n increasing number of Americansare transferring personal ownershipof residential property to trusts, lim-ited liability corporations (LLC),limited liability partnerships (LLP), andother entities designed to protect assets ortake advantage of favorable tax treatment.Although transferring residential and otherreal property to an entity can providenumerous benefits, it might also result inan unintended lapse in insurance cover-age for both the families transferring theproperty and their professional advisors.Although it is impossible to document withprecision how many trusts and other enti-ties are created each year for asset-protec-tion or tax-advantaged purposes, a reviewof IRS records verifies past and projectedgrowth in fiduciary tax filings (

Exhibit 1

‘Personal Property and Casualty Insur-ance 101’

Much has been published on the prop-er use, design, and implementation of thetax and asset-protection benefits availableto individuals who transfer residential prop-erty to entities. This article focuses on theneed to properly structure the insurancepolicy that is used to protect the majorityof residential properties—the commonhomeowner insurance policy.An insurance policy is a legal contractin which one party agrees to indemnifyanother party against certain risks inexchange for an agreed-upon sum of money. Many advisors operate under thelogical but false premise that the commonhomeowner insurance policy covers theactual home. In fact, the party thatreceives the benefit of coverage is the

named insured.

The contract language used in home-owner policies was developed when peo-ple, not entities, owned homes. As a result,the definition of “insured” was carefullycrafted to protect the interests of a veryspecific group of people. Although defini-tions used by carriers can vary in subtleways, the insurance industry’s leading sup-plier of statistical, actuarial, underwriting,and policy language, the Insurance ServicesOffice (ISO), uses the following languagein its commonly adopted broad-formhomeowners policy to define an insured:“Insured” means you and residents of your household who are:a. your relatives; or

Property and Casualty InsuranceSolutions for Entity Owners

INANCE

personal financial planning

JUNE 2008 / THE CPA JOURNAL

By Tim O’Brien and Michael Markiewicz

Plugging the Holes in Asset Protection Plans

b. other persons under the age of 21 andin the care of any person named above.“You” includes the named insured andspouse if a resident of the samehousehold.The definition of “insured” has beentested many times in court to determinewho is eligible to receive the benefits of coverage provided by a homeownerinsurance policy. Regardless of the actu-al ownership interest in the property atthe time of loss, in no known instancehas a court required an unendorsed home-owner policy to provide coverage to anyparty other than those defined by theinsurance contract.Given this background, one can seethat when residential property is trans-ferred from a person to an entity, theinsurance policy that protected the indi-vidual owners is not structured to pro-tect the new entity owner of the proper-ty. When asset protection is among theprimary reasons for transferring the prop-erty, the resulting absence of insuranceprotection is an especially problematicunintended consequence.

Critical Form of Asset Protection:Liability Insurance

Although often overlooked, the verybroad liability coverage provided by ahomeowner insurance policy serves as acritical form of asset protection. Indeed,homeowner policies not only provide pro-tection against many forms of suits alleg-ing bodily injury or property damage asso-ciated with residential premises, but pro-tection is also extended to the namedinsured for acts arising away from thehome. In addition, regardless of the mer-its of such legal actions, the liability pro-tection provided by a homeowner policyobligates an insurance carrier to providethe insured with a legal defense for cov-ered losses.Compared to other causes of loss, lia-bility losses occur with far less frequencythan those that result in damage to thehome (

Exhibit 2

). Because liability losseshave a low overall impact on total losscosts, carriers apply only a small chargefor the liability coverage on a homeown-er policy. Liability claims are infrequent,but the costs to settle the few losses thatdo occur can be high. Compounding thisconcern is the fact that carriers find it chal-lenging to understand and underwrite thetrue purpose and scope of all entities thatown residential property. Consider, forexample, the situation in which an entitythat owns a residence is named in a law-suit alleging damages sustained far awayfrom the insured home. The broad liabili-ty coverage provided by a homeowner pol-icy may obligate the insurance carrier topay defense costs and related damages.Given this potential for severe losses, insur-ance carriers have not been eager to pro-vide liability coverage to entities, whichmay present a far greater exposure tolawsuits than individuals.

Avoiding Hidden Gaps in Coverage

To avoid potentially disastrous gaps incoverage, individuals and their advisorsmust take steps to ensure that insurancepolicies are structured to protect the inter-ests of all parties that have an insurableinterest (i.e., something to lose) in theevent of a property or liability claim. Thismay include a number of different indi-viduals and entities, such as a trust(including beneficiaries, trustees, andgrantors); an LLC (and its members); anda family limited partnership (FLP, and itsmanaging partners and limited partners);as well as the individuals who occupy theresidence.Protecting the insurable interests of allparties that have a risk of loss connectedto a residence requires considerable exper-tise. Consider the following example of anactual claim that occurred in the south-eastern United States, for which coveragewas denied: An extended family owned alarge property consisting of 140 acres,

JUNE 2008 / THE CPA JOURNAL

YearIndividual ReturnsGrowth 1041 ReturnsGrowth

198093,196,100—1,881,800—1990112,596,00020.82%2,680,90042.46%2000128,049,00013.72%3,456,00028.91%2010140,522,2009.74%4,003,20015.83%10-year avg.14.76%29.06%

Cause of Loss: 2001200220032004Property Damage

Fire, lightning, and debris removal30.8%32.6%31.8%20.5%Wind and hail21.720.725.551.2Water damage and freezing22.321.521.915.7Theft4.74.53.32.2All other property damage 13.212.310.76.1

Liability

Bodily injury and property damage6.57.35.83.7Medical payments and other0.70.80.80.7Credit card and other0.20.30.20.1

Source: Insurance Information Institute

EXHIBIT 2

Homeowner Insurance Losses by Cause, 2001–2004(Percentage of Losses Incurred)

EXHIBIT 1

Past and Projected Growth in Fiduciary Tax Filings

JUNE 2008 / THE CPA JOURNAL

divided into 15 different sublets. Some lotswere owned by family members, otherswere owned by LLCs controlled by fami-ly members. The property was dividedfor mixed use. Portions of the propertywere covered by a commercial policy, oth-ers by a homeowner policy. One familymember’s employee died while landscap-ing a residential property. The LLCs withownership interests were not listed asnamed insureds on either the commercialor homeowner policies. Suits were filedagainst the family and the LLC that ownedthe property where the fatality occurred.Although the family’s personal assets wereprotected by the homeowner policy, thefamily had to retain counsel to defend theLLC, because it was not covered by thehomeowner policy. A long period of liti-gation followed, and the family that formedthe LLC was required to pay substantiallegal fees, as well as an undisclosed judg-ment against the LLC.Although precise coverage needs varywidely based on many factors (especiallythe use of the residence), the followingcharacteristics outline the most commonrisk profiles when residences are owned byan entity:

■

An entity is established to replace theprivate ownership of a personal residence;

■

The family that has transferred owner-ship of the residence to the new entity con-tinues to reside there;

■

A family retains personal ownership of the household possessions in the home; and

■

The family occupants are often close-ly connected to the entity (as trustees,grantors, or beneficiaries of a trust, or asmembers of an LLC).

Exhibit 3

identifies the insurable interestsof each party for this common risk profile.

Cookie-Cutter Solutions andOther Pitfalls

The insurance industry offers no univer-sal approach to address the protection needsof residential properties owned by all kindsof entities. ISO, which assists most insurancecarriers in developing policy language, makesthe

Residence Held In Trust HO 05 43

endorsement available to carriers that use itsservices. This endorsement is not intended toaddress the coverage needs of entities otherthan trusts; it is not available from all carri-ers; and it deems certain residential proper-ties to be ineligible. Furthermore, even ininstances where this endorsement offers anideal solution, it is used so infrequently thatmany insurance agents neglect to recommendit. The lack of a well-focused and standard-ized approach to effectively address thecoverage needs of all parties presents a realdilemma.To better meet the protection needs of each party, an experienced independentinsurance agent or broker can accesseffective coverage solutions through car-riers with experience writing customizedpolicies for entity-owned personal resi-dences.

Exhibit 4

provides a sample of one carrier’s “additional insured” contractendorsement. Carefully crafted solutionssuch as this enable experienced insur-ance professionals to structure coverageto properly protect the insurable interestsof each party as described in the commonrisk profile.The most common pitfall when struc-turing coverage for entity-owned residen-tial property is issuing a homeowner pol-icy with the entity as the named insured.Although commonly prescribed, such“solutions” often neglect the needs of oneor more parties. In this instance, thoseresiding in the home would have noinsurance protection for liability claimsfiled by third parties, first-party losses totheir personal possessions, or additional liv-ing expenses should they need to live else-where due to a loss.Another common pitfall is neglectingto add the new entity as an additional

Party with insurableinterestCoverage required for...

Trust (LLC)

■

Dwelling owned by the trust

■

Other structures owned by the trust

■

Premises liability; trust can be named in a lawsuitTrustee (LLC member)

■

Premises liability; trustee can be named in a lawsuitBeneficiaries

■

Contents owned by occupants(LLC member) and those

■

Additional living expenses (loss of use); occupantsresiding as occupantswould incur costs to reside elsewhere after acovered loss

■

Liability; occupants’ negligence may cause them tobe named in a lawsuit; coverage required for thislocation and elsewhere

EXHIBIT 3

Insurable Interests of Each Party for Common Risk Profile

Additional Insured—Residence Premises

Name and address of person or organization:The definition of insured in this policy includes the person or organization namedabove with respect to:

Coverage for Damage to Your Property

Dwelling and Other Structures; and

Coverage for Liability and Medical Payments to Others

The person or organization named above is covered for Liability and MedicalPayments to others but only with respect to the residence premises and only where the person or organization is held liable for an act or failure to act by any insured.

EXHIBIT 4

Sample “Additional Insured” Contract Endorsement