Re-pricing Your Clients’ Life Insurance – Can You Reduce Premiums?
By Lee Slavutin MD, CLU and Steven H. Goodman MBA, CPA
A few years ago interest rates hit their lowest point in about 50 years. Many of us refinanced our mortgages at these low rates. You were regarded as a fool if you did not consider it. The same phenomenon is occurring now in life insurance pricing. Term insurance premiums today are often 30-40% lower than premiums on policies issued 10 years ago. Universal life premiums are also significantly lower. (Universal life is a cash value policy with flexible premiums.) Clients who are allocating significant dollars to insurance premiums will welcome the opportunity to reduce costs. So the door is open for financial advisors to bring this idea to clients and perform a life insurance “check-up.”
Why Have Life Insurance Premiums Come Down?
Term and universal life insurance premiums have come down for a number of reasons:
As life expectancy improves, mortality charges decrease.
New “preferred” underwriting classes for healthy individuals mean lower premiums.
New medical treatments have altered underwriting of hypertension, hypercholesterolemia and many other conditions. Clients with well controlled blood pressure can qualify for preferred insurance rates.
New universal life policies can be structured like term insurance. They do not accumulate much cash value and premiums are lower. They may be suitable for clients whose primary need is estate liquidity. Premiums and death benefits are often guaranteed in these policies (“universal life with secondary guarantees;” “guaranteed universal life [GUL].”) Note that GUL, unlike universal life policies in general, has a fixed inflexible premium (to be discussed below.)
Why Should We Approach Clients about Repricing?
The approach to evaluate a client’s life insurance portfolio should encompass pricing and many other important life insurance issues that are often neglected. We need to educate our clients to monitor their life insurance policies like any other investment. Policies should be reviewed at least once every two years or annually. We have identified 8 steps in the life insurance check-up:
Locate all the policies. Remember to look at policies owned in retirement plans, group insurance, association insurance (e.g., AICPA, ABA, AMA), buy-sell insurance, trust-owned policies.
Create an inventory for the client on a spreadsheet showing for each policy the name of the insurer, policy number, type of insurance (term, universal, whole, variable, second-to-die), issue date, anniversary date for premium payments, policy owner, beneficiary, death benefit, premium, premium mode, cash value, and loan amount (if any).
Get updated financial strength ratings for each insurance company from A. M. Best, Fitch, Moody’s, Standard & Poor’s, and TheStreet.com. We strongly recommend purchasing the September 2007 issue of The Insurance Forum, which provides a complete guide to financial ratings (www.theinsuranceforum.com). In general, we prefer to use insurance companies rated A+ or higher with Best, AA or higher with Fitch, Moody’s and S&P, and B+ or higher by TheStreet.com.
Identify the policy owner. Some clients make uninformed decisions in choosing the policy owner. For example, policy proceeds owned by a C corporation as part of a buy sell agreement may be subject to the alternative minimum tax.
Identify the beneficiary. Here is another area where clients need help. For example, a client gets divorced and his ex-spouse is still the beneficiary of his life insurance.
Is the amount of coverage adequate? For example, a doctor earning $400,000 annually may need $3 -5 million of coverage to replace his after-tax income stream in the event of premature death. Many clients are under-insured.
Obtain an updated in-force illustration of the policy. For example, a universal life policy bought in 1992 was illustrated with an interest rate of 9%. The death benefit is $5 million and the current premium is $74,000. The original illustration shows the death benefit maintained to age 95 with growing cash values. An illustration obtained in 2007 shows that the current interest rate for this policy is 4.5% and that the policy will lapse without value at age 83. The client is now 68 and in good health. He will likely outlive his policy, unless something is done now. We will address the available options below.
Remember that life insurance is tax favored and there are important tax rules to follow. Has the policy been transferred for value, thereby jeopardizing the income tax exemption of the death benefit? Is the policy includible in the client’s estate? Are there outstanding policy loans that may cause the policy to lapse and create phantom income? This article will not cover all the possible tax traps, but one must constantly look to preserve the favorable tax treatment of life insurance policies.
It is clear that we have many good reasons to enthusiastically recommend a policy check-up for our clients; re-pricing is the obvious reason, but not the only one.
Which Clients Should We Approach?
Every client should have their policies regularly reviewed. However, two client groups stand out – trust-owned policies and clients spending large premiums, say over $50,000 a year. Trustees of life insurance trusts (ILITs) have a fiduciary duty to monitor the trust’s policies, just as they would monitor any other investment. Not uncommonly, the client’s accountant is a trustee. This is another strong reason to do the check-up.
I Am Too Busy to Do a Life Insurance Check-Up!
The accountant does NOT have to do the check-up. He acts as the quarterback. The life insurance broker who services the policies gathers all the information and compiles the inventory. If the original insurance broker is no longer servicing the client, the accountant can bring in a broker he has confidence in.
We Have the In-Force Illustration. Now What?
We will now focus on a particular case to illustrate the process of evaluating an existing policy. The client is the one described in step # 7 of the life insurance check-up: 68 years old, $5 million universal life policy, annual premium is $74,000, cash value is $326,000,
and the policy will lapse at age 83 based on the current (non-guaranteed) interest rate of 4.5% and current (non-guaranteed) mortality charges. Based on the current premium of $74,000, the policy is guaranteed to stay in force only to age 71!
Here are the options available to the client:
Leave the policy as is and run the risk of losing the coverage.
Increase the annual premium to lengthen the coverage. This should be evaluated at both current and guaranteed interest and mortality rates. Mortality charges are VERY important in determining premium costs and are often overlooked in evaluating policies. Insurance companies can and have increased mortality charges on in-force policies to maintain profitability on a block of business. To minimize this risk, look at the “Guaranteed” columns of death benefits and premiums, which cannot be changed, as long as the company stays solvent (hence the importance of financial ratings.)
Reduce the death benefit to lengthen the period of coverage. Be careful not to create modified endowment contract (MEC) or any other adverse tax result (ask the insurance company to confirm in writing that a death benefit reduction will have no adverse income tax result BEFORE you change the policy.)
Replace the policy with a new policy. When replacing an existing policy, always keep in mind the possibility of a life settlement to obtain more than the current cash value. A life settlement involves the sale of a life insurance policy to an institutional buyer (bank, insurance company, hedge fund). Clients over age 70 are, in general, good candidates for a life settlement and may realize an after-tax sales price well in excess of the policy’s cash surrender value. This article will not cover all the ins and outs of a life settlement, but it must be considered in the context of any policy replacement. Also note that a life settlement means that the sales proceeds will not qualify for a 1035 tax free exchange, but the net after-tax result may still be better with a settlement. You will need to know the policy’s cost basis to determine this.
Replacing an Existing Policy
We have to approach the idea of replacing a policy with caution. There are many potential traps. In addition, insurance agents and brokers must follow state insurance laws regarding replacements and complete all the necessary disclosures. Joe Belth in the Insurance Forum (September 2006) has identified 8 factors to look at before replacing an existing policy:
Is the client in good health and will he qualify for a new policy at favorable rates? We usually obtain the client’s medical records with the appropriate HIPPA authorization. We then submit the file to a number of insurance companies BEFORE the client undergoes any medical examination. This makes the process “painless” for the client. If the initial review is favorable, then the client will have the medical exam.
Are there any surrender charges if the client surrenders the existing policy? Even if there are surrender charges, the net premium savings may still make the replacement worthwhile.
What are the front-end expenses of acquiring the new policy? The new policy may have a much lower cash surrender value than the old policy. The client needs to understand this. It may not be important if the death benefit, not the cash value, is the primary focus of the client, but it should be disclosed.
Is the cost of continuing the current policy reasonable? We discussed this in the previous section.
Are there any adverse tax results if we cancel the policy? Will surrender trigger taxable income? Are there any outstanding loans that will trigger taxable income on surrender? Can we qualify for a 1035 tax free exchange?
Realize that a new policy has a new two year incontestability clause. Obviously, the client must honestly answer all questions on the application and provide a complete medical history.
Realize that a new policy has a new two year suicide clause.
What is the insurance broker’s compensation if the policy is replaced? Is the broker making a suitable recommendation?
Let us assume that we have looked at all these factors and determined that the client in our example will clearly benefit from a new GUL policy. The new policy has the same death benefit, a lower guaranteed premium and is guaranteed to last longer than his existing policy.
The New Policy is a GUL Policy. Are There Any Issues to Look For?
A new GUL policy may be attractive to the client because premiums are lower, guarantees are better, and the death benefit lasts longer. These are all positive features, but the client needs to understand that this policy has at least three important limitations:
The premium is fixed and if it is not paid in full and on time, the initial death benefit guarantee may be lost. For example, the new GUL policy is guaranteed to last to age 100. The annual premium is, say, $45,000. In year 5, the client pays $30,000. The death benefit guarantee is now cut back to age 97. If the client repeatedly misses or pays a lower premium, then the guarantee gets shorter and shorter. With some policies, he may be able to make up for the lost premium with an additional lump sum payment. With some policies, he may not have that option.
Most GUL policies do not accumulate significant cash value over the long term. So if the client cancels a GUL policy after 15 years, he may get little or nothing back.
The death benefit guarantee is like a cliff. If the death benefit is initially guaranteed to age 95, that means there is no insurance at age 96, or, if the client wants to continue the coverage beyond 95, then the premium will increase sharply at age 96.
Our Experience
We have reviewed many clients’ policies, both our own clients and clients that have been referred to us by their accountant or lawyer. The results vary but the client always gets educated about his portfolio and, in many cases, can do something to improve it. Some policies are in good shape and should stay as they are. Some clients are no longer insurable and re-pricing is not a viable option, but the existing policy can be restructured to lengthen its duration of coverage.
A significant number of clients can replace their policies, lower their premiums, and get better guarantees.
