New techniques can help you help them.
Protection of all sorts is an overriding concern for
high-net-worth individuals. First and foremost, they want to protect
themselves and their loved ones from harm. As a result, many wealthy
individuals and families employ security experts and bodyguards to
ensure the physical safety of their inner circle. Next, they want to
protect the assets-tangible and intangible, liquid and illiquid-they
have amassed over the years from unexpected threats, such as
irresponsible lawsuits, or known quantities such as children, in-laws
and former spouses.
As expected, the greater an individual's assets are,
the greater the requirements will be for protection. And while the
ultra-affluent-those individuals or households with a net worth of $25
million or more-have much to safeguard, they also have sufficient
assets to allow a sophisticated and innovative advisor to use
cutting-edge financial and legal techniques that are only viable past a
certain asset threshold.
Asset protection should not be approached as a
substitute for a financial plan, but rather one component of a
broad-based plan that might include such activities as investment
planning, tax planning and estate planning. In many cases it should,
however, be regarded as prelitigation planning. For the majority of
situations, the plan must be complete and the protective structures in
place prior to any event occurring that may place the assets at risk,
such as a divorce, a failed business arrangement or an accident.
The preferred scenario for most wealthy clients is
to avoid litigation and, in effect, asset protection planning is
"insurance" against costly lawsuits in the form of a deterrent. In our
experience, the best asset protection measures are never tested in
court because the plaintiff concludes that pursuing the lawsuit will be
too costly, time-consuming and difficult given the structure of the
assets, and opts to settle for significantly less out of court. This
is, of course, the desired outcome for anyone who embarks on the asset
protection process.
The Basics
We define asset protection planning as: The process
of employing risk management products and legally acceptable strategies
to ensure a person's wealth is not unjustly taken from him or her.
At its most basic, asset protection is a form of
legal planning that borrows from several legal fields simultaneously,
such as international business law and tax law, to craft a customized
solution for a client. Many top-notch asset protection plans capitalize
on current tax laws in combination with specific risk management
techniques, such as hedging, to create a seemingly impenetrable
defense.
Most financial advisors are in a good position to
identify asset protection opportunities for their clients. As they
undertake other financial planning activities, they can do so with an
eye toward the inherent vulnerabilities of their clients' portfolios.
More often than not, devising and implementing asset protection
strategies will require the involvement of a specialty attorney, and
wealth managers with a network of strategic partners will be prepared
to capture the business opportunities as they arise. Delivering a
qualified expert to wealthy clients is an expected part of the wealth
management experience and will reinforce an advisor's role in managing
complex financial affairs.
Select Strategies
For The Ultra-Affluent
An advisor and a client can explore a variety of
methods to protect assets, and a subset of those methods are restricted
to use with a sizeable base of assets. The balance of this article
discusses three techniques-private agreements for liability insurance,
advanced equity stripping and "floating islands"-which can be used by
and for the ultra-affluent.
Private Agreements
For Liability Insurance
The starting point for all asset protection planning
is liability insurance, but many wealthy individuals need more coverage
than traditional policies can provide. Private agreements are a way to
obtain more extensive, highly customized insurance through an
arrangement between the insured and a deep-pocketed third party, such
as a family office or a hedge fund. Some of the fundamental mechanics
include: an upfront appraisal of the risks involved; the escrow of
funds, many times in offshore trusts; and hedging the risks against
relevant benchmarks. Without question, private agreements can be very
complicated to structure and will require the input of a professional
advisor, a risk management professional and an attorney. But under the
proper circumstances these agreements can prove quite profitable and
effective for all parties.
Private Agreement Example: Piers, an international
businessman with a net worth of US$60 million, wanted more liability
coverage than was available through conventional products. He found
other individuals with similar needs and formed a consortium of six
families with an aggregate net worth of US$280 million. Together they
established a limited liability company and entered a private agreement
with a hedge fund. The fund escrowed US$600 million of its own assets
and manages the LLC's money within a specified risk corridor. The
agreement allows for automatic adjustments in the LLC's investment
strategy when risk-adjusted performance targets are achieved. The
escrowed money becomes the "insurance policy," providing the desired
amount of coverage for Piers and the other families, and the hedge fund
profits from a combination of management fees and the growth of the
escrow account.
Advanced Equity Stripping
The objective of equity stripping is to reduce the
net value of assets by securing a loan against them, diminishing their
appeal to creditors while still making them accessible to the owners.
Equity Stripping Example #1: As part of a long-term
plan, Gregor placed his personal and commercial real estate holdings
and an art collection worth roughly US$50 million in a series of
trusts. The assets were appraised, then leveraged in the form of loans
from a commercial bank. Gregor invested the loans with a goal of
outperforming the interest rates on the assets. In the meantime, the
bank sold a promissory note for the loans to a private lender where
Gregor was a principal. If he is successful, Gregor will have a net
inflow of investment income and direct control of his attached assets,
while potential creditors will see only encumbered assets with the
commercial bank as the lender.
Equity Stripping Example #2: Jacqueline has been a
successful hedge fund manager for more than a decade and was
increasingly concerned about the number of unjustified investor and
class action lawsuits. She cross-collateralized her residences and her
collection of antique jewelry by taking two loans from commercial
lenders. The lenders, in turn, placed the loans in trusts and sold them
to the hedge fund where she is a partner. With the help of her
financial advisor and his network of experts, Jacqueline established a
captive insurance company to hold the assets from the loans and create
another level of protection. Jacqueline still uses both her homes and
enjoys her jewelry, while the assets in the captive insurance company
help her self-insure against personal or professional litigation.
"Floating Islands"
The objective of the "floating islands" strategy is
to continually move assets from one jurisdiction to another while
gaining incremental tax-adjusted returns by capitalizing on the
different and changing interest rates, tax treaties and exchange rates.
The movement is automatic but not regular, and is generally driven by a
set of computerized algorithms making it difficult for creditors to
track with accuracy.
"Floating Islands" Example
In her early forties, Beatrice assumed a controlling
stake in her family's drilling equipment businesses. After her second
divorce, she worked with a team of experts including her counsel, a
private banker, a tax specialist and a quantitative professional to
develop a program to automate the movement of approximately US$160
million from one offshore jurisdiction to another. This strategy is not
about avoiding taxes; Beatrice has homes in three countries and paid
taxes in all of them in each of the past five years. The approach has,
however, helped her elude the divorce attorneys and forensic
accountants hired by her third and fourth husbands.
For years, high-net-worth individuals have been
targets of speculation from those infatuated with the wealth and status
of upper crust society. And while most speculation is not harmful, some
is, and can breed closer interest and scrutiny than is comfortable. As
a result, more and more wealthy individuals are turning to professional
advisors for assistance with asset protection planning. An advisor that
can deliver fresh thinking, top-notch experts and proven strategies to
ultrawealthy individuals will cement their role as a trusted counselor
and open the door to bigger opportunities and partnerships down the
line.
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.