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

Protective Covering

Insurance has never been a favorite subject for fee-only advisors. First of all, your clients would rather talk about making money than spending it, especially if spending money involves discussions of death, serious illness, lawsuits or natural disasters. Second, insurance is commission dominated--an uncomfortable fit for a business model based predominantly or entirely on fees. Yet advisors who focus on asset accumulation and management to the exclusion of risk management not only miss advantageous planning strategies that incorporate risk management products, but leave the door open for clients to deal with other advisors.

The greater availability of low- and no-load insurance products, combined with the recent spotlight on fiduciary standards, likely will move insurance out of the shadows and into the limelight, says Joseph Maczuga, president of Comprehensive Planning & Insurance Analytics in Troy, Mich., which provides insurance analysis to the RIA market. "More advisors are embracing the idea that they must practice asset management and risk management to fulfill their fiduciary responsibility to clients," he says.

For fee-only planners who advise their clients on insurance, life insurance--either to pay estate taxes or to protect clients who lack liquidity--is generally the conversation springboard. Maczuga notes, however, that many advisors fail to point out the key benefit of life insurance for the vast majority of clients: That in most states, cash value life insurance is protected from litigation and bankruptcy.

"Advisors develop an asset allocation that matches the client's goals, but pay little attention to the ratio between assets that are protected from litigation or bankruptcy and unprotected assets," he says.

In fact, in his reviews, Maczuga often finds more than 60 percent of the assets that will one day generate a retirement income stream are unprotected. "We suggest shifting that ratio so at least 70 percent of assets are protected and favor no-load life insurance policies with no surrender charges; a transparent, fully disclosed cost structure; and high liquidity," he explains. "The death benefit is a secondary issue to the policy design. Our goal is to put a protective wrap around the assets so we develop a minimum amount of death benefit, just enough to maintain all the tax advantages of a life insurance policy--tax-deferred growth and tax-free income to the beneficiary."

When discussing life insurance with his clients at Baystate Financial Services in Boston, Herbert K. Daroff, J.D., CFP, is sure to point out that life insurance sufficient to pay the income tax due on a qualified retirement plan can be used to create a stretch IRA for heirs. "If we do a Roth conversion for the surviving spouse or kids, that creates a stretch Roth IRA where all the retirement money is available tax-free," Daroff adds. "And with the anticipated increase for the death tax exemption, we are also talking about buying the life insurance inside the profit sharing plan with tax deductible dollars, not worrying that it's in the taxable estate, and using the death benefit to do the Roth conversion."

Given that a life insurance policy is a client's longest-term capital because, unlike retirement accounts, it does not have to be systematically distributed after age 70 1/2 , Ben G. Baldwin, Jr., CFP, ChFC, CLU, of Baldwin Financial Systems Inc., in Arlington Heights, Ill., says variable universal life insurance is an "effective, appropriate, prudent" choice.

"Our clients agree liquid cash for their legacy needs to be invested while waiting for distribution, and they are used to a diversified investment with volatility," he explains. "It's always amazed me that the same advisors who manage people's retirement plans and would not ever advise investing all of their money in bonds and mortgages, recommend straight universal life or whole life insurance where that is exactly what you are doing."

In addition to the fact that life insurance allows clients to change their investment strategy without cost or taxation, Baldwin likes the privacy it affords. "Privacy is important to our clients," he says. "There is no place on a tax return for returns on life insurance to be reflected. This may be the last bastion of financial privacy," he notes.

Peter Katt, CFP, founder of Katt & Company, a national fee-only life insurance advising firm in Mattawan, Mich., says advisors who want to turn the purchase of life insurance from an emotional into a rational decision should stress price and choice. He explains: "Insurance agents often figure if your client is worth $300 million, then they need a $150 million life insurance policy. However, we always begin with premium sensitivity. Even with the highest-net-worth individuals, the decision comes down to what they are willing to pay."

Katt also cautions planners about salesmen who are "rewarded for their ability to establish and move relationships along in the direction that benefits them and know practically nothing about the complicated actuarial math of what it is that they sell. The difference between insurance salesmen and our firm is the difference between magicians and physicists," Katt continues. "Magicians are a lot more fun, but our role with the client is not to tell them what to do, but rather to present a menu of choices. Our point isn't that the client should avoid any one product, but rather that each product has its own set of potential advantages and disadvantages."

With the popularity of cash-value policies like universal and variable life, there is another role for the fee-only advisor, perhaps in concert with an insurance consultant: Selecting the premium deposit strategy that best meets the objectives of the client

Explains Maczuga, "Old paradigm policies were premium dependent. If you missed a premium, all guarantees were off. With universal life and variable universal life, there is no premium requirement. The client can pay more or less, even skip a payment. There just needs to be enough money inside the policy to pay the premium for that year. The policy continues as long as there is cash value to pay the costs."

In making recommendations for ways to pay the premium, Maczuga says most people wrongly focus on the assumed return. "Managing policy risk requires looking on the other side of the coin to the cost component, and understanding what assumptions actuaries have used in the illustrations. One of our systems takes those illustrations and plugs in data to run cost assumptions," he says.

Glenn Daily, a fee-only insurance consultant in New York, agrees that clients can save thousands of dollars by taking advantage of the flexibility the contracts offer. However, by permitting this flexibility, it is possible for a consumer to pay more or less for the same guaranteed death benefit," he explains. "In fact, we're thinking of offering a review of the best way to pay as a contingency service. I might charge 25 percent of the amount saved, if we can agree on how to measure what's saved."

Daily is also doing analysis in the life settlement area, where brokers pay an amount greater than the policy's cash value, but less than the death benefit to policy owners who no longer need life insurance due to a change in their family life or estate planning strategy.

"While the real focus has been on life settlements as a bonanza, or free money, many people fail to consider the benefits to their families and beneficiaries that they are giving up by selling the policy," Daily says. "Sellers also must consider that if they sell and convert their death benefit to cash, that they will owe taxes on the part that exceeds their cost basis."

And he goes on to warn: "Life settlement brokers have an incentive to push the sale through, and it's important that clients understand that they have choices. They can keep the policy, sell it, sell part of the policy, or sell it later. Life settlement brokers won't present these options because they want their commission on the entire policy."

While he stresses that the current offer will not be the policyholder's only opportunity to sell, Daily says there are cases where selling makes sense. "I had a case a few months ago where the client was going to get hundreds of thousands of dollars more than the cash surrender, and we had an attractive offer to replace the policy," he explains. "A lot of the gain was sheltered by the cost basis, and we replaced all of the death benefit with a new policy for which the client is now paying less."

Advisors looking for assistance in how to evaluate a proposed life settlement buyout deal can visit Daily's Web site at for more information.

Of course, comprehensive risk management requires more than a discussion about life insurance options--and luckily for advisors, it's easier to add value with other forms of insurance. For example, in the excess liability department, Baldwin says advisors should recommend that clients simply buy as much liability coverage as they can get.

Adds Diane M. Pearson, CFP, at Legend Financial Advisors Inc. in Pittsburgh--a firm that works with a number of physicians, "If spouse A is the primary wage earner and has the exposure to liability, from an asset protection standpoint, you may consider putting more assets into Spouse B's name."

Pearson's firm also has a new program to protect clients' assets from the increasing threat of identity theft. "One of our clients is a physician and also a veteran and was very upset over the theft of veterans' information from federal computer systems over the last few months. To give him peace of mind, we have set up credit monitoring systems for all our clients with one of the three big credit bureaus," she explains.

At Calfee Financial Advisors Inc. in Cleveland, Peter Haas Calfee, CPA, CFP, CLU, says that particularly in light of industry changes after 9/11, it's important to review property and casualty insurance every year or two. "Your client's coverage should be as current, complete, and comprehensive as the marketplace will sell," he notes.

With clients lamenting about increasing premiums and decreasing coverage, many advisors advocate high deductibles that don't break the bank and provide coverage for catastrophic situations. Suzzette B. Rutherford, CFP, of Rutherford Asset Planning Inc, in Naples, Fla., employs the high deductible approach with health insurance. "Many clients retire before age 65 and have to find their own insurance. Because of their high net worth, we favor insurance with an annual deductible of $5,000 to $10,000. Clients can afford that and are happy to avoid the paperwork for small claims. They really need only catastrophic insurance to kick in for long hospitalizations or surgeries," she says.

Peace of mind is often the sales hook for long-term care insurance, coverage advisors say wealthy clients don't need unless they want to protect their estate. "Clients who don't want to drain their estate with healthcare bills and are interested in long-term care insurance often put off the purchase. But why wait?" asks Daroff. "It's term insurance, so if you buy it and the price goes down or coverage improves, and you are still healthy enough to buy the new policy, you can simply let the old policy lapse and buy a new one."

Calfee cautions planners about policies that mix long-term care insurance with annuities. "It's like saying, 'I want a car that will take me off-road into the Rocky Mountains, but that car better have the ride of a Cadillac and all the comforts of home.' Mixing and matching products rarely serves a purpose," he says.

According to Daily, these combination products and also variable annuities amount to faith-based investing. "I'm working with a client now who is considering putting $400,000 into a variable annuity, primarily for the guaranteed income. But how do I evaluate the product? How much benefit is he getting for each dollar?" he asks. "Because there's no disclosure of the benefit/cost ratio, of the money's worth, you really buy these products on the basis of the sales pitch--peace of mind. That's fine, but how peaceful are you going to feel if you read an article later that says you were a sucker?"

Daily's advice is that clients hold off on these purchases for three months to a year. "There's more academic research on these products all the time. Also, regulators may focus on them some more, and new products will be introduced," he notes.

Big picture--managing risk for clients involves managing insurance as an asset. That is, advisors should evaluate clients' needs, present options that fit with their goals, and commit to an ongoing review. In Maczuga's experience, policies rarely run on track with client's objectives. He estimates that in his consulting work with wealth management firms, more than 80 percent of the policies he reviews are in default of their original objectives.

"Paying attention to insurance not only improves risk management for clients, but improves the advisor's business," says Maczuga. "When the client benefits from comprehensive service, advisors pick up assets clients had with other advisors and get better referrals."

Concludes Baldwin: "Insurance is that rare topic advisors reluctantly talk about and then let clients make their decisions alone. However, because ideally we want to be managing our clients' children's assets one day, not looking at what insurance can do around legacy capital is a mistake. Insurance is the key to multigenerational planning."

And that's just how it's worked for three generations of the Baldwin family. Baldwin's son now manages assets that his grandfather--whom Baldwin describes as "an old insurance man"--once managed.

Nancy Opiela, a freelance writer in Medfield, Mass., wrote about investing in Broadway plays in September.

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