Advisors are fond of using analogies when describing the value of a product or planning technique. So here is one more to wax poetic about the next time you discuss with a prospect the need to conduct an life insurance policy review: It is akin to getting a regular medical check-up.
Reasons for the Review
And, in terms of funding one’s life goals, it is likely as critical. Generally conducted annually (though often more frequently for market-sensitive variable contracts) the review helps the advisor to determine the continuing suitability of the product in terms of (1) financial/economic risks faced by the policy owner and (2) the appropriate level of insurance coverage.
The determination as to suitability, say experts interviewed by NU, hinges on the answers to a host of questions. Among them: Assuming no change in the client’s family or financial situation, is the policy continuing to perform as anticipated? If not, what adjustments might have to be made to realign the policy with plan objectives? And would the client benefit by purchasing a new policy that offers comparable benefits at lower cost?
“Term insurance is incredibly affordable today,” says Terry Sachman, a financial professional at AXA Advisors, New York, and managing director of AXA’s Sterling Group. “Also, the internal charges for permanent life insurance have continued to be reduced. The cost of insurance has come down because people are living longer. “
Factors apart from cost might dictate a recalibration of coverage. Among them, say experts, are changes in the client’s health or occupation, the birth of a child, a divorce from an estranged spouse or an expansion of one’s business. Any of these might point to a need for supplementary or reduced coverage.
They may also necessitate a change in owner and beneficiary designations. A client who had remarried since the policy was issued might want to name as a primary beneficiary the second spouse, but keep the children from the first marriage as contingent beneficiaries. Similarly, setting up a trust to dispose of estate assets may require changing a policy’s designated owner or beneficiaries to remove taxable assets from the estate.
“The ownership and beneficiary designations are among the top things thing to check when determining whether the policy is still appropriate and current,” says Paul Games, a financial planner and principal of Pathfinder Financial Group, Newburyport, Mass. “These designations are so often overlooked, and yet they may be set up incorrectly or be out-of-date.”
They may also be besides the point if the policy is in danger of lapsing. Enter the in-force policy illustration: a tool that advisors use to determine, for example, the necessary premium payments to sustain a policy to maturity or to reach a cash value benchmark given a certain assumed interest rate.
Depending on market conditions, the exercise might require the client to ratchet up premium contributions. Or, when compared to the performance of a new policy offering comparable features, the in-force illustration might recommend a policy replacement or “1035 exchange”: a provision of the federal tax code that allows investors to transfer accumulated funds in one policy to another without incurring an income tax liability.
Beyond the Charts
The advisor cannot, however, depend only on fancy tables and charts when recommending whether to keep or replace a policy. Also to be considered, says Elizabeth Sampson, a Beverley Hills, Calif.-based certified financial planner, are market risk associated with the policy and the financial strength of the insurer.
“The quality of the insurer–it’s reputation, credit rating and the strength of its balance sheet–has to be examined,” say Sampson. “Many carriers I would never dream of doing business with. I’ve seen companies not accept death benefit claims.”
Market risk, she adds, has become a significant issue for many policy owners of variable universal life contracts in the recession’s wake, as equity-based subaccounts of many VUL policies got pummeled during the downturn.
The result, Sampson notes, were contracts with dangerously low cash values, requiring policy owners to boost premium payments–potentially beyond their ability to pay–to keep their policies from lapsing. The threat of a lapse was all the greater for those policy owners who have taken loans or withdrawals against their contracts.
Because of the market risk associated with variable contracts, say observers, clients that had taken a hit during the downturn, or those who are less risk-tolerant than they were pre-recession, may be advised during the policy review to consider alternatives that are less prone to potentially damaging market fluctuations.
“I’m always looking to reduce risk and the cost of insurance for my clients,” says Sampson. “Variable life insurance was great until the markets totally tanked during the credit crisis. The market risk associated with equity indexed life insurance”–permanent policies that tie cash value accumulation to a stock market index, such as the S&P 500, and that offer a minimum guaranteed fixed interest–”is much less,” she says.
Another option, adds Games, is a policy offering a no-lapse premium guarantee universal life policy. Offered on universal life contracts, the NLPG feature stipulates that, should the cash value falls to zero (or less than zero), provided that the policy owner makes a “minimum continuation premium,” the policy will not lapse.
Clients who can no longer sustain premium payments might also choose to purchase a single-premium, guaranteed UL policy using the accumulated cash value of an existing contract. Paul Lang, a financial advisor at Edward Jones, St. Louis, Mo., says he suggested this option for a retired client who needed to fund a special needs trust for a child.
“With a minor reduction in death benefit, we were able to provide [the client] with a new single-premium guaranteed UL policy that would cover what he needed for his son without the additional premiums,” says Lang.
For many, the appeal of chucking an old policy for a new one may hinge on the appeal of superior features and benefits. Competition and among carriers has intensified in recent years. And that has led to many new product innovations. Among them: more generous accelerated death benefits for the terminally ill, long-term care benefits, as well as return of premium and no-lapse protection riders.
Increased life expectancy, a concurrent decline in mortality costs, plus technology gains that have reduced underwriting and policy administration costs, have also yielded policy benefits, experts say.
At times, the argument for a 1035 exchange may be overwhelming. Games cites one case involving a policy that was due to reset in 20 years with a significantly higher premium. Because the policy owner was in good health, Games was able to buy with the policy’s cash value a new contract that doubled the old policy’s death benefit, but carried a guaranteed, level premium.
More often than not, however, Games argues against replacing a policy. The case for retaining a policy is especially strong, he says, where the policy is more than seven years old. The reason: the insured is much older, and thus any new policy is likely to carry a higher premium than on the old contract.
Sampson also warns of a temporary loss of earnings: The cash value of a permanent policy does not grow in the initial years after inception because the agent commission, underwriting and marketing expenses first have to be paid.
Also to be factored in, says Kevin Kimbrough, a principal of Saybrus Partners, Hartford, Conn., is a new policy’s surrender charge (the fee levied on a policyholder upon cancelling a policy); and the contestability period (generally the first two years of a contract, during which the insurer may deny coverage, void a contract or question the validity of a death claim).
As an alternative to a 1035 exchange, Kimbrough notes also that premium contributions to an existing policy could potentially be restructured to allay client concerns (as for example, about the sensitivity of a variable’s contract’s cash value to market gyrations).
“Instead of replacing the policy, the client could reallocate all or a portion of the premium from the variable subaccounts to a fixed or general account,” he says. “That might allow the client to feel greater peace of mind about holding the policy.”
Also to be considered in a policy review, say experts, are changes in tax law. Sampson points to legislation enacted by Congress in December that extended the Bush-era tax cuts and raised the lifetime gift tax exemption level to $5 million from $1 million. An existing or new policy, she says, might be ideal for gifting purposes.
Life insurance might also be the solution for tax-efficiently transferring to heirs required minimum distributions from an individual retirement account. Rather than take mandatory RMDs after age 70 1/2 , which many clients don’t need because they have other retirement assets, the distributions can be reinvested in a life insurance policy, thereby providing an income tax-free death benefit for heirs.
Doing Due Diligence
Whatever the policy recommendation for the client, insists Games, it needs to be supported by proper due diligence: a comprehensive review of the client’s financial situation; a full accounting of the pros and cons of proposed solutions; documentation of items discussed; and, not least, disclosure of potential conflicts.
“Advisors need to be transparent with clients,” he says. “They may recommend products from only one carrier because they’re captive agents. There is nothing wrong with that, but they must disclose the reason to the client.