Know your client – or suffer the consequences

The importance of knowing as much as possible about clients, their financial structures and personal relationships can avoid costly court cases when something goes wrong.

This is particularly true when it comes to risk insurance — as a mock court case organised by Zurich proved.

An adviser had sold loan protection insurance and buy/sell cover to the directors of a company, One Fel Pty Ltd.

There were two directors, ‘Howard Abbott’ and ‘Peter Johnson’, running the small family business. Everything was proceeding well until Howard suddenly died.

Howard had a wife and three children and the company loan was secured by the family homes of both directors.

As the insurer delved deeper into the client’s business and personal structure, the ownership of the proceeds from the policies was subject to a dispute.

This resulted in a court case to decide who owned the proceeds.

The first problem had developed because the adviser, ‘Andrew’, who undertook his fact-finding with the client three years before Howard’s death, had not asked the right questions.

In the witness box, Andrew admitted his fact-finding form was cobbled together from a number of sheets he had seen life companies distributing.

He had been quite happy that he knew the structure of One Fel was a proprietary limited company and hadn’t asked if the two directors he dealt with were actually shareholders… which they were not.

The company was owned by the directors’ family trusts and, as individuals, they owned no shares.

The directors had been referred to a tax lawyer when they were deciding on the policies, but the appointment was never kept and Andrew did not follow this up.

Howard and Peter were trustees of their family trusts and that also created a problem in the Abbott family trust because the trustee was now dead — consequently, the company could no longer operate.

Andrew was asked about follow-up meetings in the intervening three years before death. He said he made a couple of phone calls to see if the client was happy, but hadn’t discussed any change in the circumstances of the two directors.

Because of the lack of understanding about the company structure of the clients, the adviser sold policies to the wrong entities.

The loan cover had not listed Howard or his wife as beneficiaries if something happened.

As a result, the wife might lose the house if the company decided to keep the proceeds, which as the policy owner, it was legally entitled to do.

The buy/sell cover had been sold to help with the transition of the business ownership in the event of unforeseen circumstances. However, as the policy had been sold to the directors who didn’t own the company, it was — in effect — worthless.

There was another complication. Howard’s wife had not read the trust deeds of the family trust, even though she was a signatory to the document.

She was not aware of the second mortgage on the family home to secure the $1 million loan to the business.

The wife didn’t know who would run the business now as the original plan was that she and Howard were going to retire to Queensland eventually.

Andrew had neither discussed exit strategies with either director nor provided any financial planning advice.

At this point in the court proceedings, a third party entered the scene. ‘Miss Monicca Morossi’, carrying a baby boy she claimed was Howard’s son.

The son was paid an income from Howard’s family trust and the mistress understood all about the trust, as she had read its deed document.

She also knew about the second mortgage and had discussed future directions for the company. Just before Howard’s death, the pair had discussed insurances for her and the child.

Monicca had planned to work in the business and target new markets for the company.

She also expected a share of Howard’s estate and was willing to go to court to secure it.

Andrew had never heard of the mistress or her son.

The mistress had worked in the company until the arrival of the child, yet neither she nor any other important personnel had key cover insurance. This was something Andrew admitted would have been useful.

Andrew had failed his clients by not finding out enough information initially and subsequently failing to update the client information when material changes occurred.

The case went to court because everybody thought they knew what Howard’s intentions were, but there were no agreements in place to enact his wishes.

The adviser needs to ask the ‘hard questions’ about relationships, their interests and their impact on assets. This includes asking about relationships other than the obvious ones, such as marriage.

Because of the inability of the adviser to dig deeper than the simple initial questionnaire, his recommendations were not appropriate for Howard’s exit strategy.