The Importance of Insurance Planning in Wealth Management

Why is it Important to Have Insurance?

Insurance is necessary to cover risks that cannot be eliminated or mitigated to an affordable level. Covering these risks is especially important for high-net-worth individuals. If you cannot eliminate a risk, the next best thing is to reduce the potential loss to a level you can afford to absorb. If you’re still faced with a risk after you try to eliminate or mitigate it, you need to consider insurance coverage.

The greater your net worth, the greater the probability that many everyday risks could devastate your financial situation. As a result, insurance planning becomes a critical piece in wealth management. It’s good to have a plan to build wealth, but it’s also important to have a plan to preserve wealth as it’s accumulated. 

How Can Insurance Protect You From Financial Loss?

Insurance protects you from financial loss by covering risks that could result in significant expenses. This is what makes insurance part of a healthy financial plan. When you purchase an insurance policy, you pay premiums in exchange for coverage. If a covered event occurs, such as an accident, illness, or property damage, the insurance company reimburses you for the associated costs, up to the policy limits. This helps you avoid depleting your savings or going into debt to cover unexpected expenses, thereby safeguarding your financial stability and future. 

Key Considerations For a Comprehensive Insurance Plan

Not all insurance policies are created equal. The amount and type of insurance that you need will be dictated by your unique needs and goals. Here are the key issues high net-worth families need to consider when developing a comprehensive insurance plan.

Match Your Insurance Coverage To Your Real Needs

In the mass market, insurance salespeople often offer rough rules of thumb for how much insurance you should carry. That may be acceptable in some situations, but it becomes absolute nonsense at higher income and net worth levels. Increasing wealth almost always brings increasingly complex risks. 

We can look to fine art as a classic example. Most homeowners’ policies won’t cover unique, high-end artwork. If you just bought a policy based on some multiple or percentage of your net worth, you’d lack specific coverage for a key part of your net worth. The ratios just don’t work,

The same is true for life insurance. Because of the many potential uses of life insurance, applying some quick ratio or multiple of your annual income to determine how much life insurance you need won’t work. Such ratios only address the income replacement component of life insurance; they neglect the tax and legacy components.

Understand The Policy Details

Every insurance policy is unique. There are certain common features, but you must read your insurance policy before buying one. Every policy has coverage limits, different deductible limits, and specific exclusions. High-net-worth individuals need to be very specific in identifying which risks they want to cover.

If you can’t find where each specific risk is covered in the policy, ask your insurance agent or a trusted financial advisor to point out the exact sentence or paragraph stating the coverage amount for that risk. A good rule of thumb is: if you don’t understand it, assume you’re not covered.

Evaluate The Tax Benefits Of Insurance

Beyond the simple reimbursement of loss, which is the heart of all insurance policies, significant tax benefits are available in certain situations. Some policy premiums are tax deductible if paid in certain ways from certain sources. High-net-worth individuals often have great flexibility in how and where they pay premiums. 

Benefit payments from the insurance company when you’ve suffered a loss can hold hidden tax benefits worth hundreds of thousands, and often millions, of dollars in tax benefits. In fact, certain life insurance policies owned by tax-advantaged entities offer some of the most generous multi-generational tax benefits.

Many are simple enough to structure, while others require more complex approaches. However, the added complexity can often add several million dollars of tax-free proceeds for one, two, or three or more generations, often extending out 100 years. 

Understanding the potential tax benefits will require the assistance of an experienced, knowledgeable, and 100% objective advisor. The typical insurance agent does not have the training or experience to structure your insurance coverage to provide the maximum tax benefit possible. They suffer from inherent conflicts of interest, where their advice is driven by a sales cycle aimed at earning a large commission. A true 100% objective, fiduciary wealth manager can offer this much needed insight and experience.

If there are any concerns, ask your wealth advisor to stipulate in writing that they provide 100% objective advice and will not sell you an insurance product. This planning is not the place for a sales pitch; ensure you get unvarnished and comprehensive advice.

Consider How Insurance Can Perpetuate Your Legacy

If your stage of life and net worth are such that you’re considering the benefits of multi-generational tax benefits, then most likely, there are legacy goals that you should consider when designing your insurance plan. In many ways, this is an extension of the available tax benefits. If structured properly, you can use life insurance to benefit both a favored cause and your family while in the process, also reducing taxes across multiple generations. 

Several charitable organizations employ “planned giving” or “endowment officers” to sell the benefits of donating to the organization using these strategies. But here again, you’ll benefit immensely by using an experienced and objective wealth advisor to design the right strategy for you. 

Shop Around, But Don’t Be Cheap

Insurance policies are typically sold in what is described as a “relationship sale process.” Policies are sold more on the basis of the relationship between the buyer and the insurance agent (golf buddies, fraternity brothers, etc.) than on the merits of the actual policies. By extension, once the buyer has purchased an insurance policy from a specific insurance company, the buyer overwhelmingly stays with that same carrier through numerous annual renewals.

This is particularly dangerous for high-net-worth families whose situations are unique, whose risks can be enormous, and whose needs change over time. It is absolutely critical that you work with your trusted advisor to identify and design the right type of coverage to fit your needs and then shop around for the right coverage through the right carrier at the right price.

The right price is not the cheapest price. Because of the potentially specialized nature of insurance policies, the cheapest policy – even from an A++ rated insurance company may not be the best policy for you. If a needed coverage option is missing or the benefit is too low, the premiums will be lower than another carrier, and it may not properly cover your risk.

Anticipate Changes In Your Insurance Needs By Reviewing Regularly

Insurance planning and purchasing are not set-and-forget activities. Life changes for everyone, but high-net-worth families often see more dramatic changes in their circumstances and risks than the average American. Growing business, growing portfolios, new business activity, changes in health, additions to the family, etc., all impact your specific needs. The types of risks you can eliminate and those you have to insure are likely to be significantly different today than they were five years ago, and they will still be different in another five years.

Insurance planning in wealth management needs to be ongoing. Each policy anniversary is a reminder and opportunity to review your needs and coverage. Sometimes, that will be a short, easy process; your needs do not necessarily change every year. Other times, the process will need to be more exhaustive and comprehensive.

Over time, your needs and coverage options will change, and based on each insurance carrier’s appetite for certain risks, their pricing for the same coverage can change substantially. 

Add to all this the changes brought about by new tax laws and family additions (kids, marriages, grandkids, etc.), and it’s fairly obvious how disastrous set-and-forget could be.

The Value Of Objective Guidance

Building wealth and preserving wealth go hand in hand; both are critical to successful wealth management across the generations for high-net-worth families. Wealth preservation is usually short-changed in the wealth management process because so few advisors are truly experienced in building and maintaining an insurance plan. It’s much easier to review investment statements and talk about how the portfolio grew or how it will recover if the market is down. It’s that safe place of discussion for most advisors.

It often takes years or decades to build significant wealth, but a single poorly timed event can wipe out several generations of accumulated wealth. We live in a world of real risks, many of which carry significant potential financial costs. You need to evaluate your risks, eliminate those you can, mitigate others, and finally cover the ones that remain and potentially jeopardize your future.

This is not the place for a salesperson’s pitch or shortcut to a commission. It is also not the place for a well-meaning, honest, but inexperienced advisor’s mistakes. If you’re a high-net-worth individual who wants to properly protect your family’s accumulated wealth, you must work with an experienced, 100% objective wealth manager. 

First Financial Consulting has a 45+ year history of successfully growing and preserving our clients’ wealth. We are committed to both sides of this issue; preserving wealth is just as important to us as helping clients grow their wealth. We would love to have that conversation with you to determine how we can help; of course, these initial consultations are always complimentary. Please give us a call, send us an email, or use the link below to schedule your complimentary consultation.