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Feature: The Estate Planner As Risk Manager
Matthew Erskine
11 March 2013
Here, Matthew Erskine, principal of The Erskine Company, outlines a process he has adopted for thinking about risk management in estate planning. Much has been written recently about risk management, especially after the catastrophic failure to manage the risks associated with the real estate bubble, and subsequent collapse of the financial markets in 2008. As clients and their advisors reassess risk management for their investment portfolios, is it time for estate planners to assess their role as risk managers for private clients? What is risk management? The International Organization of Standards in 2009 published their ISO 31000 as standards for risk management and created a major shift away from the probability of loss to the “effect of uncertainties on objectives.” Risk management, therefore, includes not only the negative possibilities, but the positive possibilities as well. The result is that, when discussing risk management, the coordinated and economical application of resources - not just to monitor and minimize unfortunate events, but also control and maximize the realization of positive events – is what is meant. The two key terms of risk management for the estate planner are “uncertainty” and “objectives.” Is an estate planner also a risk manager? Estate planning strategies typically include 1) transferring the risk to another party (ie, life insurance), 2) avoiding the risk (ie, asset protection), 3) reducing the negative effect or probability of the risk (ie, discounting techniques), or even accepting some or all of the potential or actual consequences of a particular risk (ie, including closely-held stock in an estate to gain section 6166 treatment). For the most part, these strategies consist of the following elements, performed, more or less, in the following order: 1. Identify and characterize the various threats, such as taxes, mismanagement, death, disability and so forth, to the financial well being of the clients. 2. Assess the vulnerability of the client’s significant assets to these specific threats. 3. Determine the level of risk the client’s assets face (ie, the expected likelihood and consequences of specific types of attacks on specific assets). 4. Identify the ways the client can reduce those risks. 5. Prioritize risk reduction measures based on an effective estate planning strategy. The estate planner is, therefore, a risk manager. And a key component of the estate plan is risk management. Rethinking estate planning as risk management Since 2001, the changing estate tax laws in the US have created situations where certain aspects of many of the standard estate planning risk management techniques have come under criticism. This is, in part, because the planning has been focused on taking advantage of very short-term trends (such as the use of short-term GRATS or FLP discounting techniques) that are under intense legislative, regulatory and judicial pressure at both the federal and state levels. Additionally, they are criticized for having no measurable improvement on clients achieving their objectives, whether or not the confidence in estimates and projections seems to increase. The estate planner as a risk manager has to both reduce the possible loss due to the uncertainties surrounding the techniques now under assault and increase the opportunities the client has in achieving their objectives in the long term. To do this, the estate planner needs to include scenario planning in the estate planning process. Scenario planning Scenario planning is not a new planning technique: it has been used in business as a medium (10 years) and long term (50+ years) forecasting tool since World War II. Its purpose, in the business context, has been to reduce uncertainties to a manageable level, while at the same time not concealing the risks. Using scenario planning techniques, business planners can open up divergent thinking in the organization and reduce complexity, while avoiding oversimplification. At its best, scenario planning provides a common language to bridge the communications gap between one group and the next in the organization. Used in estate planning, scenario planning can reduce uncertainties by providing the means by which a family oriented organization can collectively learn from their and others’ mistakes; have agreement on marshalling the resources (both financial and human) needed to cope with those risks they can anticipate; and have the ability to react and innovate in the face of challenges that could not reasonably be anticipated, both from within and outside of the organization. Further, by fostering a shared understanding of the desired and feared scenarios for the future between generations, between family members inside a business and outside a business, and between non-family employees and family employees, communication is opened up, and opportunities are uncovered to achieve the client’s objectives. The scenario planning framework A framework for thinking about the future that I use is based on the “observe-orient-act” principle, and has been further defined in the terms tracking, analysis, imaging, deciding, acting (TAIDA). • Tracking – Keep from being blinded by the light: our instinct is to “look where the light is shining” rather than observe all that is going on. The result is that we lose track of risks, so a deliberate effort needs to be made to track as widely as possible all elements of news and thought, not just tax-related matters. • Analysis – What is really happening? This involves taking the data from tracking and trying to determine what the future consequences will be from the actions of the present, as well as a digging deeper into the creative and intuitive models and visions by repeatedly asking: What is happening and what seems to be happening? What are the necessary conditions for this to be reality? How tenable is this model? What are the points of strength and weakness? • Imaging – Bringing dreams to life: be more intuitive, to create not only an intellectual understanding, but also an emotional meaning of the future. Use intuition, will, and relationship with the future as part of the imaging process. The key to success may be action, but the key to successful action is the imaging of that success when the action is taken. • Deciding – Selection and rejection: decision is that moment between vision and action, between the intangible which can only be envisioned and the concrete that can be tested and quantified. This step is mostly taken by the client, and shows the difference between an entrepreneur (who can blend both concrete actions and desires), the dreamer (who has desires, but no ability to make them concrete), and the manager (who can follow through with concrete actions, but does not have the ability to create the desire). • Acting – presence and learning: learning, the art of integrating new information into old knowledge, requires a clear purpose if it is to be more than just academic. Signals from both the outside and inside worlds of the family and the organization need to be considered in learning, but doing and acting control the learning process. The most efficient families and organizations are those that learn to foresee and act, and thus are one step ahead, rather than react and expend energy on emergency situations. The key to this step is to keep actions focused on a vision, so-called “centered actions.” Conclusion Today’s clients look to risk managers to both avoid financial loss and increase the likelihood of successfully achieving their objectives. Estate planners are risk managers, but traditional estate planning risk management strategies are duly criticized because they focus too much on avoiding short-term financial risk and not enough on long-term risks. Estate planners can both reduce the long-term risks of the ongoing legal, judicial and regulatory environment and increase the opportunities to achieve their objectives if they adopt a scenario planning framework for their estate planning techniques.