Exploring the Unique Insurance Needs of Embedded Family Offices

A family office is a private organization designed to help a high-net-worth family manage its wealth. A family office can exist as a stand-alone entity or in an embedded structure within a family business. In this article, we’ll discuss the differences between the two structures and the unique insurance needs of an embedded family office.

Stand-Alone Family Office versus Embedded Family Office

A family office provides a range of services tailored to meet the individual needs of high-net-worth families. Let’s examine the differences between a stand-alone family office and an embedded family office. 

Stand-Alone Family Office: An organization that manages the wealth and personal affairs of a high-net-worth family or multiple families. This can include a range of services, from investment and asset management to estate planning, philanthropy coordination, tax planning, trustee services, and other services tailored to the needs of wealthy individuals.

Embedded Family Office: A family office that is integrated into the structure of a larger organization, such as a business owned by the family. The two organizations may share services such as accounting, investment, distribution, and concierge services for family members.

The advantages of an embedded structure over a stand-alone structure include having centralized services and the resulting cost efficiency. However, there can also be complicating factors.

While most court cases involving family offices are settled privately, it's not a far stretch to imagine how some public family challenges can affect the family businesses. If embedded family offices are involved, it can be challenging to effectively separate the services. Some examples that made the headlines are the Sackler family’s involvement in the opioid crisis, Sumner Redstone and Viacom, and Hank Greenberg’s dispute surrounding personal property and artwork with AIG.

Insurance Considerations for Embedded Family Offices

The structure of your family office has an impact on your insurance needs. Here are the factors to consider with an embedded family office:

• Lack of Clear Boundaries: Along with the blurring of lines between family business operations and personal family affairs, there may be challenges in delineating which assets and liabilities belong to the business and which to the family. This lack of boundaries could potentially expose family assets to business-related risks or challenges if there is a sale or bankruptcy of the operating entity.
• Conflicts of Interest: Since an embedded family office is closely tied to the family's business operations, there could be conflicts of interest, particularly involving investment decisions or transactions that may benefit one part of the family's holdings over another.
• Regulatory and Compliance Risks: Depending on the jurisdiction and the specific activities of the embedded family office, there might be regulatory requirements. Failure to meet these can lead to financial penalties and legal consequences.
• Operational Risks: The close intertwining of family and business operations can lead to operational inefficiencies, errors, or oversights that might not occur in a more distinct separation of entities.
• Reputation Risks: If the family business becomes embroiled in any public scandal or controversy, having an embedded family office might mean that the family's private affairs are also dragged into the limelight.
• Privacy Concerns: The more integrated the family office is with business activities, the greater the number of individuals who might have access to private family information. This integration could raise concerns about the privacy of the family's financial and personal data.
• Legal Disputes: If disputes arise within the family or with external entities, an embedded family office might become more easily entangled in legal battles.
• Lack of Independence: A family office that is embedded might not have the same level of independence in terms of decision-making. This situation could be problematic if the family needs to take actions that aren't in the best interests of the business (or vice versa). Additionally, there could be tax consequences if the IRS perceives the family has too much control over the assets that have been placed in trust.
• Succession and Governance Issues: With family and business matters intertwined, it might be challenging to set clear governance structures and succession plans, which could lead to disputes and disruptions down the line.
• Dissolution Complications: If there's ever a need to dissolve the family office or separate it from the business, an embedded structure can complicate the process.

The above issues impact insurance placements when the embedded family offices' exposures are thought to be insured by the operational companies’ insurance policies. For this discussion, we’ll focus on the directors & officers (D&O) and professional liability (E&O) insurance.

Should You Buy Separate D&O and E&O Insurance Policies?

For embedded family offices within an operating company, the decision to separate the D&O and E&O insurance policies may come down to the following considerations:

Nature of Activities and Risks: Does the embedded family office have a significantly different risk profile or conduct activities that are distinctly different from those of the operating company?

Coverage Limitations and Exclusions:

• Sharing policies between the family office and operating company might result in coverage limitations such as the insured versus insured exclusion.
• If one entity faces a significant claim, it could exhaust the policy limits, leaving the other entity exposed.
• The definition of “wrongful act” may not be expanded to cover the services provided by the embedded family office to family members.
• In some cases, such as trustee services, the person is serving individually and not as an employee, which may create capacity issues.

Clarity and Simplification: There might be disputes or ambiguities about which entity's activities led to a claim and how the insurance coverage applies.

Conflicts of Interest: If a claim arises that involves both the family office and the operating company, a combined policy could create conflicts in terms of defense strategies or indemnification.

Future Flexibility: If there's ever a consideration to spin off the family office as a separate entity, having separate policies can make the transition smoother and ensure there aren’t runoff issues or prior acts exclusions. 

Claims History and Renewals: If one of the entities has a significantly adverse claims history, it might impact the renewal terms or premiums for a combined policy, potentially penalizing the other entity.

Market Cycles: Insurance markets don’t cycle at the same time and are more driven by market segment today. Therefore, changing markets will affect coverage grants and pricing differently, creating challenges in leveraging market conditions.

We recommend consulting with an insurance expert or broker who has experience with family offices and can provide guidance tailored to the specific situation and needs of the family and its entities.