For years, my best sources have referred me to Lee Slavutin whenever I ask about a complex estate planning strategy. In addition to integrity and honesty, Slavutin has great technical expertise. An Australian who moved to New York in 1978, Slavutin was dissatisfied with his career as a pathologist and decided he wanted to be in sales. Almost by accident, he moved into insurance. His firm, Stern Slavutin-2, now works with many of the nation’s top estate planning attorneys and generates a majority of its revenues by advising the ultra-wealthy on insurance and estate planning. I spoke with him recently.
Let’s talk about basics. How do you advise a client on the amount of life insurance he or she needs? Don’t look only at the dollar value of a life insurance policy. Think about cash flow. If someone has $1 million of insurance, the annual cash flow could be $40,000 a year for a conservative investor. And do not automatically assume the general economic rate of inflation. My son goes to college and his fees are not going up at the 2% average rate of inflation. They are going up 6% or 8%. You should insure your life as you would your home, based on replacement value. You should be insuring for the replacement of income.
How do you keep up with the creditworthiness of insurers? One of the best ways to keep up is through Joseph Belth’s The Insurance Forum newsletter. Every September, Belth puts out a ratings issue, and it is a phenomenal reference. If you are actively involved in advising people on insurance, you need to have this publication. Joe divides companies into three groups. The top group has about 75 companies and these are the companies you should buy from.
A good insurance professional will also look at the history of the ratings of a company with each of the ratings agencies: Moody’s, Standard & Poor’s, Fitch, and A.M. Best, and see the trends. Moody’s has had a good track record of detecting problems early. A truly diligent advisor would go one step further and look at the insurer’s annual report. Finally, BestWeek, a weekly news publication from A.M. Best, is a great source of information on all the things going on in the life insurance and property/casualty insurance industry.
What are the other basics that you think advisors need to be aware of? Another is term insurance and the conversion option. Some term policies are advertising very low prices because of their conversion options. If you buy a policy that only allows you to convert to a permanent policy during the first 10 years and then in the eleventh year you develop a medical problem, you may be hampered in your ability to get a well-priced permanent insurance policy. Just be aware that the lower price you pay may reflect your reduced options.
Any thoughts on long-term care insurance? The message with long-term care insurance is that we are dealing with a fairly immature market. This product took off maybe five, six, seven years ago. My suspicion is that many of these policies have been sold under their proper price to grab market share. That’s why some companies are taking products off the market. Some practical advice: There is a very nice option available with some of these policies now that can minimize the risk of higher future premiums. You can buy a 10-payment option policy. Instead of buying a policy where you pay the premiums forever, the rest of your life, you buy the policy and you pay for it within 10 years. At the end of 10 years, you have no more premiums and that’s guaranteed. So then your only risk is that during that 10-year period the premium may be increased. But once you pay for 10 years, you’re done. This is a real guarantee. If a client is in a C corporation, the LTC insurance premium is fully deductible, for income tax purposes.
How much faith can you have in these companies and these policies? A few names that have a good reputation, that are well rated, and that I would look at, are John Hancock, Metropolitan Life, and GE.
What’s the hot product these days? Guaranteed-premium universal life. This is very popular these days because of what has happened to market returns in the last 10 years. The industry responded to that uncertainty and developed a universal life policy with a fully guaranteed premium–no ifs, ands, or buts. You pay the premium, your death benefit is guaranteed. The product has been a huge seller in the last year or two. In many cases, existing policies–universal, whole life, variable life–are being replaced by this product.
I think [there's a] problem with LTC insurance similar to what we had with disability insurance some years back. Some companies are pricing too aggressively and they may get into a problem. There is another very tricky thing here, which is not obvious. If you don’t pay your premium on time, you can lose your guarantee, or you may have to make up and pay extra money to restore the guarantee. If your policy premium is due on December 1, you have to have the money in to the company by December 1. You can’t send your check on December 1. Otherwise, you lose your guarantee or you will have to pay some extra money to restore it. The makeup amount could be huge.
What other tips like that can you give advisors? It is important not to pay the premium on disability insurance with pre-tax dollars. I’ll give you an example from a recent court case. A doctor was advised by his accountant to buy disability insurance and pay for it with corporate pre-tax dollars to get a tax deduction. Down the road, the doctor became disabled. Because of the way he financed his disability insurance, his benefits were taxable. So instead of getting $10,000 monthly tax-free, he has to pay tax on the $10,000 a month.
So if a business owner buys disability insurance through his company and buys a policy for all the employees, their benefits are going to be taxable? If the employees are not picking up the premium as income, and it is being paid by the company, then, yes, their benefit will be taxable. Report the premiums as income. You have to make the determination whether that premium is going to be picked up by you as income before the year begins.
We’ve been talking about bread-and-butter insurance issues. Any ideas for high-net-worth clients? Say you have clients who set up insurance trusts for their children and grandchildren. Everybody knows you can make a tax-free gift of $11,000 per year to a child or grandchild. If I have an $11,000 exclusion, I can give the $11,000 to my child outright and that will not be a taxable gift. But if I give $11,000 to a trust where my child is the beneficiary, an insurance trust, I can’t get the $11,000 exclusion because my child is not getting that money outright. It’s being held in trust for him. If you put a Crummey power in the trust, allowing your child to withdraw money from the trust during a 30-day period, however, you can satisfy the law and get the exclusion. But here is the trick in terms of more sophisticated planning. People think they can use the same rule for grandchildren. The answer is no. The GST annual exclusion has a different set of rules for grandchildren as opposed to children. One rule that particularly is important to grandchildren in trusts is that you must have a trust (to get the annual exclusion) that is only for the grandchildren. Another rule is that the trust, besides being only for the grandchildren, has to be included in the grandchild’s estate, if he or she dies before the grandparent. The GST is awfully complicated and people can get into a lot of trouble if they do not know this area. Unless you really know the GST rules very well, and not everyone does, you need to be very careful. If you make a mistake on the way you report the GST exclusions and exemptions, you can have a huge liability.
With President Bush’s re-election, the elimination of the estate tax is more likely. What should advisors be telling clients? Clients with estates of more than $10 million are behaving as if the estate tax will remain. They are not playing the game of let’s wait and see if Bush will eliminate the estate tax. They are planning on the assumption that there will be an estate tax. The practical matter is that if I have a client with a family business or a lot of real estate, that client is not going to take a chance, assuming he wants to transfer the business or real estate or other assets to children and not have a huge problem with estate taxes. They are not going to play around.
How about the under-$10-million-net-worth individual? That’s much more marginal. We are not, in our practice, seeing people with a net worth under $10 million buying insurance for estate taxes. Families with a net worth of $3 million or $5 million today have a $1.5 million estate tax exemption per person. If I’m married, I have $3 million covered with the exemption. And the exemption rises in 2006 to $2 million, which means a married couple has $4 million protected. So the estate under $5 million is very marginal, unless it is a business or there are other reasons. Between $5 million and $10 million, you have a bit more of a reason to look at insurance. But remember in 2009, it is going to be a $3.5 million exemption, which is $7 million per couple.
Any other new strategies? Life settlements. They developed in the early ’90s as an outgrowth of viatical settlements. People with AIDS who had life insurance wanted to get the money before they died and they wanted to sell their policies.
Viatical settlements were a bit of a racket, though. With some, yes. But other viatical settlement business was good and clean. I’ll give you a very good story we were involved in where it provided a phenomenal service to a client.
A viatical or life settlement? A life settlement, which, by the way, is different from a viatical settlement because a viatical means the individual is going to die within 24 months. A life settlement is just a quantitative difference where the person doesn’t have a life expectancy of two years, but maybe has a life expectancy of anywhere between three and 10 years. It’s for an older person, particularly those who are over age 65–often, someone older with a health problem that has shortened his life expectancy.
Anyway, my wife [a partner in Slavutin's practice] got a call from a lawyer whose client was terribly injured in a ski accident and no longer able to take care of himself. He had a $1 million term insurance policy, but his wife could not afford to convert it to permanent insurance. She couldn’t even afford to pay the premium. She was going to simply cancel the policy, and you know what happens when you cancel term insurance: you get nothing. But instead, the lawyer asked us to see if we could sell the policy through a life settlement. We were able to do that and the client received $100,000.
Explain what happens in the transaction of a life settlement. Basically, you contact a settlement-funding company. This entity purchases your policy. The price you receive is dependent on your present age, medical condition, and life expectancy. One company that has been around for a long time that has a very good reputation is First Coventry. They also just received a rating from Standard & Poor’s. A life settlement is often appropriate if the only other option is to drop the policy. There are brokers who have access to six to 10 different settlement companies, buyers of policies, and they can shop the market for you, so that you get a good sense of what is out there. I use a guy at Financial Legacies, but there are many such brokers.
Editor-at-Large Andrew Gluck, a veteran personal finance reporter, is president of Advisor Products Inc. (www.advisorproducts.com), which creates client newsletters and Web sites for advisors. Advisor Products may compete or do business with companies mentioned in this column. He can be reached at firstname.lastname@example.org.