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Patricia Annino
Patricia Annino
Do Your Clients Have Family Risk-Management Policies?
Here are three reasons why you should encourage your clients to have one today.

December 15, 2011
by Patricia Annino, JD, LLM

Families and family-owned businesses have faced always faced risks. Traditional risks have included the unexpected death or disability of key stakeholders; incomplete or out dated estate planning or corporate documents; the lack of liquidity, a disaster plan, effective communication among key stakeholders and more.

In addition to these traditional risks, families and family-owned businesses now face new risks, that include lack of privacy in the Internet age, cyber-attacks, the social media risk to family reputation; new attacks on  business valuation; pre-nuptial agreements and post-nuptial agreements; complex alimony calculations for the family business owner (taking phantom income into account); the baby boomer transfer of wealth; the impact of the increased working lifespan of the senior generation on succeeding generations etc.

Key areas “at risk” for family business are family cohesiveness, business ownership and wealth management.

Family Cohesiveness

In the area of family cohesiveness, reputation or the family brand is at risk. Traditionally this risk was triggered by a scandal that leaked out to the press. The new way this risk is triggered is through the Internet. Videos on YouTube and comments on Facebook, Twitter and other social media networks can affect your client’s family’s reputation. They can be used in divorce litigations, custody matters and employment decisions. Once viral, it is hard to remove.

The younger generation, if not educated, is not mature enough to understand the afterlife omnipresent power of the digital era. A family risk-management policy should include education about the dangers of social media and a morally binding decision among family members to understand the consequence of social media on the reputation of the entire family.

Business Ownership

Another risk to family cohesiveness is the impact to individual goals and life plans.
Traditional risks included the illness, death or incapacity of a key family figure.

In the family business, the new risk is the increased work lifespan of the older generation, which results in the delayed succession of the middle generation. With the older generation in good health and working longer, the individual goals plans of the middle generation may be passed over.

Intentional strategic planning and clear communication among all generations as to what the expectations are for the working lifespan and when the baton should/will pass can mitigate this new risk.

Traditional risks to business ownership and the economic sustainability of the family enterprise include the death or the divorce of a shareholder when proper planning is not put in place.

The new risk is the evolution of laws governing how assets are allocated in a divorce. In some states, gifted and inherited assets are divisible in a divorce. This does not just include what the about-to-be divorcing family member owns when married; it also includes the expectancy of what that divorcing family member will receive in the future.
Those expectancies are taken into account when determining the allocation of assets between the couple about to be divorced. 

A significant side effect to this is how a hostile soon-to-be ex and their attorney will value the family business assets and put that valuation into the public realm of divorce court. The goal of that hostile divorcing member is to value that business high. That valuation may do serious damage to the estate plan of the older generation.

There is also an increased risk for the allocation of alimony. Many family businesses have phantom income that is earned during the course of the marriage that shows up on the tax return and is plowed back into the family business. At issue is how that phantom income should be treated for alimony purposes.

If it was earned during the marriage, is it marital income taken into account for alimony and child support purposes even though not actually received?

When thinking about these risks, it is important to remember that the law and the court in the jurisdiction of the divorcing spouse that will control these decisions. These risks can be mitigated by a well negotiated pre-nuptial agreement or post-nuptial agreement.

Wealth Management

Traditional risks related to a family’s wealth (including financial, intellectual and social assets) include the illness or death of the key family stakeholder, economic downturn and changes in the regulatory or legal environment.

The dissipation of wealth sometimes triggers new risks. With each ensuing generation, wealth is splintered. Besides that, new risks also come from the lack of creation of new wealth during turbulent economic times, the increased complexity of legal and tax matters and the increased complexity of wealth management choices.

These risks can be mitigated when the family coordinates its advisers and monitors the integration of all professional services.

The risks are further mitigated when the family embraces and encourages financial education and financial literacy across the generations. Mentoring, shadowing, exposure to the concepts and resources along the generation continuums reduces unintended consequences.

Creating a Risk Management Policy Statement

A solid risk-management policy contains the purpose, principle and procedure for implementation. The purpose of a family risk management policy may be to reduce the risk for family members, both individually and as a whole. Adherence to the policy would go far to protect the family’s human and financial assets and minimize potential liability. The principle of the policy may be to make clear that the responsibility is to identify the areas of high risk and to do whatever possible to mitigate that risk. The procedure of the policy may make it clear that each family member is expected to:

  • Achieve financial literacy with regard to their wealth as well as the wealth of the family enterprise.
  • Draft and have both parties sign a pre-nuptial agreement.
  • Contact insurance providers annually to review coverage policies and ensure that they are current and adequate.
  • Have basic estate-planning documents, such as will, revocable trust, healthcare proxy and power of attorney for financial assets in place.
  • Participate in the development of an investment policy that is aligned with the family’s shared values.
  • Protect the family’s reputation by learning how each individual’s behavior, both positive and negative, can impact the family’s reputation.

Conclusion

Your client’s risk-management policy statement should be reviewed and adjusted as the risks their families evolve and change. 

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Patricia M. Annino, JD, LLM, is chair of the Estate Planning Practice Group at Prince Lobel Tye LLP. She is a Fellow of the American College of Trust and Estates Counsel.

* The AICPA’s PFP Section provides information, tools, advocacy and guidance to CPAs who specialize in providing tax, retirement, estate, risk management and investment advice to individuals and their closely held entities. PFP Section members, including PFS credential holders will benefit from additional resources on this topic in Forefield Advisor on the AICPA’s PFP website at aicpa.org/pfp. All members of the AICPA are eligible to join the PFP section. For CPAs who want to demonstrate their expertise in this subject matter, apply to become a PFS Credential holder.