Ignore Insurance at Your Peril

The Consequences can be Disastrous

This article examines the importance of having an integrated wealth management plan in place.

It is always prudent to put into place an integrated wealth plan that takes into account one’s business succession and the financial needs of one’s dependants. An integrated and disciplined approach to wealth planning involves consideration of the uses of the various forms of insurance as a means of risk transfer in business and personal risk management. Death and its financial consequences can cripple a family’s financial security. The following is an example of how not to approach wealth management.

Mr A was a wealthy entrepreneur and the majority owner of a successful trading business incorporated under the laws of Singapore. He had two trusted business associates who were shareholders of the company. Mr A owned a few residential properties in Singapore. Most of them had been fully paid for with the exception of one, which was mortgaged. He invested prudently over the years in the shares of several telecommunications companies based in London, and also executed a will detailing how he would like the shares and his other assets to be distributed among his children.

Upon Mr A’s death, his equities portfolio was valued at £10m at the peak of the stock market rally. His estate on the date of his death was assessed for UK inheritance tax at £4m (40% of £10m).

The Singapore estate duty assessed on the value of his business and other assets on the date of his death was S$1.2m.

The executor of his will (his daughter) had to confront the following issues:

• the UK shares were registered in the name of Mr A and without the grant of probate, the portfolio of telecommunications shares could not be distributed to any of the beneficiaries under the will, nor be disposed of in the market. The grant of probate was subject to payment of UK inheritance tax;
• there were insufficient funds to settle the UK inheritance tax and the authorities would not release the UK shares except against full settlement. A short-term bank loan to fund the payment of the inheritance tax had to be obtained at a high interest rate, as the UK shares were not available as collateral;
• the stock market had been declining and the value of his UK equities portfolio was falling by the day;
• Mr A’s two shareholders served notice that they intended to purchase Mr A’s shares in the business as he had no obvious successor. A dispute arose over the valuation of the shares and the timing of the cash payment for them, as the two shareholders were short on cash; and
• Mr A had a mortgage outstanding for S$2m.
  

When the inheritance tax was finally settled and the probate formalities completed six months later, the value of the UK shares had declined to £3m, with the result that instead of enjoying their father’s inheritance, Mr A’s children ended up owing £1m to the UK Inland Revenue.

The dispute between Mr A’s family and his business associates caused severe financial losses to the business and to all concerned. New business activity had ceased, accounts receivables were collected for half their value, creditors pressed their demands for full payment and goodwill very nearly vanished. Competitors were eyeing the business as a take-over target.

Fortunately, Mr A’s family had sufficient funds to settle his Singapore estate duty payment of S$1.2m. The mortgaged property was sold to settle the outstanding mortgage.

What was the Cost of Mr A’s Lack of Planning?

1. Mr A’s objective of bequeathing the equities portfolio to his beneficiaries was not realised;
2. the successful business, which was Mr A’s most important asset and his life’s work, was finally sold to a competitor at a fraction of its value;
3. the monetary costs to settle the UK estate were £4,227,500, which included financing cost, legal and other professional expenses; and
4. the loss of interest and investment opportunity costs from the delayed distribution of assets.

An Effective Alternative to Achieve Mr A’s Financial Objectives

Mr A could have avoided the telecommunications shares from being assessed at the UK inheritance tax rate by using an offshore trust to hold the equities portfolio (with appropriate trust structuring and tax advice).

Mr A could have used insurance in his wealth management plan.

• Life insurance to fund a buy-sell agreement between the shareholders. By holding life insurance policies on each other, the surviving shareholders, upon the death of a shareholder, can receive the cash needed to purchase the deceased’s interest from his family. This would have enabled the surviving shareholders to obtain full ownership of the business and for Mr A’s family to receive a fair price for his interest.
• Additional life insurance could have been used to replace loss of income for the surviving spouse and children and provide liquidity prior to a distribution of assets from the estate. Alternatively, on reaching retirement age, the policyholder could have received the cash value of the insurance policy and utilised it to supplement retirement lifestyle goals or for estate planning purposes.
• Mortgage protection insurance could have helped to repay Mr A’s S$2m outstanding mortgage loan. The property need not have been sold to pay back the bank and the family would have gained an asset.
  

Life insurance proceeds can provide a family the funds required to maintain the lifestyle to which they are accustomed, pay off debts or invest in the children’s education or fund retirement plans. In Singapore, where a policy is purchased for the benefit of family members, and provided the insured retains no interest in the policy henceforth, local laws create a separate estate for the insurance policy that can avoid estate tax and protect the policy benefits from creditors.

A few simple insurance policies could have served to prevent the collapse and ultimate loss of Mr A’s business and the fissure in his family. They could also have circumvented the considerable distress suffered by his loved ones and long-term business associates.

Dora Cheok
UBS Private Banking