Using Impaired Risk SPIAs: Strategies For Unhealthy Clients

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.