Life Insurance: An Efficient Way To Pass On Wealth

Life insurance has been a challenging financial product to manage in the last year or so and we have written often about the issues that surround this asset. But we also believe that this is a powerful financial tool. In our last blog entry we wrote about its use to mitigate the negative effect of a tax law change that may occur in 2017. At ITM TwentyFirst, we manage life insurance, we do not sell it. In fact, we are one of the few firms that manages life insurance without earning any compensation from sales. We show our support not just by managing in-force business as efficiently as possible for trustees, grantors, and especially beneficiaries nationwide, but also by pointing out the value of life insurance as a tool to efficiently leverage assets for the next generation, especially in a trust setting. We believe strongly that life insurance, when selected properly and managed efficiently, can be one of the most important assets a person owns.

For many insureds, the internal rate of return on a life insurance policy held in trust is appealing compared to alternative fixed investments, even if fixed interest rates begin to kick up a bit over the next few years. And the use of life insurance for older aged insureds can actually make the golden years more enjoyable by freeing up additional cash flow.

Here’s an example: A couple, both age 65, have come to an advisor for financial advice and estate planning as they enter their retirement years. Assuming that both are in good health (preferred, non-smoker underwriting), they could purchase a $1,000,000 Survivorship Guaranteed Universal Life (SGUL) policy from an A+ AM Best rated company for an annual premium of about $13,420. If you have attended any of our education sessions, you know that a GUL policy has a required fixed premium, one that, if paid in full and on time, guarantees the policy death benefit no matter what happens with interest rates or other market factors. (1) A survivorship policy, often used in estate planning cases, pays a death benefit at the second of the two insureds’ deaths.

If we calculate the internal rate of return (IRR) on the death benefit (2), in this example, we see that the policy’s rate of return (shown in spreadsheet to the right) is extremely attractiv1-irr-fixede. Even if the insureds do not pass away until their mid – 90’s, the rate of return on the premium funding the policy will be over 5%. Should death occur earlier, the rate of return will be much higher. Remember that a life insurance death benefit is received free of income tax and, if placed in a trust, is not subject to estate taxes. With this particular policy, the death benefit is guaranteed, locking in the returns. (3) What other asset can your clients purchase that will enable them to pass on wealth this efficiently?

For the client who wishes to maximize his or her retirement lifestyle while also leaving a legacy, life insurance can actually help to smooth out retirement income. Though an annual premium payment will have to be made to the trust (in this case, equal to 1.34% of the death benefit), the comfort in understanding that a known, completely tax-free amount will pass to beneficiaries at death can free up additional funds for retirement activities.

Life insurance is a powerful financial tool. When properly designed and managed wisely, it can create a legacy more efficiently than almost any other asset. As we mentioned in our last post….The next few years will provide challenges and opportunities for…advisors to help clients rethink their financial plans and goals. ILITs will remain a viable tool for leveraging assets.

  1. ITM TwentyFirst does not sell life insurance, nor do we advocate one type of life insurance. Every life insurance purchase should be based on the personal situation (health, cash flow, risk tolerance, etc.) of the insured. There is no one “best policy” for all situations.
  2. The IRR on death benefit is the net rate of return that would need to be earned if the cumulative premium were invested in an alternative asset.
  3. The policy death benefit is guaranteed as long as the premium is paid in full and on time. While market risk is eliminated, carrier risk must still be monitored.

Another Life Insurance Carrier is Sold…Why This Sale May Be Bad News For You and Your Clients

In the past year we have witnessed a number of transactions in the life insurance industry.  One of the largest was the sale last year of Hartford Financial Services Group, Inc.’s individual life insurance business to Prudential Life. That deal was a win/win/win. The transaction allowed Hartford to free up capital it felt could be better used in other areas. Prudential expanded its business line in a business it wants to be in. And the consumer won because the Hartford business and service has moved rather seamlessly over to Prudential. In fact, the Hartford name still exists in the marketplace, backed by Prudential, and is a very “competitive” product.

Last week we witnessed another transaction. This one is not being viewed as positively. According to a July 17th press release, “Allstate Corporation reached a definitive agreement to sell its Lincoln Benefit Life Company (LBL) to Resolution Life Holdings, Inc. (“Resolution Life”) for $600 million.”  The block of business will continue to be serviced by Allstate for 12-18 months, after which Resolution Life will take over.

Who is Resolution Life Holdings?  It is the US operations for a UK company, whose mastermind is Clive Chowdry, a well know British entrepreneur. This is Mr. Chowdry’s first deal in the US, and according to an article in the Financial Times, this deal has, “ signaled his ambition to do stateside what he first managed in the UK, namely to buy up and roll together a number of life assurance businesses and to run them for cash instead of hunting for new customers.”

The “runoff administration” business model that is employed at Resolution Life is not new and in this case is designed to close off a block of business and turn it into an “investment” that can be bought and sold.  While we will have to wait to see exactly what happens, this clearly does not seem to be a company (like Prudential) interested in developing a consumer oriented, high service model.  Many in the industry see the opposite…a company interested in wringing maximum profits out of a “closed” block of life insurance policies.

What are the issues for you, the trustee, holding LBL policies?

  • Service levels on Guaranteed UL Policies will more than likely drop making them much harder to manage. Lapses on Guaranteed UL products can be a profitable part of Resolution Life’s business plan. What is their incentive to providing good service levels to maintain these policies until eventual death benefits are paid?
  • The financial stability of Resolution Life, especially if you are holding LBL Guaranteed UL products in your trust portfolio with minimal or even no cash value.  Resolution Life is not currently rated.
  • Mortality charge increases in LBL non-guaranteed products.  I am working on a Blog citing a situation we have come across where another carrier has told us they will probably be raising their mortality charges dramatically before year’s end. In a recent insurancenewsnet.com article it was mentioned that insurers in general “will start to raise the mortality charges that are inherent in universal policies” because of marketplace pressures. In an entry about this transaction in lifeproductreview.com,  Bobby Samuelson, notes, “LBL’s contracts have a provision that eliminates surrender charges if policy charges are increased.”  Even so, keeping an eye on non-guaranteed policy charges on LBL policies going forward will be vital to your policy management program.  I have to think some increases are coming down the road.

ITM will be accessing this situation for our clients going forward and will update you on this Blog as developments warrant.

Are You Sure That Guaranteed Universal Life Policy Is Guaranteed?

Guaranteed Universal Life (GTD UL) policies have been a mainstay in the TOLI world, providing lifetime “guaranteed” coverage for a very cost efficient premium.  As our earlier Blog (Happy New Year……The Cost of (Some) Life Insurance Just Went Up) pointed out, GTD UL’s do not provide significant cash value, but in the TOLI world where low cost death benefit is important, they fit the bill.

The key to managing the GTD UL policy is to pay the policy premium in full and on time each and every year the policy is in effect EXACTLY as shown in the life insurance illustration.  Unfortunately that happens in a perfect world, not the TOLI world we live in.  In fact, one of our favorite online subscription publications (The Life Product Review) recently pointed out an audit just completed by a major name life insurance carrier that has sold GTD UL policies for 3-4 years.  They found that 31% of the policies they’d sold are already off track.  That is right…31% in less than 4 years.  The reasons?  8% because of insufficient premium, 29% because of skipped premium, but the majority – 53% – because of early payments.  Let me repeat…53 percent are off track because premium was paid early.  GTD UL policies have “shadow accounts” that you never see.  They lurk beneath the surface of the policy illustration.  As pointed out in this article, this particular carrier has different crediting rates in their shadow accounts depending on funding levels so paying early actually resulted in a lower credited rate. 

It was thought that GTD UL policies were fairly straightforward.  Turns out that is not the case.  Shadow accounts, contingent charges, premiums loads, all differ between carriers and their differences can have a dramatic effect on the outcome of a policy if premium is late, insufficient or even early.

So, what do you do if you are managing one of these policies?  First of all, make sure that when a grantor brings one of these policies into the trust, they clearly understand the gifting requirements for it….premium paid in full, on time, etc.  I’d recommend putting it in writing and making it a part of the trust file.  Secondly, make sure your trust administrators understand GTD UL policies.  Universal Life policies used to be flexible premium products, they are no longer.   Lastly, if you really want to manage these policies, you have to be able to “look under the hood”.  Not an easy proposition and a reason you need to have an insurance specialist on your staff.  

We will be discussing this issue in greater detail on one of our scheduled webinars this year as we believe it is an evolving problem that needs to be addressed.

Happy New Year……The Cost of (Some) Life Insurance Just Went Up

In the last decade, one of the most popular life insurance products has been the no-lapse guarantee universal life policy (note: for a white paper that explains the different types of life insurance go to http://www.youritm.com/Sites/17/docs/WP_MikeBrohawn.pdf).  With its low cost, guaranteed death benefit coverage over the lifetime of the grantor/insured, this product was tailor made for the TOLI market where the focus is usually on death benefit, not cash value. Because of this focus, the fact that these policies did not generate significant cash value was irrelevant for most people, and the death benefit guarantees made them very attractive, delivering the most bang for the buck. 

The internal rate of return on death benefit was impressive.  For example, a husband and wife, both aged 65 in good health, could purchase a survivorship no-lapse guarantee universal life policy that could produce rates of return on the death benefit of 7-8% at average mortality and rates approaching 4% even if the policy did not pay off until age 100.  Not bad, especially considering the death benefit was guaranteed. 

There are two main challenges for insurance carriers with this type of product. The first is the current, historically low interest rate environment. Remember that a life insurance carrier is really an investment manager.  They take your money, invest it and hand it back in the form of a death benefit (or surrender value).  The investments backing this type of policy are fixed investments.  It is clear that the Federal Reserve will keep rates low for the next few years, so there will not be much relief on a carrier’s general account which consists primarily of long-term bonds. 

The second challenge for carriers deals with changes to the reserve requirements that occurred January 1st of this year.  Carriers must set aside reserves for their life insurance policies.  For these guaranteed universal life policies, some carriers used shadow accounts and other methods to lower the reserve requirements on their policies.  Those who were “successful” had an advantage in the marketplace.  However, a few weeks ago the National Association of Insurance Commissioners (NAIC) issued revisions to the AG 38 reserve rules which had the effect of changing the carriers’ formula for these reserves, effectively increasing their cost.

What will be the effect on the marketplace?   We are seeing it right now.  Carriers are dropping costly lifetime guarantees on new policies that ran to age 100 and beyond, in favor of universal life policies that are guaranteed only to expected mortality, sometimes less.  Costs have gone up on most of these new policies, with some carriers raising rates 10-15% or more at some ages. 

Since the premium levels and guarantees are locked in for inforce universal policies, the consumer should not be hurt. However, reserve requirements will probably go up for the carrier, hurting the profitability on their block of guaranteed policies.   Some have worried about the effect this will have on carrier solvency.

The insurance industry is resilient and new policies will be developed to provide marketable products and solutions, but the age of the “low cost” lifetime no-lapse guaranteed universal life policy seems to be over.