Bill Boersma: On Life Insurance

I continue to be amazed at the willingness of consumers in the market to put life insurance transactions in force with no outside analysis and no evident level of sophistication. Here is a very simple example.

Recently I was involved in some planning where the annual premium was $150,000 a year on a full pay basis for the desired death benefit. At least 99 out of 100 situations I get brought into involve a level premium scenario because when one hits the button on the computer, this is what comes out and little further thought or analysis is brought to the table.

In this situation we have a 77 year old individual and we played around with the premium flow. We put together a scenario where we started the contract with $100,000 a year for the first five years and increased it to $125,000 for the next 5 years. So at age 87 we have saved $375,000 of cash flow or a 25% reduction in premiums from the typical approach. In the eleventh year we start paying $150,000 for five years. Now we’re at age 92 (life expectancy). From that point we pay $200,000 and the policy is guaranteed past age 100.

What is the result? Better than a 200 basis point increase in internal rate of return (IRR) at life expectancy. The break even on an IRR basis, ignoring time value of money, is age 100. Also, given inflation, the “increasing” premium schedule is really more of a level premium than the traditional level premium schedule which is more of a decreasing premium when you think about it.

Add in time value of money and it is a whole other ball game. If one takes the spread between the level premium and the increasing premium and puts it in a side fund at a reasonable return assumption, say 7 percent, the side fund is $820,000 by age 92 when any premium is due above the $150,000. The interest alone from the side fund can pay for the increase, resulting in a total amount available (death benefit plus side fund) which is 20% greater. This works well at much more conservative return assumptions and sings at better than return assumptions.

If your client is like many, they think they can do better than the insurance company anyway so why not give them the chance. I would clearly bring this strategy to the table only for clients with the appropriate financial resources and who you trust to manage it correctly.

The bottom line is that policy owners deserve a little more sophistication than they have traditionally been exposed too. They may not choose to go that route but I feel it is important to bring options to the table. They have gotten where they are by making astute financial decisions so why not help them to continue the track record?

As the founder and principal of Opportunity Concepts, LLC, a life insurance consulting and management practice, my days are filled working with policy owners and their advisors regarding many aspects of life insurance, from simple front-end, second opinions to in-depth, actuarially defensible analysis of portfolios of policies. This is the story of a “typical” engagement.

Clients and advisors seek me out for my fee-based approach to life insurance consulting. While there are great life insurance professionals who do a good job and bring tremendous value on a commission basis, some policy owners and advisors in the market have had experiences which leave them cynical. One answer is to pay a consultant for analysis and advice.

Not long ago I was brought into a situation by a respected estate planning attorney who was acting as the trustee for his business owner client. He told me that after years of hearing me preach the importance of policy analysis and management, he realized that as trustee he had a fiduciary duty to fulfill and he couldn’t lean solely on the work and advice of the agents involved, regardless of how well intended they were and how much he trusted them.

As always, we first had to introduce the fee-based concept to the client. The idea of paying for something which has historically been “free” sometimes takes a little getting used to. A little reflection produces the realization that this practice would be normal in many other consultations and the magnitude of the investment into the insurance portfolio at hand warrants such an expenditure.

The client’s existing portfolio consisted of roughly twenty policies from a handful of carriers sold by as many agents over the years. After spending time with the stakeholders to understand the nature and the goals of the planning, we reviewed the performance of the existing policies relative to earlier projections and relative to each other and we put this into perspective by exploring market alternatives. Diversification by carrier and by policy type was deemed important with the ultimate goal to maximize death benefit for estate planning purposes with cash value accumulation a secondary consideration.

At the end of the day, a relatively simplistic analysis determined that despite a multi-year drop in crediting rates across the board which resulted in more out of pocket premiums than originally anticipated, most of the policies were sound. A few of the policies would need some sort of remediation strategy in order to have any faith they would persist until policy maturity or even actuarial life expectancy and some of the policies simply didn’t fit the estate plan moving forward.

It became apparent that for this client in this situation, maintaining each of the existing contracts was not optimizing resources. Alternate policies available in the market offered greater death benefits both today and beyond life expectancy, granted more assurance that the death benefit would be there when needed and guaranteed that there would be no additional outlay of cash. Read more…