A client chooses between HK$900 for certain and a lottery paying HK$10,000 with a stated probability of 10%, otherwise zero. He says the prize “feels more likely than 10%”. Which interpretation is sound?
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Written case practice · 50 marks
Keeping a design business running while planning its succession
Nadia Wong, 48, owns 60% of Harbour Design Ltd; an unrelated partner owns 40%. Nadia manages the firm's principal client relationships. Her spouse does not work in the business. One adult child wants to join it; the other prefers a different career. No succession or share-purchase agreement has been agreed. For a hypothetical death-of-Nadia stress test, the company forecasts nine months with no customer receipts, unavoidable operating payments of HK$250,000 a month, a one-off replacement/recruitment cost of HK$350,000 and an HK$800,000 company debt repayment. It can use HK$900,000 of company cash and an existing HK$1,000,000 key-person policy payable to the company. Separately, Nadia's family would require HK$360,000 a year for eight years, HK$600,000 for education and HK$1,200,000 to repay the home mortgage. Family resources available for these needs are HK$400,000 cash and HK$1,500,000 life cover payable to the spouse. None of the company's resources belongs to the family, none of the family resources is available to the company, and no other receipt, asset sale or support may be assumed. For both calculations, ignore investment returns, inflation, tax, costs and timing within the eight-year period; assume the stated policies pay promptly and in full in the stress event. These are simplified needs estimates, not policy quotations. Nadia also has a separate HK$2,000,000 investment portfolio, excluded from the family resources above because it is earmarked for her spouse's independent retirement needs. An SFC-licensed adviser recommends using that portfolio to buy a single illiquid fund, which pays the adviser a material distribution commission. Nadia says, 'I know successful entrepreneurs, so I can identify winners; I only read reports supporting this fund.' Assume client-information, suitability and conflict provisions apply without exemption.
Write your answers before opening the marking guide. Self-assess this case separately from the MCQ score.
1. Identify five further fact-gathering priorities before preparing Nadia's business-protection, family-protection and succession plan. Explain the relevance of each. (10 marks)
Model answer and marking guide
Establish who can manage client relationships and sign or make decisions if Nadia is absent, so operational dependency can be reduced. Review company borrowing, guarantees and cash availability, because Nadia's personal exposure and the firm's survival needs may differ from the simplified stress test. Examine policy ownership, insured events, beneficiaries, exclusions and actual payment terms to check whether resources would reach the intended recipient when needed. Discuss the partner's and each family member's objectives, willingness and ability to run or own shares, distinguishing management succession from ownership succession. Obtain a supported business valuation and review share-transfer arrangements, existing wills and relevant jurisdictions with advisers, so any proposed buyout or estate allocation has a workable funding and legal basis. Confirm the continuing priority of the spouse's retirement assets rather than silently using them twice.
- Operational dependency and substitute authority: 1 for information sought and 1 for its planning relevance. (2 marks)
- Debt, guarantees or usable cash: 1 for information and 1 for company/personal funding implications. (2 marks)
- Actual insurance terms and recipients: 1 for information and 1 for protection/timing implications. (2 marks)
- Partner/family intentions and capabilities: 1 for information and 1 for ownership/management implications. (2 marks)
- Valuation, legal arrangements or competing personal goals: 1 for information and 1 for a specific succession/funding implication. Accept distinct equivalent pairs without double counting. (2 marks)
2. Calculate the company's total stress-event cash need and residual funding gap. Separately calculate the family's total need and residual protection gap. Show the resources deducted and explain why neither gap can automatically be met by the other party's insurance proceeds or by Nadia's share valuation. (15 marks)
Model answer and marking guide
Company need = 9 × HK$250,000 + HK$350,000 + HK$800,000 = HK$3,400,000. Company resources = HK$900,000 + HK$1,000,000 = HK$1,900,000; its residual gap is HK$1,500,000. Family need = 8 × HK$360,000 + HK$600,000 + HK$1,200,000 = HK$4,680,000. Family resources = HK$400,000 + HK$1,500,000 = HK$1,900,000; its residual gap is HK$2,780,000. Company and family needs require separate funding because the resources are owned by or payable to different recipients and the case expressly excludes transfers between them. A share valuation is not a cash receipt; without an executable funded purchase or sale, it cannot meet scheduled payments. The retirement portfolio is also expressly reserved for a separate goal. These gaps are starting points for reviewing affordable cover and other feasible funding, not automatically the correct sum insured under an actual policy.
- Company need: nine-month operating amount HK$2,250,000 (1), inclusion of replacement cost and debt (1), total HK$3,400,000 (1). (3 marks)
- Company resources HK$1,900,000 (1), correct subtraction (1), gap HK$1,500,000 (1). (3 marks)
- Family need: eight-year support HK$2,880,000 (1), education and mortgage inclusion (1), total HK$4,680,000 (1). (3 marks)
- Family resources HK$1,900,000 (1), correct subtraction (1), gap HK$2,780,000 (1). (3 marks)
- One each for separating company/family recipients, explaining that share value is not available cash, and avoiding double counting the separately earmarked retirement portfolio. (3 marks)
3. Outline five linked elements of a workable business-protection and succession plan for Nadia. Distinguish immediate continuity, ownership arrangements and funding. Do not assume a trust, insurance policy or will alone resolves all issues. (15 marks)
Model answer and marking guide
First, reduce immediate operating dependency through a trained deputy, documented client contacts, delegated authority and an emergency continuity plan. Second, discuss and document management succession with the partner and children; joining the firm, managing it and owning its shares are different roles, and the interested child's capability needs assessment. Third, have qualified advisers develop any agreed share-transfer or buy-sell arrangement, addressing triggering events, valuation method, decision rights and the partner's and estate's obligations. Fourth, fund the agreed arrangements: compare additional key-person protection for company continuity, family life protection and any separately required buyout finance, checking affordability, terms and recipients and avoiding double counting. A policy payment to the company is not itself payment for Nadia's shares. Fifth, coordinate estate planning and fair treatment of the child outside the business with the ownership plan; review wills and any suitable trust or other structure with relevant professionals. Test whether sufficient liquid non-business assets exist and whether the proposed structure's cost and control arrangements meet the family's wishes. Set responsibilities and review after changes in valuation, family circumstances or business dependence.
- Continuity: identify Nadia dependency (1), a concrete replacement/authority measure (1), and an operational contingency plan (1). (3 marks)
- Management succession: consult partner/family (1), distinguish ownership from management (1), assess/train a successor rather than presume suitability (1). (3 marks)
- Ownership arrangements: professional drafting (1), agreed triggers/valuation (1), clear transfer or decision rights/obligations (1). (3 marks)
- Funding: distinguish continuity, family and buyout purposes (1), align ownership/beneficiaries and avoid double counting (1), check affordability and actual terms (1). (3 marks)
- Estate coordination: address the non-participating child's position (1), assess liquidity and appropriate professional structures without universal claims (1), assign implementation/review responsibilities (1). (3 marks)
4. Identify two behavioural biases in Nadia's fund reasoning and give a practical response to each. Explain how the adviser should handle the commission conflict and suitability of using the retirement portfolio for the proposed fund. (10 marks)
Model answer and marking guide
Nadia's claim that knowing successful entrepreneurs lets her identify winners suggests overconfidence; compare her belief with documented risks and downside scenarios and avoid treating business experience as investment expertise. Reading only supportive reports indicates confirmation bias; deliberately examine independent adverse evidence and competing investments against pre-agreed criteria. The material commission creates a potential conflict: disclose it and take reasonable steps to treat Nadia fairly, including assessing alternatives and not steering the recommendation for remuneration. Disclosure alone does not establish suitability. The adviser must understand the spouse's retirement goal, liquidity needs, loss-bearing capacity and investment experience and the fund's risks, terms and costs. Committing the entire separate retirement portfolio to one illiquid fund creates concentration and access risks that must be assessed; Nadia's confidence or willingness to sign cannot replace reasonable suitability. The stated facts do not establish that this recommendation is appropriate.
- Overconfidence (1), linked to Nadia's asserted ability (1), with a practical calibration/downside-testing response (1). (3 marks)
- Confirmation bias (1), linked to selective reading (1), with a practical contrary-evidence response (1). (3 marks)
- Disclose the material commission conflict (1) and take reasonable steps for fair treatment rather than treating disclosure as sufficient (1). (2 marks)
- Assess client goal/capacity and product risks for reasonable suitability (1), identifying whole-portfolio illiquidity/concentration as a concern and rejecting consent/confidence as a substitute (1). (2 marks)
