PERFORMING A LIFE INSURANCE POLICY CHECKUP FOR YOUR CLIENTS

Part 1

An important step the planner must take regarding life insurance is to determine what life insurance the client already owns and how the policies are structured. Performing a life insurance checkup or audit for the client is an invaluable service.

Note: Planners without ties to a particular insurance company bring credibility to insurance check-ups because of their objectivity. When marketing this fee based service, this point should be emphasized to potential clients. See section 802 for additional discussion regarding the marketing of life insurance planning services.

Clients need to have their life insurance policies reviewed because the review may uncover significant errors in policy ownership or beneficiary designations. The cost of correcting these errors is usually small, while the cost of ignoring them may be enormous. Another important reason for a checkup is to evaluate the pricing and performance of existing policies. (See paragraph 303.19.)

Example: The need for a life insurance checkup.

Joe has 19 individual and group life insurance policies with total coverage of $2,379,000. He wants his children to receive these funds at his death without paying estate tax. However, 12 of the policies are owned by Joe, which would cause $1,300,000 of his insurance coverage to be included in his already taxable estate. At an approximately 50% combined federal and state estate tax bracket, this would result in a tax of about $650,000. In effect, Joe is paying a 200% premium on these policies to get $650,000 of proceeds to his kids. Assuming the policies are term policies with no cash value (and thus, causing little or no gift tax issues), a simple change in the ownership of the 12 policies (possibly to an irrevocable life insurance trust) will allow Joe to save $650,000 of estate tax, if he lives for at least three more years. (See section 502 for a discussion of irrevocable life insurance trusts.)

Although this example is dramatic, it illustrates the amount of tax savings that can be a common occurrence if proper reviews of clients' life insurance policies are performed. Not only can such a review save substantial tax dollars, it can also generate significant client goodwill.

Eight Steps to Performing Life Insurance Policy Reviews

The following paragraphs discuss eight steps for reviewing life insurance policies. Use them as reference points when performing life insurance checkups for clients.

Step 1 - Locate All of the Policies and Riders. Although this may seem basic, helping the client locate all of the policies is a valuable service in itself. Remember to ask about corporate-owned policies (often part of a buyout agreement or fringe benefit plan), split-dollar plans, insurance in qualified pension and profit-sharing plans [including 401(k) plans], group term policies, association policies (e.g., AICPA, icies is a valuable service in itself. Remember to ask about corporate-owned policies (often part of a buyout agreement or fringe benefit plan), split-dollar plans, insurance in qualified pension and profit-sharing plans [including 401(k) plans], group term policies, association policies (e.g., AICPA, ABA, AMA), policies owned by a trust, and all individually owned policies.

Practice Tip: Clients often have insurance policies issued by their professional/industry associations. For example, lawyers, accountants, and doctors typically have term life insurance policies issued by their respective associations. However, they may forget to take these policies into account when doing their estate planning. They may not know that they can assign these policies to irrevocable trusts, thereby removing the insurance from their taxable estates.

Step 2 - Create an Inventory for the Client. The inventory of a client's policies should show the following information for each policy:

• Name of insured
• Beneficiary(ies)
• Name and address of the insurance company
• Policy type (whole life, universal, variable term, etc.)
• Policy number
• Policy anniversary date
• Annual premium
• Current cash value
• Term of coverage (often capped, for example, at age 70 in some group plans)
• Date of any change in policy ownership
• Death benefit amount (including accidental death coverage)
• Outstanding loans
• Policy owner

Appendix 3F contains a blank worksheet to use when obtaining this data from a client. Step 3 - Review the Financial Strength Ratings of the Insurance Company. The financial strength of each insurance company should be reviewed. Insurance companies in dire financial straits are not such a rarity anymore. Planners should get up-to-date ratings on any insurance company by checking the websites of the major rating services (A.M. Best, Fitch, Moody's and Standard & Poor's). (See Appendix 4D for a summary of different types of ratings used to evaluate life insurance companies and section 404 for a detailed discussion of financial strength ratings.) Another approach is to order a copy of the most recent ratings issue of The Insurance Forum (September 2006). This issue lists each insurance company's rating from all of the major rating services and explains how to interpret these ratings. [Reprints of the issue can be obtained for $25 by contacting The Insurance Forum, Inc., P.O. Box 245, Ellettsville, Indiana 47429 or by calling (888) 876_9590] Their products can also be reviewed online at www.theinsuranceforum.com.

All the rating services evaluate the same key elements of an insurer's financial strength: surplus adequacy, asset quality, liquidity, asset liability matching, profitability, management quality, and effectiveness of the carrier's distribution system. Planners should remember that the rating services do not evaluate policy performance, product features, or illustration credibility.

If a client is considering replacing a policy because the issuing company's financial strength is in question or the product is performing poorly, the following points are worth addressing before a change is made:

• The client must be insurable (in good health) to qualify for a new policy at reasonable rates.
• Surrender charges on the old policy and a sales load on the new policy could make switching policies expensive.
• The annual premiums for the new policy may be greater than for the existing policy because the client is older.
• Surrendering an existing policy may create adverse income tax consequences unless the transaction qualifies as an IRC Sec. 1035 exchange (see the discussion of income tax issues in section 201).
• Buying a new policy starts a new two_year period for suicide and incontestable clauses. (These provisions allow the insurance company to void the policy if the insured dies within 24 months after the policy is issued and either the cause of death is suicide or the application for the policy contains a material omission or misstatement of facts.)

Note: The September 2006 issue of The Insurance Forum lists 43 life insurance companies with .high ratings" based on extremely conservative criteria.

Continue to Part 2