Life Insurance Analysis: an Art or a Science

October 8th, 2018 No comments

DECK: Is it worth taking an undue risk to save a few bucks? 

Earlier this year, I was introduced to a policy owner by his estate-planning attorney regarding the evaluation of a survivor life policy on himself and his wife.  It was a $1 million 1995 universal life contract that was underfunded due to decades of decreasing crediting rates.

Fundamentally, he wanted to know how the policy was doing, what it would take to firm it up and if the recommendations he’d received three years earlier from a nationally recognized life insurance consultant were correct.

It was a very straightforward task, and I was able to provide him the information he was looking for relatively quickly and easily.  It’s rare that I’m asked to opine on earlier analysis.  I pride myself on being objective, and I don’t hesitate to give credit where credit is due and the same with criticism.  However, a lot falls in a gray area.  Besides, am I being given the same input as another at a different time?

Prior Advice

In the end I disagreed with the prior advice.  In the situation at hand, the earlier consultant had strongly taken into consideration the current health of the insured individuals.  To be clear, this can be exceedingly important… within limits.  Does one really need to fund a contract to guarantee to age 120?  If the premium is within a couple of bucks to guaranteeing to age 100, why not?  If meaningful cash flow can be saved by reducing the guarantee to age 105 and no member of the family has ever lived beyond 85, maybe not.

Neither insured was deemed to be insurable at the point of the earlier analysis.  At the time, they were 83 and 86, and the consultant calculated their joint life expectancy at six years (actuarially, the wife living to age 89).  Original premium was $13,200 annually, and no premiums were being paid at this point.  The consultant stated that if the wife  lived to age 94, when the policy was projected to run out of money, the three subsequent annual premiums would be $99,000, $108,000 and $134,000 respectively and “Beyond that there is zero probability of her being alive.”

Finally, he states that when the probability of death before the end of the policy, assuming no premiums are paid, is put into context against the probability of death beyond that point when additional premiums are required, “… it is more actuarially prudent to pay no premiums.”

Actuarially Prudent?

This is where I have the issue.  Actuarially prudent.  Let’s think about that.  Assume you put one bullet into a six shooter revolver, spin the cylinder, point at your head and pull the trigger.  You have a one in six chance of making a mess.  Is there anything you could be offered that would make the 83.33 percent chance of coming away with your noggin intact worth it?  But isn’t it actuarially prudent to pull the trigger?  When the potential outcome is disproportionately negative, should that not play in to the decision making?  Especially when the cost of avoiding the negative outcome is relatively innocuous.

In this case, continuously paying an annual premium to keep the policy going would cumulatively cost much less than paying the very large premiums due if things didn’t pan out as expected and the cash flow is peanuts for these people.  This couple is now 87 and 90.  Saying there’s a zero probability of either of them living to a point that would destroy this life insurance policy (now only a handful of years away) is malpractice.

Winning the Spreadsheet Game

Just yesterday I was talking with the trustee on a policy for a 90- and 92-year-old couple.  I was the one who helped put that policy in place in the mid-1990s.  Back then, they were both unhealthy enough with cardiac issues to be rated on the contract. Maybe they didn’t get that memo, but if they did, they certainly weren’tpaying attention to it.  I see this over and over again; consumers advised or willing to save a few bucks to take on undue risk.

In a case years ago, I ran a test to see the difference in required funding of a policy for a contract to have cash value equal to death benefit at age 100 versus cash value going to zero at age 100.  In other words, what would it take to fund a policy soundly to be able to account for unexpected (or even expected) changes in market conditions and still be fine relative to building a contract on a razor’s edge that would collapse with minor variations between expectations and reality.

The premium of one was $10,000 and the other, $10,100.  Guess how many agents will go for the lower number to win the spreadsheet game.  Guess how many policy owners will do the same because… I don’t know, they’re uninformed or unreasonable?

Back in December of 2017 I wrote a piece that reflected on another analysis I was working on where I had an issue with the agent’s funding recommendation.  I found the agent’s assumptions too aggressive and I recommended a more conservative approach which basically meant paying more premiums into the contracts.  In the end I put together a simple decision tree juxtaposing my recommendation with the agent’s.  If the client went with my recommendation and I was right he would have his death benefit and if I was wrong he would have even more.  Going with her recommendation, if she was right, he would have his death benefit and if she was wrong, he wouldn’t have anything.

Is one recommendation technically right and one wrong?  Not really.  But the competing recommendation was based on static, theoretical data, guaranteed to be wrong, not a real world likelihood.  This is very difficult to get through to some people.

Consider Real World Aspect

One has to take another real world aspect into consideration; how much do consumers understand life insurance, and how willing should we be to assume they’lll make educated, nuanced and rational decisions on an ongoing basis?

Bill Boersma is a CLU, AEP and LIC.  More information can be found at www.oc-lic.com, www.BillBoersmaOnLifeInsurance.info, www.XpertLifeInsAdvice.com or email bill@oc-lic.com.

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Letters Of Explanation – Policy Funding Options

September 24th, 2018 No comments

Dear Mr. Client:

It was a pleasure to speak with you last week and I appreciate the opportunity to review your life insurance policy. Per our discussion, this note is intended to be a follow up summary of our conversation. If there is any additional information you were looking for which I have forgotten to include, or if you have questions about what I have written, please do not hesitate to get back with me.

Your $1,000,000 was originally an Alexander Hamilton policy which was acquired by Jefferson Pilot and subsequently merged with Lincoln Financial. Though I do not have the original sales ledgers, the original premium of $13,750 was likely calculated to maintain the policy indefinitely given the interest crediting and expenses assumption in play at the time the policy was issued in 1995.

Since that time interest rates have come down significantly; probably 300 basis points or more. For full post, click here…

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A Life Insurance Carrier Offer Your Client Can’t Refuse?

September 18th, 2018 No comments

Last week, I was contacted by an agent with whom I’ve had a long-term relationship regarding a question from a client. The client is a gentleman who’s the surviving insured on a $1 million second-to-die policy and he’s very old. His policy has little cash value and it may or may not last as long as he will without throwing a lot more money at it. In fact, next year the policy has no cash value and it’ll lapse in four years.

What initiated the call was something the client received from the carrier. It was an “Enhanced Cash Surrender Value” opportunity. The bottom line is that the insurance carrier is offering the policy owner a chance to surrender the contract for more money than the cash surrender value and, in this case, more than the gross policy cash value. For full post, click here…

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Letters of Explanation: Donating a Policy to Charity

August 16th, 2018 No comments

Good Afternoon:

It is my pleasure to be introduced to you.  Your accountant referred you to me because of the frustrating, yet required process when donating a life insurance policy to a non-profit.  I understand it is not pleasant to hear you won’t be getting the deduction you were expecting for your policy donation to the school but the process I will bring you through will get you everything you are entitled to.

Unfortunately, your cash value is not the number the IRS looks at when taking donations into account.  To think about it in a simplistic way, they aren’t eager to let you take a deduction for something you have never paid tax on.  In other words, the special rules which allow your life insurance cash value to grow tax free is what is preventing you from fully deducting that same cash value. For full post, click here…

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Life Insurance Premium Financing

August 15th, 2018 No comments

It’s too often improperly presented, implemented and managed.

I’ll start out by saying that I’m not opposed to premium financing. I’m simply a strong advocate for making sure it’s understood and done right. That being said, many of these proposals are not understood and can be misleading.

Fundamentals of Financing

First, it’s a good idea to look back to the general fundamentals of financing. Financing comes into play when someone needs or wants to purchase an asset of something but doesn’t have the money or the liquidity to pay the entire purchase price. Financing fills this void, not to get something that’s otherwise unaffordable.

We do this day in and day out. We finance our homes, cars, businesses, equipment and more. Generally, we can afford these things but the money isn’t readily available. Additionally, we often finance things we do have the money for if the financing provides a positive arbitrage to be taken advantage of. For full post, click here…

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Letters of Explanation – Trustee Liability

July 31st, 2018 No comments

This letter is to the management of a law firm.  Multiple attorneys act as trustees for clients.  There has been no program of management regarding these policies and I was called in to suggest a plan.  I was also able to look at redacted policy information and could see at a glance that many policies are underperforming and headed towards failure.  A decision was made that the attorneys deal with it on a case by case basis as they see fit.  I see this as a grave mistake.

Dear Firm Management:

It’s been a while since we’ve talked and the last time we did you mentioned the attorneys who are acting as trustees will be deciding independently on how to proceed.

I understand this but as we discussed earlier, if things go wrong (which they have and will) and result in a lawsuit, case law has shown that an independent third party is critical to a successful defense.  I am currently involved in four litigation support and expert witness cases, some going after trustees and some defending trustees. For full post, click here…

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Letters of Explanation: Whole Life Term Blend

July 25th, 2018 No comments

This letter is to a client explaining why the term blended whole life policy on his mother is failing:

Dear Mr. Client:

Unfortunately I still do not have what I requested from XYZ Life but I was able to do some work anyway.  Also, what I requested may end up being sent directly to the policy owner, which is you as trustee, at the address of record.

You had asked about potential income tax consequences regarding this policy and I believe there would be none as it looks like the gross cash value is less than what I calculate the basis to be in the contract.  I am waiting on a formal basis and gain calc from the company. For full post, click here…

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Success Story: Another Second Opinion

July 20th, 2018 2 comments

The attorney for a billionaire family called me one day at the behest of a mutual acquaintance. The clients were looking to procure $100,000,000 of new coverage and simply wanted a second opinion.

The couple worked closely with a large bank and their advisor had brought in the bank insurance specialist. I went in with no preconceived notion as I have seen many similar situations and in some I supported the transaction and others I stopped it. success-stories-logo

In this case the existing advisors had been doing a very good job. They seemed sincere and had looked at many angles. I am not sure how excited they were that I was brought in but they had to deal with me. I quickly realized they are among the “good guys” and all I did, after understanding the goals and objectives, was to challenge a few things, brought a couple of ideas to the table and offer some opinions. In the end, what they moved forward with was substantively what they had planned before I was in the picture. For full post, click here…

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Giving Life Insurance to a Charity

June 13th, 2018 No comments

Make sure clients understand rules before taking action.

Life Insurance and associated tax issues are complicated. When you throw charity into the mix, it can get downright diabolical. It’s not as much that the rules are so complex, it’s that they don’t make sense to the typical taxpayer/donor.

Recently, I had another call about appraising a life insurance policy donated to charity. The one thing these calls have in common is that the policy in question was donated a number of months ago and only well after the fact did the policy owner understand the “special rules.” Very few people understand the tax and deduction rules before they make the gift. This also leads me to believe that whomever the donor is dealing with at the nonprofit in question doesn’t really know the rules either. For full post, click here…

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Is Working For One Life Insurance Carrier Ethical?

May 23rd, 2018 1 comment

In some cases, agents may be crossing the line.

The life insurance world is certainly a lot different today than it was decades ago. Rather than just whole life and term insurance, there’s a wide menu of products available. Some products are driven by interest rates, some by market returns and some by indexes. Some are guaranteed while other aren’t.

Distribution models vary widely. There are internet marketing models, traditional agencies and independents who work though brokerage general agencies (BGA) that represent multiple insurance carriers, among others. One can get life insurance from financial advisors, banks, those predominantly in the property and casualty and health insurance market, traditional agents, etc. It seems the most unique way to get insurance today is through a dedicated life insurance agent. Times change. For full post, click here…

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