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Beware … Term Convertibility

September 15th, 2021 No comments

Categories: Beware Series, Life Insurance Tags:

Explaining Whole Life vs. Guaranteed Universal Life Insurance

August 10th, 2021 No comments

Hi Tim:

It was good to chat this morning. I understand what you’re looking for when you asked about articles comparing and differentiating WL from guaranteed UL products in the market. However, as I mentioned, what sounds so simple isn’t so easy to find.

I thought I’d take a stab at talking this through, and maybe this will be enough for your clients at this point.

My understanding is your client currently owns mutual WL. WL is a perfectly fine life insurance product but it comes in a number of forms, and I often discover that policy owners don’t understand what they really have. For example, one of the biggest misperceptions is that the policy they believe is traditional WL actually consists of a significant amount of term insurance. In fact, I’m currently working on a situation for a business owner in Grand Rapids who has a $1 million mutual WL policy from a well known and highly rated provider issued in 1990 with $1,000 of WL and $999,000 of term insurance. He had no idea. Given the precipitous drop in the interest-rate market and the accompanying drop in the carrier’s dividend rate that is crediting the policies, the policy is failing badly and will likely never pay the death benefit unless significant changes are made.

This is different from true traditional WL. However, many of those WL policies have some term blend, and this is greatly affected by the low interest-rate and low insurance dividend crediting environment. What’s exceedingly important for policy owners to understand is only the original WL portion of the policy had a level guaranteed premium. Many of my clients have discovered, much to their chagrin, that they have to pay significantly more premium, or more years of premium, than expected, and the cash value and death benefit isn’t growing to anywhere near original projections.

There are multiple types of permanent, cash value life insurance in the market. This includes the WL policies as discussed above, traditional UL, variable WL and variable UL, indexed UL as well as guaranteed UL and guaranteed variable UL contracts. There are additional products in the market with some unique nuances, and each of these contracts is available in a single life or survivor life format.

Most of my work with the business owner community is for trust owned life insurance to provide liquidity for estate tax planning and business succession planning. That being said, we’re generally focusing on death benefit type products more than life insurance contracts designed to accumulate significant cash value. It’s important to understand that you can’t really have your cake and eat it too in the life insurance world. It’s an ongoing game of horse trading, where you give up one thing for something else. For example, you may give up cash value for death benefit and premium guarantees. Some policies have more upside potential than others. Some perform better at different points in life. You generally can’t find something with low premiums, guaranteed premium and death benefit as well as significant cash value and upside potential.

In my market for my clients who look to life insurance for death benefits, we generally look at guaranteed products. Though guarantees are often associated with higher costs, that’s not always the case with life insurance.  Given that so much is riding on the death benefit coming to fruition for planning purposes, and the fact that these business owners are already taking significant risk in the balance of their estates, guarantees are very attractive. Also, given that they’re focusing on death benefit, they don’t put a lot of weight on significant cash value though they’d obviously take it all things being equal.  Many also value flexible premium products as their cash flow‘s can vary from year to year.  WL life products have limited flexibility while UL products have flexible premiums to an extent.

Given these goals, for the last two decades we’ve focused on guaranteed UL along with guaranteed indexed UL and guaranteed variable UL when available. These products have a guaranteed premium and a guaranteed death benefit and generally have been the lowest priced life insurance. Traditional WL without a term blend typically has a much higher premium, and it accumulates more cash value over the long term.  It likely has a growing death benefit so the projected internal rate of return on premium to death benefit at life expectancy may be similar but there’s big differences in how you get there. It’s neither right or wrong, just different.

However, given the financial dynamics of the market, insurance companies have had a difficult time making money on their money, and given some changes in the regulatory market, pricing for guaranteed UL products has generally increased over the years and many companies are no longer in that market at all.

My concern over this is reduced because of the continued availability of guaranteed variable UL products. Though it may seem like a contradiction, these products, though invested in the securities markets, have guaranteed premium and death benefit as well. They remain competitive because they’re not as dependent on the interest-rate markets, and they follow different regulatory rules. Also, an often overlooked but important aspect of these contracts is that the cash values are separate accounts, meaning that they’re separate from the insurance carriers and the creditors of those companies. Even if a life insurance company went out of business, the cash value in the separate accounts wouldn’t be on the table like cash value in traditional life insurance products.

In my experience, the premiums of these policies are very competitive, policy owners have a choice in how the cash values are invested among a wide variety of sub-accounts, both the premium and the death benefit is guaranteed and there’s upside potential if the sub-accounts do well over time. What I mean by this is, if the cash values grow enough, they’ll push the death benefits up over time so ultimately, there may be more death benefit than originally guaranteed.

In the market today, the product du jour is indexed UL. There’s a great story behind these products that many agents pitch. They’re touted as life insurance products having the upside potential of the market without the downside risk. While in a sense this is true, these are some of the most complicated products in the market, very few people, including advisers and agents, understand them and they simply don’t work like many people believe them to. I have done a tremendous amount of research, analysis and writing on these contracts, and I’m not a fan. I’m not going to get into details here but I’d be happy to discuss as deeply as anybody has an interest.

I’ve always said there’s not as much bad life insurance as there’s life insurance done badly. Also, many agents are heavily institutionally indoctrinated by the insurance company(s) they primarily work with. This has been one of the most eye-opening discoveries over the years. Insurance companies create all of their training and marketing around the products that they specialize in and want to sell so their agents do the same, largely because they have little other perspective.

Another segment of the sales market will simply follow the in product of the day that’s largely been developed and promoted and placed based on temporary economic dynamics of the financial markets. They sell what’s easiest to sell at the time and change when the circumstances do. I see this happen like clockwork. From the traditional WL policies of the old days to the development of UL in the high interest environment of the late 70s and early 80s to the variable life policies taking advantage of the hot stock market in the 90s to the guaranteed policies in the 2000s that were marketed to consumers tired of disappointment to the indexed policies with aggressive assumptions that look so attractive when the insurance companies realize they couldn’t support the pricing of their previous contracts. It can be demoralizing.

Given that the fastest growing aspect of my practice is litigation support and expert witness work, I get to see a lot of what’s going wrong in the insurance world. Something that’s a bit counterintuitive to many people is that it doesn’t matter how highly rated the insurance carrier is. They all have similar products based on similar investment portfolios that are sold to similar people by executives and agents with similar biases and incentives.

It’s exceedingly important to work with somebody who doesn’t have a connection to a given insurance company or an incentive to sell certain products.  An expert has to study the pros and cons of any given product and align it with the goals and objectives of a given client and the situation at hand.  That’s what I too seldom see in the real world.

In recent months, I’ve discussed with you the guaranteed securities based contracts because based on my expertise and experience, these are the products that best serve many of my clients. They won’t be right for every situation, and we have a large portfolio of companies and products to choose from if they aren’t.

As I stated initially, this isn’t what you were originally looking for but it’s the best I can do today. I’ll be happy to further research articles but I’m not sure that you or your clients are going to want to spend time digging deep into them. At the end of the day, facts are facts and numbers are numbers. I’ll be happy to run anything you want to see and put it up against anything else in the market. Objective black and white data is what your clients need.

Bill

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

The guarantees described in this letter are limited to the claims paying ability of the respective Insurance Company. Securities offered through Valmark Securities Inc. Member FINRA,SIPC

OC Consulting Group and its affiliates are separate entities from Valmark Securities Inc.

 

How a Life Insurance Policy Loan Can Surprise You

July 22nd, 2021 No comments

A ridiculous analogy to bring reality into focus.

Let’s assume your client’s financial goal is to accumulate $5 million for retirement. The stock market has been on fire and it’s suggested to do your client’s planning based on a 10% rate of return. Your client is 25 years old and has a 40-year time horizon. The numbers show they need to put away $10,270 a year to hit their target.

However, 10% turned out to be too aggressive and your client actually earned 7% but never really paid attention after the original plan was put in action. At that lower rate of return the client won’t hit their $5 million target and will only accumulate roughly $2.2 million. This will be devastating to their standard of living in retirement. In reality they need to be socking $23,407 a year away to hit their goal at the lower return rate. A feature of their planning that they never really understood, or maybe were never even told about, is that their financial planner has arranged for a third-party to automatically loan them the spread, over $13,000 a year, to make up the difference so they hit their target. After the plan is in place they never sign anything, don’t have to approve it, there’s no renewal process or required disclaimer; it just happens. The loan accrues indefinitely at an 8% interest rate.

Of course, this all sounds ridiculous and we know it doesn’t and couldn’t work this way. However, I’m crafting this particular and absurd scenario to be analogous to how many whole life insurance policies really do work, not theoretically, but in real life. Countless policy owners took out whole life insurance in the high interest and dividend crediting era of the 80s and 90s. Most of them had absolutely no idea how the policies worked. Many of them didn’t realize that these policies would fall short if crediting rates were reduced and, furthermore, they had no idea that there was an internal policy feature that was chosen on their behalf and often without their knowledge that automatically borrowed the require premium from the life insurance company without them even being aware of it. Often the loan interest rate was 8%, believe it or not, effective even today.

Getting back to our retirement example, the loan over 40 years accrues to $3,675,483 at age 65.  Because of the internal automatic loan program your client does have the $5 million in retirement savings earning the 7% that’s providing for their retirement, so where’s the rub?

Of course, the loan is going to continue to accrue interest. We’ll assume your client’s retirement fund side will continue growing at 7% and they’re taking 5% out for retirement income. In our example this means the retirement fund principle will continue growing at 2%. Just so you know, we’re still closely on track with the analogy of the life insurance policy and its loan.

What you probably see coming is that the $5 million retirement plan growing at 2% is going to be caught by the currently smaller loan that is growing at 8%, just as the insurance cash value is larger than the insurance policy loan. However, it takes less than six years for the loan to catch up with the plan balance. At that point, the loan can’t continue to accrue to a level greater than the plan balance because the plan balance is what’s collateralizing the loan, just like the cash value is collateralizing the loan from the insurance company. The hypothetical plan administrator will require the annual interest on the loan to be paid out of pocket or the entire transaction will go into default. That’s $448,000 a year. Of course this is ridiculous as that’s close to double the retirement income.

Pure Insanity

We all agree that this is insane all the way around but stick with me. No one’s going to do this so your client would walk away from the transaction. What would then happen is that the investments in your client’s retirement fund would be liquidated to pay back the loan. What happens then is that taxes are paid on the gain in excess of the $936,000 basis. But there’s nothing left to pay that tax because the plan principle was just used to pay off the loan, right? So there’s over $4 million of phantom gain on which taxes must be paid out of other assets your client may have and all of the retirement funds are gone and there’s no more income available to live on moving forward.

The insanity of this is almost comical and could be easily dismissed if it weren’t for the fact that this is how it works with life insurance and an unmanaged loan. Whole life policies, back in the day when dividend rates were in the double digits, projected an unrealistically modest out of pocket premium requirement that increased significantly when dividend rates were reduced, the same as our retirement example above. The additional premiums needed by the policy for it to persist were (unknowingly by most) borrowed from the life insurance company at a stated interest rate, often 8%. The loan balance quietly grew to a very significant amount but since it was less than the cash value that collateralized it, everything moved forward seemingly without issue. However, at a certain point the loan grew to equal the cash value collateralizing it so the insurance company required the policy owner to start paying more out-of-pocket in order for everything to stay in good standing.

Who Pays Attention?

What we know to be absolutely true in the real world is that most policy owners don’t closely review annual policy statements. Even if they did they wouldn’t and couldn’t project what was coming down the pipe.  Without an agent or another advisor specifically educating them on the details of the contract and running projections to illuminate the road ahead, they’d be running at full speed into a very dark tunnel.

I’ve seen this happen many times in the real world. Often the economic dynamics of this prove untenable and the policy owner decides to bail. When that happens, the cash value and loan significantly exceed the basis in the contract so when the policy is lapsed, gain is taxed at ordinary income tax rates. This is phantom gain but it’s taxed just like real money received.

As utterly ridiculous as this sounds, it’s how it really works but I seldom speak with anyone who understands it, including the professional advisor community. The death benefit is gone, the cash value is gone, other assets have to be liquidated or sold to pay the tax and there’s no policy or value left moving forward. I have been face-to-face with a life insurance policy owner literally bankrupted by this exact set of circumstances. This was a person who unknowingly ended up with a policy loan that caused a policy lapse that generated a tax due to the Internal Revenue Service that exceeded their entire net worth including the equity in their home. That there’s a system that even theoretically allows this to be a possibility is beyond me. This is so surreal that I realize there are people who are told about it and refuse to believe it.

Don’t let somebody say this can’t happen because it’s real life in the insurance world. Do you understand this? Do your clients understand this? Are you willing to risk that somebody else is paying attention? The consequences are too devastating to ignore.

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

Categories: Life Insurance Tags:

Q&A: Policy loans are often misunderstood

July 20th, 2021 No comments

A version of this question has been posed to me so many times, I’ve lost count.  Following is my answer.

Question:

How on earth do I have a policy loan when I’ve never taken any money out of my life insurance policy, let alone a loan?

Answer:

I understand your confusion as it seems almost impossible.  When they’re introduced to me, many policy owners seriously believe there is an error on the part of the insurance company.

That being said, this is not uncommon.  I more often see loans on traditional whole life policies than I do other type of life insurance contracts.  This is because there are multiple possible dividend options available and most policy owners aren’t aware of the decisions made on their behalf. For full post, click here…

Categories: Life Insurance, Questions & Answers Tags:

Premium Financing: Are the Numbers Real?

July 14th, 2021 No comments

Categories: BlogAnimate Tags:

Video: Do Dividends and Crediting Rates Mean Anything?

June 10th, 2021 No comments

Categories: BlogAnimate Tags:

Dear Mr. Client, We Need to Talk About Your Insurance

June 7th, 2021 No comments

An open letter to an indexed universal life policy owner.

Hello Mr. Client:

Thanks again for the recent phone call.  I’m glad your business associate suggested you speak with me.  I’ve received the information from your insurance company that I ordered, and I’m reviewing it now.  Based on our conversation, the bottom line is that I’m pretty confident this policy isn’t what you think it is.  It’s not that it can’t work but it’s likely not working and not doing for you what you understand it to be doing.

My recollection is that you have this policy for two basic purposes. First, you want a significant death benefit for your wife, and second, you’d like that premium to be accumulating cash value so you have access to it in the future. For full post, click here…

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How Many Ways Can You Write the ‘Same’ Life Insurance Policy?

June 1st, 2021 No comments
A policy can be highly customized, but make sure it’s built for the right party.

Recently, I was sent a life insurance proposal for evaluation that was mind boggling in its construction. Most of us understand that in financial transactions, we end up in a better place by reducing expenses and increasing crediting. This proposal did the opposite; it maximized expenses and minimized crediting. But it looked good, so the proposed policy owner was considering moving forward with it.

For full post, click here…

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The Sensitivity of Indexed Universal Life – Part 3

April 28th, 2021 No comments

The importance of conservative assumptions.

In two prior articles, I discussed the sensitivity indexed universal life (IUL) insurance. Now, I’ll turn to the practical aspects of what I covered previously.

Related: The Sensitivity of Indexed Universal Life – Part 1; The Sensitivity of Indexed Universal Life – Part 2 For full post, click here…

Categories: Life Insurance Tags:

Group & Association Term vs. Individual Term Insurance

February 18th, 2021 No comments

Categories: BlogAnimate, Life Insurance Tags: