What Kind Of Life Insurance Should Your Client Buy?
My clients always ask me, as their attorney, the same two questions about life insurance: First, how much do I need? Second, what kind should I buy?
I think most attorneys will offer suggestions about the amount, particularly because determining and solving liquidity needs is an essential part of estate planning. Nevertheless, I do not pretend to know as much about insurance products as someone who makes his or her living wholly by answering such questions.
So, when it comes to the type of policy, in particular, I always defer to the agent.
But I still listen to the agents answers about what kind of product to buy. Sometimes I think the answer is wrong. Then, as the clients attorney, I will engage the agent in a critical analysis of the recommendation, to assist the client in evaluating it.
Often this exchange with the agent entails no more than presenting my understanding of the clients needs and personal preferences, so that I can be sure everything is properly considered.
Agents should not feel challenged when attorneys take this approach. It is simply part of the attorneys responsibility to the client. And the process can be very educational for everyone concerned.
Where my own clients are concerned, Ive concluded that, when they are considering what type of policy to buy, the most important factor to examine is the clients tolerance for risk.
Risk must be considered today not only in the policy features and projected benefits, but also in whether the proceeds will in fact be needed for liquidity purposes at death.
Before the new tax law was enacted, we did not have to consider whether there would be an estate tax law at the time of death; we knew that the law would exist, and planned to avoid it. But, now, due to the new law, this is infinitely more difficult. In fact, its all but impossible.
There is really no effective way, in my opinion, to plan for the estate tax exemption equivalent to rise from $675,000 this year, to $3.5 million in 2009–and then for the estate tax to disappear for one year–and then (due to the sunset provision discussed below) for the estate tax to be reinstated in 2011 at the levels it would have been at had the tax reform bill never been passed. Those are three distinctly different scenarios.
Like most other commentators, I do not think the current tax reform law will last very long in its present form. The tax code has been changed literally thousands of times in recent years. In addition, even if the budget surplus works out according to projections, there will not be much money left for Congress to spend.
If revenues do not meet projections, which already appears to be happening, there will be even less money available. I do not believe that Congress will tolerate not having money to spend for very long. In that case, the temptation to raise taxes– estate taxes–may be compelling.
As a result, at our law firm we have been advising clients to focus on the next three or four years, without being able to plan effectively past that point.
Under such circumstances, we believe the client should purchase the amount of coverage needed for liquidity based upon a $1 million exemption equivalent. This is the number that will be in effect through 2003. Coincidentally, this is also the amount that will be in effect in 2011, when the current tax reform is scheduled to be repealed under its sunset provision. So, this seems like an appropriate framework within which to plan.
A brief note about the sunset provision. This is the provision that requires all of the provisions of the new tax law to be automatically repealed in 2011.
The reason for this provision is that under the Congressional Budget Act of 1974, revenues must equal expenditures. The new tax law, though, does not raise revenues. Instead, it bases revenues projections upon the budget surplus. The surplus can only be projected 10 years into the future. So, in 10 years, 2011, to meet the requirements of the Budget Act, the new tax law has a sunset provision.
Considering all of these circumstances, what kind of policy should be purchased? I think that the clients tolerance for risk must be correlated with the time span that he or she has during which to tolerate that risk, and the likelihood that the tax laws will change.
The closer to retirement and eventual death, the less risk should be taken. The longer the time line, the more risk can be taken.
This analysis would point toward whole life products for those clients least tolerant of risk (or universal life products with sufficient guarantees), then non-guaranteed universal life products, and then variable products.
To me, the most troubling aspect of this analysis is that the more conservative approaches tend to rely upon interest rate guarantees, rather than equity growth.
Yet, if Federal Reserve Chairman Alan Greenspan has his way, our economy will continue to grow–and with low interest rates. I am concerned about adopting a course that is contrary to the one apparently chosen by the person who is trying to direct our economy. So, if I do that, I would use low interest assumptions. Of course, such assumptions usually cause more expensive premium projections.
While selling variable products may put the client at greater risk, it also puts the agent at greater risk. As the downturn in the stock market this year has shown, there is more finger-pointing when clients lose money. Clients may become litigious. I expect the claims currently being made against some brokers for unsuitable advice may escalate into similar claims against insurers on variable products that lose substantial value.
These elements–risk tolerance, time, and tax law changes–must be considered together. This is not an easy task, but it is an essential oneand one that must be worked through step by step, individually for each client. Only then can we say that we have discharged our professional responsibility as advisors and consultants.
Douglas I. Friedman, a partner in the Friedman & Pennington, P.C. law firm of Birmingham, Ala., is national counsel on estate and business planning for insurers. E-mail him at [email protected]
Reproduced from National Underwriter Life & Health/Financial Services Edition, July 20, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.