Statistically and anecdotally, we all know that the number of divorces, lawsuits and bankruptcies is staggering. While no one believes lightning will strike them, wealth created through a lifetime of work, saving and investing can be lost overnight if these forms of man-made lightning do strike. To protect your assets from such disaster, proper risk management strategies should be given careful consideration. These strategies include exempting your assets from the claims of creditors and limiting your liability through legal entities and transferring your risk through insurance.
State and federal laws may exempt some of your assets from the claims of creditors. Depending on your state of domicile (i.e., your legal residence), the equity in your primary personal residence may be protected from creditors. Protection also may extend to your retirement funds and even the cash value of your life insurance.
Once you have identified the protected asset classes available to you under applicable law, it may be prudent to maximize your protection by converting non-exempt assets into exempt assets. For example, if the equity in your home is exempt from the claims of creditors under the laws of your domicile, then using non-exempt resources to pay off your mortgage may be a smart move.
Many entrepreneurs operate their businesses as sole proprietors rather than through a legal entity, such as through a Corporation or a Limited Liability Company. Whether their business is home-based or in the Fortune 500, these business owners are attracted by the informality of sole proprietorship. They also do not want to incur legal fees to create and maintain a legal entity. However, in addition to other advantages, conducting business through a legal entity may offer substantial risk management benefits.
While lawsuits brought against a sole proprietorship are really lawsuits against the owner’s personal assets, lawsuits against a properly created and maintained legal entity are really lawsuits against the entity’s assets. Nevertheless, the selection of an appropriate legal entity is critical for managing your risk.
When was the last time you reviewed the details of your liability insurance program with your insurance professionals? Are your policies current? Are the coverage limits adequate and are the deductibles reasonable? Have you scrutinized the policies for loopholes? Remember: the fundamental philosophy of any insurance coverage is to pay a premium you can afford, to transfer a risk you cannot afford. Take time to understand both the risks you have retained and the risks you have transferred.
Managing your risk, like avoiding lightning, requires that you make proper plans in advance of the storm. Take time today to protect your wealth tomorrow.