From the June 2006 issue of Wealth Manager Web • Subscribe!

That's Life (Insurance)

"Death lays his icy hand on kings," wrote the 17th century English poet James Shirley in "Death the Leveler." It might be a good tagline for the insurance industry: After all, it was the Great Fire of London, that claimed Shirley's life, and led to the creation of modern life insurance. Merchants, ship owners and underwriters struck early life insurance deals at Lloyd's Coffee House, predecessor to the famous Lloyd's of London. Would some of those wealthy traders have been inspired to stop in for coffee upon hearing a town crier reciting Shirley's poem on a quiet news day?

Wealthy clients in 2006 may also need their own wake up call to get their attention on life insurance. A recent one-on-one discussion with wealth managers across the country suggests there is a life insurance knowledge gap among many wealthy clients. In a kind of "virtual panel" created to gain some insights into the wealthy and their insurance needs, these advisors (see the list of participants) reported a lack of appreciation for key concepts like income replacement.

For example, Ivey notes that it is not at all uncommon for a doctor who makes close to $1 million a year to think that $2 million of insurance will suffice, not understanding that this would represent only two (four, if you think after-tax) years of income replacement for the family. The knowledge gap presents a tremendous opportunity for advisors to help shore up what can be the Achilles heel in an overall wealth management plan. Indeed, it seems a lot of potential clients with $1 million in investable assets would not get a passing grade in Life Insurance 101.

Any one of the items the panelists discussed probably merits its own article, but even brief discussions can give advisors an idea of the major issues their clients face.

The Fundamentals

We discovered that it's important to go back to basics, just to make sure clients aren't way off track. Following are just seven particularly deadly sins of life insurance. These regrettably common practices are so unwise that you'll want your guilty clients to start taking remedial action during, or within the 15 minutes following the meeting where they're revealed.

1. Not recognizing that we will all die.

2. Not conducting a thorough needs assessment to establish what coverage levels, if any, are required to address dependents' and heirs' income replacement & liquidity needs in the event of your untimely passing.

3. Beneficiary errors--which can be worse than having coverage at all.

4. Allowing policies to lapse--although no-lapse guarantees common to newer policies can reduce this concern.

5. Using term insurance for permanent needs like estate planning; when needs are permanent, minimizing premium cost (greed) has to take a back seat.

6. Ownership errors--policies still owned by the individual will be included in the estate and subject to estate taxes. (In fact, advisors have witnessed excessive complacency regarding estate taxes, which can still take a substantial bite and possibly may return full force in the future.)

7. Not shopping around for the best-priced products, provided quality criteria are met; there's probably no good reason to look at companies that are not A-rated.

Once it has been established that life insurance is needed and the appropriate product identified, maintenance is key. And this responsibility doesn't just lie with the wealthy client. A great many policies, one would hope, will be sheltered within irrevocable life insurance trusts, so trustees also need to be mindful of many of the pitfalls above. A sobering point for trustees may be a reminder of possible fiduciary liability should they not stay vigilant and, say, allow a policy to lapse.

Case Study I - The Family Wealth = The Family Business

We asked our virtual panel what life insurance factors should be considered for a family when much of its wealth is tied into a family business.

While many on the panel provided similar responses, Ivey's answer covered key points rather succinctly: He observed that with a family-owned business there are many issues that life insurance can address. First, he focused on structuring a buy/sell agreement to provide liquidity to those who need it. This may be a buy/sell with a non-family member where the family completely gets rid of the business, or a buy/sell with a family member who has experience and wants to run the business. The second issue Ivey raised was the possible loss of the "key-man." Many times it is the owner who makes the business work; without him, someone must be hired or there have to be other adjustments. Third, he stressed the issue of equalization, stating that it almost never works to have both non-working and working heirs as owners. For this reason, he feels that having life insurance proceeds go to the "non-owning/working" heirs to equalize the estate is a great use of insurance. With business owners and their heirs, he says, communication is key to making these strategies effective.

Case Study II - The Prodigal Trust Fund Baby

What if a wealthy client has a grown child who shows no signs of doing anything but living off a family trust? How should you cover that person? Should you do so at all?

Several responses alluded to the idea of trust provisions providing incentives to encourage productive activities. Some of the same advisors questioned the logic of trying to mend the child's ways from the grave when they couldn't achieve that goal during life.

Benton provided an interesting angle, asking "What are we covering?" He stated that if the trust baby has babies (who would also likely be beneficiaries of the trust), then trust assets might be used to fund a death benefit using the leverage and liquidity features of life insurance to provide critical capital to the prodigal's survivors, and effectively restore the wealth he or she may have squandered.

Innovative Uses of Life Insurance

When the panel was asked about the innovative uses of life insurance they'd seen, tax efficient methods of premium financing were a recurring theme:

Benton cited the "disappearing IRA" strategy which, he explained, allowed the family to "trade" a highly (multiple) taxed asset for a tax efficient wealth transfer.

Sebastian works a lot with surgeons. He said that many of them are sole-practitioners or have small staffs. He characterized the 412(i) defined benefit plan utilizing whole life insurance and fixed annuities as a "perfect solution" for someone who is over 50, needs life insurance and wants the aggressive tax deductions to fund the plan.

And Tuttle--noting that it was controversial--mentioned non-recourse premium financing.

D'Amato described the use of accounts receivable to finance life insurance purchases by professionals. For example, a doctor may choose to borrow on anticipated accounts receivable to purchase life insurance. At the same time, the life insurance purchase can provide asset protection in many states.

Pinson, among others, expressed a liking for the use of Survivorship Variable Universal Life (SVUL) for the right clients, emphasizing leveraging contributions to get much in the way of tax benefits on deferred growth, distribution and legacy.

Recent Life Insurance Trends

When asked about recent trends, almost everyone referenced the growth of guaranteed products. Increased product complexity was another trend they noted.

Tuttle has observed increased innovation, citing the examples of single employer Voluntary Employees' Benefits Associations (VEBAs) and insured cash balance plans for small businesses.

D'Amato noted that a growth in complexity is making it harder to compare policy features and riders and the underlying assumption of the pricing. She also cited the evolution of cash value management tools used to prevent an unwanted lapse when drawing down cash values.

Mendels mentioned the recent advent of short-term premium financing.

Ivey observed that getting preferred ratings has become increasingly difficult. Finally, he pointed to the trend toward combining insurances, such as life insurance with long-term care insurance riders.

Returning to the words of London poet James Shirley, we can truly say he was wrong, when he wrote elsewhere in the same poem: "There is no armour against Fate." We may not be able to avoid the inevitable, but with insurance, we can prepare for it. To past generations, the "insurance salesman" was a figure of derision--someone who spent hours on your living room couch pushing whole life policies. But today's complex insurance needs--and corresponding products--will be better met by the wealth manager.

Peter Phelan has won several national comedy writing awards. His column, "Benefits Disorientation," appears in Employee Benefit News. A frequent speaker at Benefits/Retirement Savings conferences nationwide, he can be reached at


The Virtual Panel

Raymond Benton, CFP, Denver, Colo.

Tere D'Amato, CFP, Director of Advanced Planning, Commonwealth Financial Network, Waltham, Mass.

Zach Ivey, CFP, Mountain Brook, Ala.

David Mendels, CFP, New York, N.Y.

Howard Pinson, CLU, Baltimore, Md.

David Sebastian, CFP, Summit, N.J.

Matthew Tuttle, CFP, Stamford, Conn.

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