance

Private placement insurance, is a customised version of insurance not available to the general public. Generally, this type of insurance is offered by an insurer only to “accredited” or “qualified” investors - those who have substantial investable assets, a documented investment track record, and certain income levels.

There can be some advantages to this type of cover including institutional pricing, lower commissions and fees, and the ability to link the policy to investment accounts which offer guaranteed benefits and build cash value over time. Because of the bespoke nature of the policies issued, it is more likely that cover might be obtained for more esoteric assets and challenging risk profiles that might be available in the public market.

Succession planning

Another common reason for people setting up trusts is to facilitate the orderly transfer of wealth between generations of a family. Again I have often found it to be quite curious in New Zealand that we seem to favour shoving all the family assets into an opaque discretionary trust and leaving it for someone else to sort out, rather than use a basic device such as a will to provide clarity and certainty.

Increasingly families are falling out over how discretionary powers in trusts settled by the parents should be exercised in favour of the now adult children. Litigation lawyers are very grateful to a previous generation of property and commercial lawyers who set up so many trusts in New Zealand over the past few decades. The beneficiaries of those trusts are not so appreciative.

One of the reasons for these issues arising is that often the trusts involved hold very valuable but not very liquid assets. This can make it very hard to achieve equality or even a measure of fairness as between the beneficiaries.

One way in which the insurance industry can help to alleviate these issues is by issuing policies over the life of a key person involved in the creation of the wealth (e.g. the family patriarch or matriarch). The beneficiary of that policy might be the trustees of the trust and they would use the sum paid out under the policy to ensure that the next generation are fairly treated under the trust.

Another option is for the adult children to fund the premia on such policies. While it is true that premia become very expensive as the life insured ages, these costs are generally dwarfed by the legal expenses associated with a family feud.

Rethinking traditional asset planning in New Zealand

Using insurance and other financial products for asset planning is common offshore but quite rare in New Zealand, where we tend to do what we have always done without a great deal of logic. Nevertheless, that is changing and families are increasingly thinking about alternatives to the traditional asset planning devices and coming up with more bespoke solutions. As a general principle, we reckon that taking a more intellectual approach and thinking laterally about these matters invariably leads to better client outcomes.