We think of risks associated with the audit and attest side of the business every time we place our signature on a financial statement. We think of investment risk every time we meet with a client who is nervous about market losses while counting on those investments to provide income or security in future years. But when it comes to traditional risks, many of which can be protected against or avoided, we are only scratching the surface of what CPA financial planners could or should be doing.

The definition of risk management, according to the American Institute of CPAs' PFP Division, is the "process of identifying the source and extent of an individual's risk of financial, physical and personal loss, and developing strategies to manage exposure to risk and minimize the probability and amount of the potential loss."

After understanding the definition of risk management, we reach our first fork in the road. That fork is whether you hold yourself out as a personal financial planner to your clients or not. If not, then the only risk management role that a client may reasonably expect from you is incidental relative to your accounting and tax work.

I understand that some practitioners don't want to be financial planners, but I believe that it is a horrible disservice when a CPA notices, or should notice, potential risks in a clients' financial life and fails to mention anything. Examples of risks that are right under your nose that should trigger some guidance from you would include:

Clients who own rental property jointly with a non-spouse owner;

The client that has jointly owned financial accounts with an elderly parent;

The client who conducts some business from their home; and,

The client who serves on boards of directors, whether for profit or not.

 

A CLEAR ENGAGEMENT LETTER

If you do hold yourself out as a financial planning practitioner or a firm capable of delivering personal financial planning services to a client, you may have a fiduciary obligation to perform risk management services. We can debate all year over whether you owe your clients the standard of care that includes risk management, but that would be a waste of time. What I can tell you, from personal experience, is that when a client thinks that you are their financial planner, perhaps evidenced by some investment services that you've delivered or mere solicitations that they may have received from your firm, then you may well owe the fiduciary standard of care that would include risk management services.

The best way to protect against this risk would be with meaningful engagement letters. Make it crystal clear what you are doing, and not doing. If your engagement letter is for general financial planning services, then I would argue that you clearly owe the fiduciary standard of care that would call for comprehensive review of risk and the management of those risks. If your intent is to avoid the risk management arena, then you should use limited-scope engagement letters for financial planning matters and clearly note the scope limitation.

Under the assumption that you are providing planning services, and do want to do a great job with the risk management planning, there are clear steps and processes that should be followed. Upon completion of your planning engagement, clients should understand their exposure to risks and whether or not they are adequately protected.

This risk assessment starts with a realistic assessment of your knowledge and abilities in each of the specific areas of risk for your clients. These may include, but not be limited to, the following types of risks:

Life;

Disability;

Health;

Long-term care;

Homeowners;

Auto;

Liability; and,

Business.

Generally, the broad categories can be classified as life and health issues and property and casualty issues. In some of the risk management topics you may be well-versed, yet barely conversant with others.

For the areas where you would not deem your knowledge adequate, you need to find another professional with the proper experience and credentials to assist. Throughout my career, I've reviewed hundreds of financial plans, and most of the plans wing it when it comes to the risk areas where the practitioner isn't experienced. Comments found in plans such as, "Make sure that you have adequate liability coverage and review your policies with a property and casualty professional," don't cut it if you are in fact engaged as the financial planner. I believe that it is your job to see that the advice is given within the context of the planning engagement, even if you find another professional. I'd suggest asking your outside professional for their advice in writing, and disclose to the client that this advice was created with their assistance.

In addition to getting you the information that you need to give the best risk management advice possible, working with another competent professional is a good way to let insurance professionals know how thorough you are as a planner. This may have the tandem benefit of opening up the door for working together on other cases.

On the life and health side, the process can be completed as a three-step process. First is to quantify the risk and the protection that may be available. Second is to evaluate what protection your client currently owns. Third is to make your recommendations for solving the problem or mitigating the risk.

 

DEALING WITH RISK

Most of your clients know from their own college days that there are four basic ways to deal with risk: avoidance, reduction, transfer or retention.

As a practical matter, there are many risks that you simply cannot avoid. Risk reduction is easier to accomplish, and a valuable discussion to have with your client regarding how they may avoid certain risks. Risk transfer is the most common answer, and that typically involves some sort of insurance.

Risk retention is the second-most popular situation that you'll encounter. Some clients are simply anti-insurance and need to be shown the potential consequences of their stubborn opinions. For these types, you may even get their signature stating that they understand their exposure and have decided to stick their head in the sand with respect to mitigation or insurance strategies.

With regard to quantification, the first step entails determining exactly how much coverage the client needs for life, health, disability and long-term care. Most financial planning software systems, as well as nearly every insurance company's Web site, can help with the needs analysis. But there's more to the discussion than a simple quantitative evaluation. What if your client can't qualify for insurance? What if the client can't afford the coverage or simply refuses to pay for such coverage?

With life insurance, define the client's need for coverage beyond the actual dollar amount that the survivors would need to accomplish their objectives. This need may be temporary, as in the need for income replacement or college funding. Or the need may be permanent, such as the need for estate planning or business succession for a client who doesn't want to ever retire.

Now, for the second step, you are in a position to evaluate what the client currently has for coverage. This starts with an in-force illustration of the existing life policies. With the illustration, you want to examine the assumptions used and assess their reasonableness or likelihood of coming true.

 

ALTERNATIVE RECOMMENDATIONS

The third step would be to make your recommendation and look at alternatives. When looking at alternatives, it would be premature simply to get new illustrations without understanding the client's health history. You'll need to ask some basic underwriting questions, such as those found on the second part of a life insurance application. With life insurance specifically, you'll see that in some cases new contracts may actually cost less than some existing contracts. New mortality tables now in use by insurers reflect a longer life expectancy, and possibly a lower mortality charge.

The same three-step process also applies when looking at health, disability income or long-term-care insurance. Determine the need, evaluate the current protection plan and make recommendations for improvement.

In many cases, the client's current protection strategy may be through group coverage offered at work. While this coverage may quantitatively fit the bill, it may not pass the longevity test if you change jobs. Many group policies are not portable and available when the client's employment terminates. In fact, the lack of portability may be enough of a risk to a client who you know changes jobs frequently for you to recommend individual coverage in lieu of or in addition to the group coverage from work.

Most CPAs did not add financial planning services so they can sell insurance, but for many this is a service they now choose to deliver to clients. Of course, proper licensing is required, but actually placing the coverage for a client may be more efficient and preferable to them. Simply ask if they'll want your help with implementation. You may be surprised at the positive responses that you'll get. The worst they can say is no. But that is better than later learning about a significant problem with one of your "A" clients because you didn't want to ask the right questions or serve to the best of your ability. AT

 

John P. Napolitano, CFP, CPA, PFS, is chairman and CEO of U.S. Wealth Management in Braintree, Mass.

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