From the March 2006 issue of Investment Advisor • Subscribe!

March 1, 2006

Still Kicking

Planners still use survivorship insurance--when it fits the bill

Survivorship, or second-to-die, insurance serves a multiplicity of purposes in planning--everything from funding trusts to wealth accumulation--but one of its most popular selling points has been as a wealth replacer for estate planning purposes. With this in mind, insurance companies had worried that with the projected permanent repeal of the estate tax, uncertain though that repeal may be, the popularity of survivorship insurance might wane and sales plummet.

That does not seem to be the case, however, says John Ryan of Ryan Insurance Strategy Consultants in Greenwood Village, Colorado. Ryan, who consults with fee-only planners on clients' insurance needs, says that instead of dropping, the demand for survivorship insurance has remained "sort of static," with the insurers' fears of disappearing sales going unrealized. "I think it's because people are continuing to plan for the worst," says Ryan of survivorship's survival. He speculates that there's a "You mentioned repeal a few years ago but I don't believe you" attitude among those who want to protect assets, as well as a feeling that if repeal comes it won't benefit anyone except those with estates of less than $3 to $5 million. "Those with larger estates may feel there's still a need for the liquidity provided by this insurance," he speculates.

Of course, he points out, there are all those other reasons people continue to buy survivorship insurance: Funding special needs trusts for children with ongoing medical concerns, for instance, or replacing wealth so that parents can leave a large chunk of their estate to charities or even spend it before they die without worrying that their heirs will be left without. "They might buy insurance as a hedge," says Ryan, "so they can do what they want to do for themselves or for a charitable interest while the kids will be made whole by the insurance proceeds."

Doing Due Diligence

Stan Hargrave, of Independent Financial Advisors in Riverside, California, is wary of survivorship insurance as the first answer in estate planning. He points out that if both insureds live to a normal life expectancy, such a policy can cost more than two individual life insurance policies (although the second-to-die can be cheaper initially), and adds that planners must perform due diligence when investigating estate planning solutions to avoid clients paying more than is necessary. "How does the policy operate after the first insured dies?" he asks. "Are cash values accelerated?" The planner has to look carefully at the cost of the policy to the surviving insured, and also consider the flexibility of the policy and the point at which the policy's net cash surrender value is greater than the amount of premiums paid. He points out that since premiums are still due and payable after the death of the first insured, the premium cost of the policy continues to rise; if the second insured lives long enough, "premiums might make up for the less expensive premiums you thought you were getting when you first signed up for it."

Karen Jessey at Wealth Strategies Group in Centennial, Colorado, concurs, mentioning the "lost opportunity cost" of the survivor's life span, during which, of course, no death benefit is paid. She points out that many of those who qualify for survivorship life insurance are "on the healthy side, and that's why they [can] get [the] insurance." If they have a longer-than-expected life expectancy, she says, they can "pay premiums over a very, very long period of time."

Caveats aside, Hargrave credits survivorship insurance as having served as a useful tool in estate planning "where there was an illiquid factor in the estate, and we needed insurance for a minimal number of years" to keep both insureds covered as other, more traditional estate planning tools and techniques were used. After the policy had been in effect for some time, he says, "we were able to take the survivorship policy and separate the contracts"--a provision he says he always looks for before advising clients to purchase a policy. While a separation-of-contracts provision is "not unusual," he adds that it isn't found in every policy.

Part of a Larger Plan

Steve Grager of Capital Advisers in Danville, California, believes that while planners have to be sensitive to the times when survivorship life insurance is not the right answer, he has found it extremely useful in a number of situations.

One instance that stands out is that of a client couple of his, elderly Basques whose greatest asset was a large apartment building in San Francisco "worth about $4 million." Says Grager, "The guy was 84, really getting up there, and tired of fixing leaky toilets; he was doing his own property management." They'd already depreciated the building "down to nothing," he says, "and didn't want to get hit with capital gains" as they would if they sold it conventionally; neither did they want to "do the 1031 limited partnership craze going on now;" they wanted to simplify their lives.

Their accountant "never talked to them about anything but 1031-ing; so what do they do now, find another apartment building?" (A 1031 exchange, allowing exchange of one property for another, with some tax benefits, was not a beneficial strategy for this couple's situation.) One big challenge facing Grager's creative approach was "persuading the accountant, estate planning attorney, and others that this was a good solution." In the end, though, everyone was persuaded, and survivorship insurance was part of the solution.

Grager proposed that they set up a charitable remainder trust (CRT), "transferring the title [of the building] through a gift to the trust, selling the building in the trust, and using the proceeds to provide income for life." To accomplish everything he wanted to do for these clients, Grager says, a portion of the building was left out of the trust, sold direct, and some capital gains taxes were paid. With the proceeds of the sale, the client bought a single-premium immediate annuity (SPIA) to help finance the trust and also to help finance annual gifting. Survivorship insurance was also bought, to help finance annual gifts and provide for the couple's charitable interests. The end result of all these actions was annual cash flow "greater than the rental income" had been, as well as provision of funds for their heirs and money for the charitable causes in which they were interested.

"They liked the idea of helping out Basque causes and helping their kids and grandkids," says Grager, "and they wanted money to go to a family foundation. We created the structure for the family foundation," he says, and at the couple's death the money will go there.

Although Grager says that "Congress is fickle" regarding the "Cinderella estate tax that will disappear at the stroke of midnight in 2010," he doesn't believe that the elimination would be made permanent anyway. "In its current form it would be incredibly problematic," he says. To this end he relies on well-researched survivorship policies to act as a wealth replacer.

Virginia Gerhart of Gerhart Associates in San Rafael, California, has found survivorship insurance to be valuable in lowering the amount of clients' taxable estates. She has opened a trust with heavily appreciated properties for a client who had a large apartment house that had appreciated for years.

The apartment was put into a trust to deplete the estate, and then the clients created an irrevocable life insurance trust (ILIT) with their children as trustees. The survivorship policy was bought inside the trust, and thus was out of the estate since the clients had no ownership. Gerhart cautions, "The main thing is to get very good legal counsel, particularly in drafting the ILIT." She points out that "people might think, 'I can influence the trustees so I can have them get money out.' You have to be very careful about that, because if you exercise any of those powers it will send up flags." Competent planners, she says, "will know to seek advice." Sometimes, she warns, a client's special circumstances can be overlooked by an insurance rep--all the more reason to have the ILIT setup reviewed by an expert.

Riders on the Storm

Ryan says advisors should be aware of two riders that can have a big effect on how the insurance is implemented: The no-lapse premium guarantee and the estate tax repeal rider. The no-lapse premium guarantee, says Ryan, enables the purchaser to "dial in how many years you want the policy to last, and you'll get the premium necessary to get it to last that number of years, regardless of what happens to interest rates, mortality assumptions, or insurance company expenses." This rider, he says, is highly controversial since some companies that don't offer no-lapse premium guarantees--notably large mutual companies--"believe that [it] is a setup for the demise of the insurance company that offers these products; that they may be underpriced for the promises being made." In fact, there's considerable discussion underway about potential changes to Actuarial Guideline 38, which specifies how much insurance companies must hold in reserve on no-lapse premium guarantee policies to make such commitments more secure. Proposed changes would require greater reserves.

Under the estate tax repeal rider, a consumer purchases a survivorship policy for liquidity and in the near future the estate tax is repealed, eliminating the need for the policy, allowing the consumer to surrender the policy and the company will waive surrender charges. Since Ryan says that "90% of survivorship cases are liquidity," he points out that this is a huge market to be affected by such a rider.

For the moment, at least, it would appear that survivorship insurance is itself surviving changes in legislation and market forces. It remains to be seen whether future changes will affect the market.

A directory of survivorship life insurance policy providers is available here.


Freelance writer Marlene Y. Satter can be reached at harpwriter@verizon.net.

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