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The Nuts & Bolts of Personal Risk Management
Safeguarding Your Assets
Financial planning involves many components. One important but often overlooked part is protecting the assets you’ve accumulated with property and casualty insurance. For expertise on this kind of insurance, we consult specialists.
So for this article we asked Mitch Freedman, assistant vice president of Lane McVicker Personal Insurance, McLean, Va., for his insights.
These days, as we wake every morning wondering which way the markets will turn, we’re coming to realize more and more the valuable lessons of risk management. For most, that means proper asset allocation, balanced investment strategies and competent financial planning. An appropriate property and casualty insurance program can go a long way toward fulfilling another element of risk management.
The unfortunate truth is that too many of us pay little attention to such a critical piece of our livelihood. Many of us tend to simply gloss over our homeowners, automobile, liability and other insurance contracts, making an annual premium payment and assuming coverage is adequate to protect us. But is it? What would happen if an accidental kitchen fire or wire shortage led to a major or total loss to your home and contents? What if a slick, wet road causes you to temporarily lose control of your vehicle, resulting in an accident involving severe bodily injury to a third party? And what if that lovely diamond bracelet falls off your wrist unnoticed while enjoying an evening at the theater? Unfortunately, none of these scenarios is all that uncommon, yet we seem to take for granted that coverage is there to protect us. Maybe it’s time for a closer look.
Although the residential real estate market continues to struggle, we must be sure to distance ourselves from current market value when it comes to properly insuring a home. The fact remains that even though our home may be worth far less than what it was valued at 12 or 24 months ago, the cost to rebuild it in the event of a fire or other covered loss is no less now than one or two years ago. Market value accounts for the depreciated value of the structure, not its actual replacement cost with like-kind and -quality materials. This is particularly true if you live in a semi- or fully custom-built home.
This brings us to two key aspects of homeowners insurance: insurance to value (ITV) and guaranteed replacement cost (GRC). Insurance to value means applying appropriate cost measures to establish an accurate dwelling coverage amount. Avoid relying on a direct correlation between market value and replacement cost; instead ask your agent to establish a per-square-foot cost based on factors such as size, year built, construction type, ZIP code and level of customization. Most insurers have matrices to which they can apply such factors to determine approximate replacement cost. But even that may not be enough. The plain truth is that you never know what it costs to rebuild until, heaven forbid, it must be done.
This brings us to the second key element, GRC. Although many policies provide a cushion above the dwelling amount listed on the policy, this still may be insufficient. For medium- to highly valued homes, it’s important to secure a policy that provides GRC, meaning you’re covered in full even if the amount to rebuild far exceeds the amount stated on the policy. To provide such coverage, insurers will likely complete a comprehensive onsite inspection to better approximate the cost to rebuild. In so doing, they’ll also offer advice on loss control and mitigation techniques (alarms, waterflow control systems and so on) and comment on reasonable levels of contents coverage to make certain your personal property is fully insured as well.
Your home may be your most valuable asset, but it’s by no means the only one worth protecting. Let’s turn our attention now to automobiles.
Whether you’re operating a high-performance luxury auto, a fuel-efficient hybrid or something in between, proper auto coverage is another key element of your risk management program. Several elements of your auto coverage are worth considering. The first is maintaining proper physical damage coverage for your
vehicles at reasonable deductibles. For too long, many policyholders viewed their auto insurance contract as a means of recovering the premiums paid. That is, they maintained low deductibles ($50-$250) and filed claims for every little dent or scratch under the sun. But carriers caught on, and insureds were penalized for frequent claims filing with higher renewal premiums or even nonrenewal. As with any other line of coverage, your auto policy should be there to protect against the more significant or catastrophic loss. Modify deductibles to $500 or even $1,000 or more for highly valued vehicles, saving premiums and deterring you from filing a minimal claim that can be paid for out of pocket.
Additionally, you might consider “agreed value” coverage for your vehicles. Agreed value locks in the value of your vehicle for the full policy period, guaranteeing you a specified amount in the event of a total loss from a covered peril. Most personal auto policies provide only the depreciated value of the vehicle at the time of loss. During a period such as now when you’re seeing vehicle values plummet as a glut of cars enters the pre-owned market, agreed value can mean a difference of thousands of dollars come claims time. In addition, some carriers who provide agreed value waive your deductible in the event of a total loss, another cash flow positive.
Even more critical than physical damage coverage to your vehicle is proper liability coverage for personal injury and property damage to others. For all the years and effort placed in building your asset base, one inadvertent turn or lane change can put that wealth at risk unless sufficient liability coverage is in place. This is implemented on two levels: primary auto liability and umbrella liability, which we’ll cover shortly. Although states regulate the minimum liability limits required by law, such limits are inadequate to cover a significant claim. Even modestly higher limits can be insufficient. With typical bodily injury limits of $100,000 per person and property damage limits of $50,000, one remains exposed if held liable for more significant injury or damage. With an increasing number of highly valued vehicles on the road today, $50,000 simply may not be enough to cover a total loss.
Becoming equally as important on the liability front is uninsured/underinsured motorist (UM/UIM) liability coverage. Despite state laws, many motorists operate without insurance or with very minimal limits. What happens if you’re struck by such an operator and there are insufficient limits available? You become reliant on the UM/UIM coverage on your own policy. The possibility of such a circumstance occurring is rising quickly. Unfortunately, too many of us don’t bother to review the UM/UIM limits we carry, and in many cases they’re far lower than the primary liability limits discussed above. So check your policy and make certain your UM/UIM limits match your primary liability limits. Additionally, as we’ll discuss in a moment, consider excess UM/UIM cover as part of an umbrella liability policy.
Let’s turn our attention back to personal property for a moment. In particular, consider those highly valued items such as jewelry, fine art, silverware and other collectibles that carry not only intrinsic, psychic value, but also real pecuniary value. You can certainly look to rely on the contents coverage on your homeowners policy, but more than likely you’ll find yourself disappointed to learn there are special sublimits for certain categories of valuables, including but not limited to those mentioned above.
A separate valuable-articles rider can adequately protect these items, either with an identified limit for specific items or under blanket coverage that provides an aggregate amount for a particular category with a per-item limit. Either way, you have broader coverage with fewer exclusions and “first dollar coverage,” meaning no deductible applies.
In many instances, if your valuables make up a significant portion of your contents, you may be able to offset some of the premium by reducing the contents limit on your homeowners policy. Not all carriers allow such flexibility, so it’s important to ask your agent whether this makes sense and whether it’s feasible. Now that we’ve protected your heirlooms and other collections, let’s turn to protecting your asset base from the potential catastrophe of personal injury liability.
We’ve already talked a bit about having appropriate liability limits in place on your homeowners and automobile policies. But even these limits may not be adequate to protect you from a major liability claim.
The most cost-effective means of protecting you from third-party personal injury claims is by securing a personal umbrella liability policy. For about $150-$200 per million, you can secure sufficient limits to protect your current assets and possibly future wages. Price, of course, can vary depending on the number of homes and vehicles owned, youthful drivers, watercraft usage, etc. A severe auto accident, injury to a house guest or other personal injury can lead to settlements in the millions of dollars. For a modest premium, often reallocated from the savings reaped from a higher deductible on your homeowners policy, you can protect yourself from such an assault. Furthermore, your insurer has a duty to defend you even if the claim is baseless, with defense costs picked up by the carrier.
Another important element of an umbrella liability policy is the definition of personal injury. In this litigious society, liability claims aren’t limited to bodily injury and property damage. A broad definition of personal injury that includes libel, slander, defamation of character and so on is important to maintain. Review your policy language with your agent and make sure the contract either includes this broad definition by default or can be added by endorsement.
There’s no set answer to how much coverage to secure. An open dialogue with your agent and other advisers should include issues such as price, risk tolerance and exposure to potential loss. One rule of thumb often used is to obtain coverage equal to your net worth, but other factors often also need to be considered. Whether it be $2, $5, $10 million or more, we think the premium associated with such coverage is arguably the best allocated dollars in your entire risk management portfolio.
Sound Program, Sound Sleep
We’ve covered a lot here, but that’s not to say we’ve been comprehensive and that other issues don’t persist. The elements and variables of a property and casualty risk management program are unique to each household. Other issues to consider may include watercraft, second homes rented to others, rental properties, young drivers, assets owned in trust/limited liability company, domestic staff, wine collections and any number of other items.
The important takeaway is that in managing risk, it’s critical not to overlook the importance of a sound P&C program to help you sleep at night. Although we continue to watch the financial markets gyrate day by day, you should at least rest easy knowing that if something catastrophic occurs in your daily routine, you have appropriate coverage in place. So ask your agent the questions that matter in determining whether your existing program is right for you and how it can be enhanced to better protect you, your family and the assets you’ve worked so hard to obtain.
Our thanks to Mitch Freedman for providing us with the expertise for this article.
Alexandra Armstrong is co-author of the fourth edition of On Your Own: A Widow’s Passage to Emotional and Financial Well-Being. She is a Certified Financial Planner practitioner and chairman of Armstrong, Fleming & Moore, Inc., a registered investment advisory firm in Washington, D.C. Securities are offered through Commonwealth Financial Network, member FINRA/SIPC. Investment advisory services are offered through Armstrong, Fleming & Moore, Inc., an SEC-registered investment adviser not affiliated with Commonwealth Financial Network.
Karen Preysnar, Certified Financial Planner practitioner, co-author of this article, is vice president in charge of financial planning at Armstrong, Fleming & Moore, Inc., and a registered representative with Commonwealth Financial Network.
Individuals should contact a financial planner, tax adviser or attorney when considering these issues. Commonwealth Financial Network does not give tax or legal advice. Consult your personal adviser before making any decisions. The authors cannot answer individual inquiries, but they welcome suggestions for article topics.