Estate planning tools and property & casualty (P&C) coverages frequently cross paths; however, there’s often a distinct disconnect among the client, the P&C advisor and the estate-planning attorney in this area. This is a troublesome concern.
For instance, there are frequent changes in laws and practices occurring in the world of estate planning, and some of these can have a direct impact on one's property and casualty insurance. One of special note is the use of qualified personal residence trusts (QPRTs), other forms of trusts and limited liability companies (LLCs) as vehicles to reduce one’s tax liability and/or provide other legal protection of assets. In those situations in which placing someone’s home in a trust can be financially attractive, the question is how to address the insurance side of the equation to coincide with this type of ownership? An additional, perhaps bigger, concern is establishing who’s making the inquiry and changes to the insurance policies, and how is this being done?
Use of QPRT
Suppose your clients, Mr. and Mrs. Smith, use a QPRT to transfer ownership of their residence from the “owner” (the Smiths) to a trust. Do the Smiths continue to have an insurable interest and right to proceeds after this has been done? I believe, based on the clear and expressed purpose of the trust, that the answer is “no.” The bigger problem created is whether a carrier will respond to a claim against, or on behalf of, the Smiths themselves, if the insurable interest is now in the hands of the trust and not them? Unfortunately, this may be a great excuse for some insurers to deny a claim. As it states early on in your client’s homeowner’s policy, the insured must have an insurable interest to benefit from the policy.
What needs to be done in this situation?
Two Possibilities
There are two possible courses of action, one, perhaps, more challenging (from the insurance side) than the other:
1) List the QPRT as the only “named insured” without mention or inclusion of Mr. and Mrs. Smith (creating separation between the trust and the individuals, which may be deemed desirable for tax reasons, but problematically, also eliminates any coverage for the individuals themselves); or
2) Add the trust as an “additional insured,” which may be slightly more limiting in coverage, but can be done without removing the individuals themselves from insurance protection.
The first approach is a bit more challenging for most insurers, as listing the QPRT as the sole named insured gives it worldwide liability coverage (possibly capturing exposures the insurer neither wants nor intends to cover), whereas the only interest the QPRT has here is in the actual property or premises itself. The conflict begins when some attorneys are adamant about eliminating any trail or sign that the former owners still live in the residence or have interest in the property.
Creating a Separation
How do you create this separation? The ideal answer (if achievable with one’s insurer) is:
1) Place homeowner’s coverage showing the QPRT as the sole named insured. If the “owners” still live at the residence, they need to secure separate coverage, in their own name, for their personal property, liability and umbrella exposures.
I recommend that the owners purchase a renter’s insurance policy to cover personal property, including valuables and personal liability. Some insurers will write an umbrella policy as well on the same policy, or it may have to be provided separately.
2) In some cases, change the mailing address to a P.O. Box, instead of a listed physical premises. Although this may seem a bit extreme, attorneys have requested it in the past, and it may create the perception, at least, of a certain level of desirable separation.
3) As a follow up to #2, advise the client to change mailing addresses on other types of mail as well.
Additional Insured
The second option of adding the QPRT as an additional insured is more common and easier for insurers. Simply add the name of the trust to the former owners’ existing homeowner's coverage:
1) Adding the QPRT as an “additional insured” will give the QPRT coverage for its property interest in the home and provide liability protection for the QPRT for that location only. The key is to ask for both property AND liability coverage.
2) Add the QPRT to the umbrella policy to ensure continuity of higher limits of premises liability for its specific interest.
Other Considerations
What are other considerations when a trust is formed and added for coverage?
In many cases, the original owner(s) of the home will continue to live there, and specific terms and guidelines of the trust agreement may specify that the tenant(s) will pay rent to the trust as landlord. When this occurs, it’s possible that insurers (that are less familiar with or exposed to the trust formation process) will begin to look at this as a commercial risk, rather than as a personal one, or they may simply not have the appetite, experience or comfort for continuing to insure this kind of risk.
This leads to the importance of carrier selection, if this type of risk and situation exists; as it’s imperative the insurer understands and is willing to insure this type of ownership. Unfortunately, some insurers, particularly smaller regional ones or national direct writers more suited for and used to less affluent mainstream America accounts, don’t have the aptitude or underwriting abilities and forms to do this correctly, or at all.
One of the principal reasons why things hit a snag during trust formation from the insurance standpoint is simply due to incorrect carrier selection and employment. In other words, the carrier, and even worse, the agent representing the insurer, doesn’t understand the exposure and, ultimately, may not be equipped to offer the best contract and terms for the client. Only a select few insurers do this correctly.
Get Parties in Sync
In summary, everyone needs to be on the same page, and this type of ownership change must be properly addressed and structured. The components and alternatives to successfully accomplish this are vital, and all parties must be in sync... client, attorney, insurer and agent. If any of these parties isn’t on board or doesn’t understand how this needs to be addressed and done, the results could be catastrophic.