Using Impaired Risk SPIAs: Strategies For Unhealthy Clients
An “impaired risk” single premium immediate annuity (SPIA) is one financial product that may give a health-impaired client an advantage over a healthy counterpart.
Clients with serious medical conditions generally have fewer financial planning options than healthy clients. Health-impaired clients may not easily qualify for life, long term care, disability and health insurance. They also may not be able to use estate planning techniques effectively like grantor retained annuity trusts and charitable remainder trusts. Many agents feel they have little to offer such clients.
However, an impaired risk SPIA may provide the medically impaired client with a higher annuity income than a healthy client could receive from a regular SPIA. Here are some typical uses:
Increased Income. Many clients simply want more income from the premium they pay for a SPIA. Chart 1 gives an example of a 65-year-old male with a medical condition that gives him the life expectancy of a 71-year-old male. For a premium of $100,000, he receives annual payments from his impaired risk life-only SPIA of $9,756 for the rest of this life. A regular life-only SPIA would have produced lower annual payments of $8,212. The impaired risk annual distribution is almost 19% higher.
Pay Life or Long Term Care Insurance Premiums. A health-impaired client may have to pay higher premiums for a life or LTC insurance policy than a healthy individual would pay. The extra annual income from an “impaired risk” SPIA may effectively help the health-impaired insured pay the higher premiums created by a rating that may be associated with impaired health.
Asset Allocation Improvements. With a guaranteed income, most health-impaired clients may feel more comfortable to pursue a sound asset allocation strategy. For example, we have seen many clients with 80% or more in cash, cash equivalents or low yielding bonds because they are afraid of running out of money before they die. After purchasing an impaired risk SPIA with a guaranteed income, those clients have felt better about using a balanced asset allocation strategy.
Estate Planning Applications. Impaired risk SPIAs sometimes can be used to help implement the estate plans of wealthy but health-impaired clients. The following example is taken from an actual case closed by Michael.
Harry, age 75, and Wilma, age 72, have an $8 million estate with $1 million of their assets in a money market account. Although their primary goal is safety for this money market fund, they also want to maximize the amounts that their children and grandchildren will receive from these funds.
An impaired risk SPIA combined with life insurance in 2 irrevocable life insurance trusts (ILITs) has a strong appeal to Harry and Wilma. Harry has a health condition that permits him to qualify for an impaired risk SPIA. Although the SPIAs guaranteed income of $108,000 and the tax exclusion ratio are great benefits, Harry and Wilma want to replace the SPIA at Harrys death with another asset.
First, Harry and Wilma create an ILIT that purchases a $1 million face amount life insurance policy on Harrys life ($35,000 annual premium). This policy replaces, for their heirs, the premium they pay for the SPIA. Second, they set up a generation-skipping ILIT that purchases a $3 million second-to-die life policy on their lives with an annual premium of $62,000.
From the $108,000 annual SPIA distribution, Harry and Wilma plan to give $35,000 to the first ILIT, $62,000 to the second ILIT and to keep the $11,000 difference to help pay income taxes on the SPIA distributions.
Their attorney drafts the trusts to make sure that the life insurance proceeds will pass free from estate tax, income tax, gift tax and generation-skipping tax. He drafts the first ILIT to permit it to make gifts to the second ILIT if more premium payments are needed.
By using this strategy, Harry and Wilma feel they will create $4 million of family wealth at their deaths from a $1 million money market account that ultimately would have been subject to income and estate tax.
Zero Out an Estate. Some clients with a modest estate currently may wish to die with no assets. That is, these clients want adequate income during their lives, but they wish to give away their assets to their heirs during their lifetimes. For example, they may fear future lawsuits or judgment creditors and may want a SPIA with an endorsement that eliminates their power to liquidate or assign the SPIA. Of course, the extent to which such a strategy would work largely depends upon state law, and that varies significantly from state to state.
To obtain an impaired risk SPIA, the agent will want to supply as much information as possible to support the conclusion that the applicant has a shortened life expectancy. Attending physician statements, reports from medical examinations at time of diagnosis, hospital discharge summaries and surgery reports are all items that the agent would want to submit. Chart 2 summarizes some of the common health impairments that are present in rated age cases.
If the insurance company determines that an applicants medical condition significantly reduces his or her life expectancy (usually a 25% or more reduction), then the company usually will assign a “rated age” to the applicant. For example, an impaired-health 65-year-old might receive a rated age of 71 for purposes of SPIA payments.
The number of companies that offer competitive impaired-risk SPIAs is limited. Actuarial reserve guidelines were revised a few years ago to permit lower reserves on regular impaired annuities with “a medical assessment that supports at least a 25% reduction in the expectation of life.” An insurance company must implement underwriting procedures that support application of these lower reserve guidelines for impaired risks. The quantity of the companys impaired risk SPIA business normally must be sufficient to justify the cost of establishing these special underwriting procedures and to spread risk meaningfully.
This discussion highlights some areas to consider. For specific cases, the agent should be sure that clients consult their contract, legal and tax professionals for advice pertinent to their own situations.
Gary Underwood, JD, CLU, ChFC, is an advanced marketing attorney for Genworth Financial, Lynchburg, Va. His e-mail address is [email protected] Michael Silver, CFP, CLU, LUTCF, is principal of Baron, Silver, Stevens Financial Advisors, LLC, Ft. Lauderdale, Fla. His e-mail address is [email protected]
Reproduced from National Underwriter Edition, November 11, 2004. Copyright 2004 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.