Does the impact of death events currently have a place in your loan-loss-reserve analysis? Have you considered the operational risks inherent in the death of a customer--whether consumer or commercial? These topics are explored in this installment of H.A. Lowe's series on probate collections.
Prudent individuals plan for their own deaths. Careful estate plans are calculated to transfer the greatest amount of wealth possible while paying the fewest dollars in estate taxes and avoiding creditors. There is every reason for lenders and collectors likewise to plan for the deaths of their debtors.
There are two levels on which lenders should consider game planning for the "two-minute drill":
1. The appropriateness of including in loan-loss-reserve analyses the impact of death events on the collectibility of consumer portfolios (as well as commercial portfolios, to the extent commercial loans may be guaranteed by individuals).
2. The operational risks relative to dealing with the death event once it occurs in a particular account.
Should Predictable Death Events Be Included in Loan-Loss-Reserve Analyses?
Particularly because of the anticipated (though not yet quantified) increase in consumer debt charge-offs attributable to the aging and passing of baby boomers, national death statistics may need to be part of loan-loss-reserve analyses.
According to U.S. Census Bureau statistics, based on the 2000 census, the approximately 78 million baby boomers represented roughly 37% of the total population of legal age (approximately 207,309,519) eligible to contract and carry debt in their own names. Prior generations (aged 55 and over) represented 28.4%, and subsequent generations (aged 18 to 35) represented 34.6%. The Centers for Disease Control's National Center for Vital Statistics notes there were approximately 260,000 deaths in 2001 among persons a aged 35-54. The death rate per 100,000 within each subgroup increased dramatically with age, rising from 165.9 for persons aged 35-39, to 512.4 for persons aged 50-54. Further, as one might expect, the 2001 death rates increased dramatically with the age of population. For example, the death rate for persons 70-74 years of age, which is where the oldest baby boomers will be in just 15 years, was 2,878.3.
It's reasonable to assume that the demographic group with more debt than any other will die in increasing numbers as time passes. Readily available death statistics could easily support an industry-wide statistical modeling to predict the timing and effect of baby-boomer deaths (and those of other generations) in the coming years. For purposes of loss reserve analysis, individual lenders could then make reasonable assumptions as to the impact of death events on the collectibility of consumer loans and commercial loans guaranteed by individuals.
Moreover, because a death event does not render a particular account uncollectible, failure to include death events in the reserve analysis amounts to a decision to do nothing about collecting otherwise collectible dollars when an individual dies. Conversely, an appropriate inclusion of death events in the audit committee's reserve analysis could lead to a revamping of operations to minimize the risk of loss resulting from death events.
Operational Risk Management--A New Way of Thinking
A lender's decision to include death events in loss-reserve analysis as the linchpin of effective game planning in the probate collection area will represent a fundamental change in thinking about deceased debt. During their lives, debtors have a legal and a moral obligation to pay their just debts. Once they die, however, only the legal obligation survives them, becoming an obligation of their estates. Collectors rely on a debtor's sense of moral obligation (hence, the effectiveness of certain telephone collection techniques). Once that obligation expires with the debtor, though, the entire spectrum of the best collection practices becomes almost totally useless.
The legal obligation resides in an estate, represented in most cases by a person who has every incentive to avoid paying creditors. Thus, it may be best to think of a pre-death consumer claim as a unique opportunity, within a unique marketplace, to add cash to the lender's balance sheet, rather than as a receivable that it is entitled to collect. That concept forces lenders to think in terms of managing processes to make the most of each opportunity, just as any successful business in any industry does.
Typically, by the time unsecured creditors are paid in the ordinary course out of probate, lenders will have written down or written off the receivable under applicable accounting procedures and regulations. Irrespective of and wholly apart from loss reserve analysis, adding cash to the balance sheet makes all the sense in the world. Applying a few market concepts simplifies the approach to collecting in probate. Table 1 summarizes the marketplace concept.
The marketplace analogy is perfect because, over time, the best overall strategy and operations will lead to better overall bottom-line performance. In the case of any particular estate, assuming there is net asset value in the estate, the creditor who performs best operationally will distinguish itself and outperform the competition, such performance being measured by the relative percentages of the amounts of the claim collected by the respective creditors.
The risk manager should ask questions and seek answers within the framework of the particular institution to determine its current strategic decision. For example: What is the institution's policy with respect to aged receivables? Does the institution routinely group aged accounts for sale or assignment for collection, without distinguishing between deceased debt and "troubled" debt? What other criteria for assignment or sale does the institution deem significant? Does the institution handle troubled debt in-house or through a subsidiary? Either way, does the institution track deceased debt as a separate category? Does the lender have a method of readily analyzing historical performance patterns of an account that suddenly stops performing? If the lender handles its own collection operations, how efficient and effective are those operations? What are the institution's benchmarks for measuring performance?
An institutional risk analysis around such questions could prove very helpful in devising a more sound strategy for managing deceased debt. For example, a policy of either placing or selling debt at, say, 90 or 120 days aging, without distinguishing between deceased debt and other consumer debt, is tantamount to a decision to do nothing about deceased debt. That may not be the best decision, because that approach does not take into account that the reason for the "bad debt" may not be inability to pay.
As time passes, the chance increases that good old "Freddie Debtor" borrowed money and now, well, Freddie's dead, so he hasn't paid anybody for awhile. But if Freddie left a large, solvent estate and the lender bundled his account with other "bad debt" and sold it, that was not a sound decision. And the decision to do nothing will become even less sound with the passage of time.
The key is to adopt a risk management philosophy that uses the necessary balance sheet reserve for bad debt but also optimizes bottom-line performance on the income statement by adding cash to the balance sheet. In the example case introduced in Part 1, the single unsecured creditor who got it right took about a 70% write-down several months following the decedent's death and then, a few weeks later, successfully negotiated the collection of about 45% of its original claim through early settlement. That is good strategy and good execution.
Operational Risk Management--A Few Things Worth Thinking About
Part 2 of the series offered five parameters of probate laws that are most directly pertinent to the probate collection process. Each parameter offers its own unique challenges and opportunities for risk management professionals, particularly for those whose institutions lend in multiple jurisdictions. Here are some helpful tips for a few of these challenges.
Notice of the opportunity.
Part 2 of the series alluded to a continuum of four scenarios wherein a debtor's death makes things a little weird.
* In the first scenario, where the debtor is not in default, the creditor faces the most risk because the creditor probably will not obtain notice of a debtor's death in time to present a timely claim.