Why financial stress tests should go beyond investment portfolios

Expert points to potential impacts of negative events involving corporate and legal structures

Why financial stress tests should go beyond investment portfolios

Stress-testing financial plans should be a mainstay service in a professional advisor’s toolkit, and the COVID-19-driven market selloffs coupled with the comeback of volatility has given it an added layer of importance. And according to one legal expert, it may very well be worth going beyond the scope of the usual exercise planners go through.

“Although prudent financial planners will stress-test a portfolio, it is much less common to stress-test a corporate and legal structure,” said Rob Worthington of Field LLP in a blog post earlier this month. “There are many circumstances beyond the risks of financial markets that can destroy wealth.”

Putting a fine point to the statement, Worthington noted several examples. Among other factors, he pointed to legal uncertainties, both from the rise and repeal of laws and courts’ evolving interpretation of legislation; limits to insurance protection due to escalating premiums for certain risk types and broad exclusory clauses; professional liability among businesses and working professionals; and family risks from marital breakdowns, estate disputes, and other domestic difficulties.

“Unfortunately, those with deep pockets are potential targets for those with grievances,” Worthington said, citing the risk of asset erosion from lawsuits and unfavourable judgments. “A non-consensual creditor who receives a judgement against you or a corporate entity may then enforce against the assets.”

To head off such risks, he said planning should be done proactively in advance of any potential liability, which should also include personal or family problems that could fester and lead to financial ones. The degree of effort necessary will differ from case to case, he added, as some corporate structures are set up in a more reticulated or complex way than others.

He suggested some questions to assess the necessity of a corporate stress test including, among others:

  • Whether any adult children are named shareholders in the corporation;
  • Ownership of rental property;
  • Ownership of significant non-registered portfolios, such as assets held outside an RRSP;
  • Use of corporate-owned life insurance;
  • Ownership of multiple corporations that have payments such as fees or rents flowing between them; and
  • Inter-corporate loans between one’s operating company and at least one holding company.

“If you answered yes to any of the above questions, it is a worthwhile exercise to stress-test your legal structure,” he said. “Like a medical check-up, a stress test of your legal or asset structure is far more effective if it is done regularly and well in advance of a problem arising.”

 

Follow WP on FacebookLinkedIn and Twitter

LATEST NEWS