What Is Agency by Necessity?

Agency by necessity is a type of legal relationship in which one party can make essential decisions for another party until legally recognized agents like someone with power of attorney or guardianship are put in place. The courts recognize agency by necessity during an emergency or urgent situation under which the beneficiary is unable to provide explicit authorization. Under such circumstances, those granted agency must act for the sole benefit of the beneficiary.

In finance, agency by necessity often takes the form of replacing an individual’s investment or retirement decisions.

Understanding Agency by Necessity

Emergency situations often lead to agency by necessity in the eyes of the court. For example, if an individual is sick and unable to make a critical investment or retirement decision, agency of necessity would allow an attorney, parent, or spouse to make decisions on behalf of the incapacitated party.

Agency by necessity becomes important in wealth management. For example, many wealth managers are involved in the creation of wills, trusts, and overseeing inheritances of wealth from one generation to the next. If a family member in possession of or who is an agent of the family’s wealth becomes incapacitated in an accident or is ill, another close family member of similar capabilities and understanding of the family finances may take over as an agent of necessity.

At times this can become fraught, however, particularly in cases of high net worth individuals or wealthy families that have to make decisions about wealth distribution for future generations. Family members and additional stakeholders may take issue with decisions that the agent by necessity makes.

Agency by Necessity and Estate Planning

Although many conduct their estate planning before becoming incapacitated, at times these tasks may be given to an agent by necessity. Estate planning entails a variety of critical tasks such as the bequest of assets to heirs and the settlement of estate taxes. Most estate plans require the help of an attorney. Estate planning can also take into account the management of an individual’s properties and financial obligations. If the individual owes debts and is not of sound mind to pay them, an agent by necessity may step in to figure out a plan for repayment.

The assets that could comprise an individual’s estate include houses, cars, stocks, bonds, and other financial assets, paintings and other collectibles, life insurance, and pensions. These must be distributed as the individual has chosen after passing. In addition to preserving family wealth and providing for surviving spouses and children, many individuals will undertake serious estate planning to fund children or grandchildren’s education or leave their legacy to a charitable cause.

Specific estate planning tasks could include but are not limited to:

• Writing a will
• Limiting estate taxes by setting up trust accounts in the name of beneficiaries
• Establishing a guardian for living dependents
• Naming an executor of the estate to oversee the terms of the will
• Creating/updating beneficiaries on plans such as life insurance, IRAs, and 401(k)s
• Setting up funeral arrangements

What is Allowance For Credit Losses?

Allowance for credit losses is an estimate of the debt that a company is unlikely to recover. It is taken from the perspective of the selling company that extends credit to its buyers.

How Allowance For Credit Losses Works

Most businesses conduct transactions with each other on credit, meaning they do not have to pay cash at the time purchases from another entity is made. The credit results in an accounts receivable on the balance sheet of the selling company. Accounts receivable is recorded as a current asset and describes the amount that is due for providing services or goods.

One of the main risks of selling goods on credit is that not all payments are guaranteed to be collected. To factor in this possibility, companies create an allowance for credit losses entry.

Since current assets by definition are expected to turn to cash within one year, a company’s balance sheet could overstate its accounts receivable and, therefore, its working capital and shareholders’ equity if any part of its accounts receivable is not collectible.

The allowance for credit losses is an accounting technique that enables companies to take these anticipated losses into consideration in its financial statements to limit overstatement of potential income. To avoid an account overstatement, a company will estimate how much of its receivables it expects will be delinquent.

Recording Allowance For Credit Losses

Since a certain amount of credit losses can be anticipated, these expected losses are included in a balance sheet contra asset account. The line item can be called allowance for credit losses, allowance for uncollectible accounts, allowance for doubtful accounts, allowance for losses on customer financing receivables or provision for doubtful accounts.

Any increase to allowance for credit losses is also recorded in the income statement as bad debt expenses. Companies may have a bad debt reserve to offset credit losses.

Allowance For Credit Losses Method

A company can use statistical modeling such as default probability to determine its expected losses to delinquent and bad debt. The statistical calculations can utilize historical data from the business as well as from the industry as a whole. 

Companies regularly make changes to the allowance for credit losses entry to correlate with the current statistical modeling allowances. When accounting for allowance for credit losses, a company does not need to know specifically which customer will not pay, nor does it need to know the exact amount. An approximate amount that is uncollectible can be used.

In its 10-K filing covering the 2018 fiscal year, Boeing Co. (BA) explained how it calculates its allowance for credit losses. The manufacturer of airplanes, rotorcraft, rockets, satellites, and missiles said it reviews customer credit ratings, published historical credit default rates for different rating categories, and multiple third-party aircraft value publications every quarter to determine which customers might not pay up what they owe.

The company also disclosed that there are no guarantees that its estimates will be correct, adding that actual losses on receivables could easily be higher or lower than forecast. In 2018, Boeing’s allowance as a percentage of gross customer financing was 0.31%.

Example of Allowance For Credit Losses

Say a company has $40,000 worth of accounts receivable on September 30. It estimates 10% of its accounts receivable will be uncollected and proceeds to create a credit entry of 10% x $40,000 = $4,000 in allowance for credit losses. In order to adjust this balance, a debit entry will be made in the bad debts expense for $4,000.

Even though the accounts receivable is not due in September, the company still has to report credit losses of $4,000 as bad debts expense in its income statement for the month. If accounts receivable is $40,000 and allowance for credit losses is $4,000, the net amount reported on the balance sheet will be $36,000.

This same process is used by banks to report uncollectible payments from borrowers who default on their loan payments.

What Is an Aleatory Contract?

An aleatory contract is an agreement whereby the parties involved do not have to perform a particular action until a specific, triggering event occurs. Events are those that cannot be controlled by either party, such as natural disasters and death. Aleatory contracts are commonly used in insurance policies. For example, the insurer does not have to pay the insured until an event, such as a fire that results in property loss. Aleatory contracts—also called aleatory insurance—are helpful because they typically help the purchaser reduce financial risk.

Understanding an Aleatory Contract

Aleatory contracts are historically related to gambling and appeared in Roman law as contracts related to chance events. In insurance, an aleatory contract refers to an insurance arrangement in which the payouts to the insured are unbalanced. Until the insurance policy results in a payout, the insured pays premiums without receiving anything in return besides coverage. When the payouts do occur, they can far outweigh the sum of premiums paid to the insurer. If the event does not occur, the promise outlined in the contract will not be performed.

How Aleatory Contracts Work

Risk assessment is an important factor to the party, taking a higher risk when considering entering into an aleatory contract. Life insurance policies are considered aleatory contracts, as they do not benefit the policyholder until the event itself (death) comes to pass. Only then will the policy allow the agreed amount of money or services stipulated in the aleatory contract. The death of someone is an uncertain event as no one can predict in advance with certainty that when the insured will die. However, the amount which the insured’s beneficiary will receive is certainly much more than what the insured has paid as a premium.

In certain cases, if the insured has not paid the regular premiums to keep the policy in force, the insurer is not obliged to pay the policy benefit, even though an insured has made some premium payments for the policy. In other types of insurance contracts, if the insured doesn’t die during the policy term, then nothing will be payable on maturity, such as with term life insurance.

Annuities and Aleatory Contracts

Another type of aleatory contract where each party takes on a defined level of risk exposure is an annuity. An annuity contract is an agreement between an individual investor and an insurance company whereby the investor pays a lump sum or a series of premiums to the annuity provider. In return, the contract legally binds the insurance company to pay periodic payments to the annuity holder—called the annuitant—once the annuitant reaches a certain milestone, such as retirement. However, the investor might risk losing the premiums paid into the annuity if they withdraw the money too early. On the other hand, the person might live a long life and receive payments that far exceed the original amount that was paid for the annuity.

Annuity contracts can be very helpful to investors, but they can also be extremely complex. There are various types of annuities each with its own rules that include how and when payouts are structured, fee schedules, and surrender charges—if money is withdrawn too soon.

Special Considerations

For investors who plan on leaving their retirement funds to a beneficiary, it’s important to note that the U.S. Congress passed the SECURE Act in 2019, which made rule changes to beneficiaries of retirement plans. As of 2020, non-spousal beneficiaries of retirement accounts must withdraw all of the funds in the inherited account within ten years of the owner’s death. In the past, beneficiaries could stretch out the distributions—or withdrawals—over their lifetime. The new ruling eliminates the stretch provision, which means all of the funds, including annuity contracts within the retirement account–must be withdrawn within the 10-year rule.

Also, the new law reduces the legal risks for insurance companies by limiting their liability if they fail to make annuity payments. In other words, the Act reduces the ability for the account holder to sue the annuity provider for breach of contract. It’s important that investors seek help from a financial professional to review the fine print of any aleatory contract as well as how the SECURE Act might impact their financial plan.

What Is the 52-Week Range?

The 52-week range is a data point traditionally reported by printed financial news media, but more modernly included in data feeds from financial information sources online. The data point includes the lowest and highest price at which a stock has traded during the previous 52 weeks.

Investors use this information as a proxy for how much fluctuation and risk they may have to endure over the course of a year should they choose to invest in a given stock. Investors can find a stock’s 52-week range in a stock’s quote summary provided by a broker or financial information website. The visual representation of this data can be observed on a price chart that displays one year’s worth of price data.

Understanding the 52-Week Range

The 52-week range can be a single data point of two numbers: the highest and lowest price for the previous year. But there is much more to the story than these two numbers alone. Visualizing the data in a chart to show the price action for the entire year can provide a much better context for how these numbers are generated.

Since price movement is not always balanced and rarely symmetrical, it is important for an investor to know which number was more recent, the high or the low. Usually an investor will assume the number closest to the current price is the most recent one, but this is not always the case, and not knowing the correct information can make for costly investment decisions.

Two examples of the 52-week range in the following chart show how useful it might be to compare the high and low prices with the larger picture of the price data over the past year.

These examples show virtually the same high and low data points for a 52-week range (set 1 marked in blue lines) and a trend that seems to indicate a short-term downward move ahead.

The overlapping range on the same stock (set 2 marked in red lines) now seems to imply that an upward move may be following at least in the short term. Both of these trends can be seen to play out as expected (though such outcomes are never certain). Technical analysts compare a stock’s current trading price and its recent trend to its 52-week range to get a broad sense of how the stock is performing relative to the past 12 months. They also look to see how much the stock’s price has fluctuated, and whether such fluctuation is likely to continue or even increase.

The information from the high and low data points may indicate the potential future range of the stock and how volatile its price is, but only the trend and relative strength studies can help a trader or analyst understand the context of those two data points. Most financial websites that quote a stock’s share price also quote its 52-week range. Sites like Yahoo Finance, Finviz.com and StockCharts.com allow investors to scan for stocks trading at their 12-month high or low.

Current Price Relative to 52-Week Range

To calculate where a stock is currently trading at in relations to its 52-week high and low, consider the following example:

Suppose over the last year that a stock has traded as high as $100, as low as $50 and is currently trading at $70. This means the stock is trading 30% below its 52-week high (1-(70/100) = 0.30 or 30%) and 40% above its 52-week low ((70/50) – 1 = 0.40 or 40%). These calculations take the difference between the current price and the high or low price over the past 12 months and then convert them to percentages.

52-Week Range Trading Strategies

Investors can use a breakout strategy and buy a stock when it trades above its 52-week range, or open a short position when it trades below it. Aggressive traders could place a stop-limit order slightly above or below the 52-week trade to catch the initial breakout. Price often retraces back to the breakout level before resuming its trend; therefore, traders who want to take a more conservative approach may want to wait for a retracement before entering the market to avoid chasing the breakout.

Volume should be steadily increasing when a stock’s price nears the high or low of its 12-month range to show the issue has enough participation to break out to a new level. Trades could use indicators like the on-balance volume (OBV) to track rising volume. The breakout should ideally trade above or below a psychological number also, such as $50 or $100, to help gain the attention of institutional investors.