There may come a time in an insurance policy owner’s life when they no longer have the same need for insurance that they did when they initiated the policy, or financial circumstances render such policies un-affordable. Ending the payment cycle on a term policy is as simple as not paying the premiums – like car insurance, the policy will only last up to the point where payments stop, at which point the policy will terminate. Of more import is the conclusion of an existing permanent policy. Considerations include
• the premium payments and how many more payments, or how many more dollars, will be required to pay off the policy
• whether the policy was under-performing (so that the policy is consuming itself until it lapses)
• whether there is cash value, and if so, the amounts.
The simplest alternative is to contact your broker and ask to cash out the policy. However, there may or may not be taxes due, and the death benefit will be gone.
There are two other methods that are worth considering – the Insurance Swapout Process™ and the Life Settlement Market.
Insurance Swapout Process™; The Insurance Swapout Process™ takes advantage of the tax regulations that allow taxes gained to be deferred or eliminated on the gain within a policy as long as the proceeds are used to buy a ‘similar’ policy. Similar means the same owner, insured, and beneficiary. Thus, the Insurance Swapout Process™ allows us to essentially ‘trade’ a bad policy for a better one. ‘Bad’ policies include those of the variable sort which have under-performed market expectations, or those issued before the current life tables which now grant more favorable premiums. For example, typically new mortality tables are established every decade which have historically granted longer life expectancy to the population. It is axiomatic that it will be cheaper to insure a person today on the new mortality tables because there is an expectation that they could live to a maximum of age 120. Versus a person on the older mortality table where it was expected a person would live to a maximum of age 100.
Further, advances in software modeling and increased efficiency (and competition) in the market have allowed (or forced) carriers to underwrite more modern policies with less ‘fat’ than older ones. Thus again, they increase benefits for the consumer.
It is incumbent upon the practitioner to inquire as to the existing policies of clients, whether sold by them or not. A CPA with an insurance license is not merely able to sell insurance – that CPA will be held accountable (pun intended) and held to a higher standard regarding insurance policies than a CPA without a license. That license may well become a liability. Accordingly, the practitioner MUST review policies – whether by himself or by bringing in an experienced life insurance agent who will then be able to ‘shop’ carriers for more efficient policies.
The authors stress the Swapout Process™ is NOT necessarily appropriate for every client or every policy – care must be taken to avoid abuse. Only when the client’s best interest is served should a Swapout be performed.
Efficiency can bring lower premiums for the same (or better) death benefit, or perhaps take existing cash value and eliminate the need for future premiums.
Should the actual underlying need for the insurance no longer exist, such as insurance used to protect a mortgage which has since been paid off, and the client no longer even wants the coverage, one option is to dump the policy in favor of the existing cash value. Most large, reputable insurance companies allow this option.
The industry is highly regulated, and many carriers still have black eyes from dubious practices in the recent past regarding cash values. Thus, they are extremely conservative. However, simply offering an insured the cash value of his policy may NOT be the sole option available to that consumer, and may in fact leave the adviser open to malpractice claims.
According to Joseph Maczuga, an industry expert:
“Almost 83% of the policies in force today
• are not functioning in line with the original objective of the client,
• were poorly designed in relation to premium deposit strategy,
• have high costs with low probability of success,
• will implode/lapse at an age that is much younger than previously illustrated,
• have not been annually monitored since issue,
• will contractually increase the premium, which the client will not be prepared for or understand…
This is the result of an industry that has not trained agents in the understanding of new paradigm (Universal Life and Variable Universal Life) structure. Similar problems exist with these policies that have secondary guarantees, as well as policies with heavy term blends and participating whole life.
I see a questionable level of professionalism in the methodology, design and application of life insurance policies by planners. To be fair, I also come across planning strategies and product integration that was well designed, communicated and implemented. But that is not the norm.”
Mr. Maczuga suggests:
• Accept the fact that there is an almost 83% probability that life and annuity policies owned by your clients are in trouble.
• Embrace the fact that almost 83% of the proposals that your clients will be exposed to will become problematic.
• Make a decision – Will you be passive or active in this arena?
• If passive, understand that what your clients have, or will buy, may not be advantageous for them.
• If active, require that your clients bring in their life and annuity policies for an inventory analysis. Also, communicate to them that you have an established resource for life and annuity issues and that they should consult with you before they purchase anything.
Use a Consultative Approach to Your Advantage. Most of the regulatory bodies are getting more concerned and sensitive about policy replacement, but replacements are still taking place with great frequency. In many cases, the initiative is to produce commission, as the summary analysis provided lacks depth and usually misses the factual issues. This is the transitional approach.
The problem for the client is that they are transferring assets (cash value) from an existing policy to that which may not be more cost efficient, but more importantly, introduces them into a new period of surrender charges and liquidity. When challenged, the agent/planner who proposed the replacement will be hard pressed to quantify the true economical benefits for the change and to justify any reasoning for the new commission and new surrender charges.
As an example: A 50-year old male, preferred non-smoker, has a $1 Million policy with $180,000 of cash surrender value. When an illustration is used to demonstrate the policy’s potential, it can make this policy appear an excellent choice. A chart for the policy having an assumed 6.5% interest rate makes the policy look a good choice, but the actual current interest rate was the minimum guaranteed rate of 4%. The high interest rate assumption initially used helped to cover up a very costly policy.
With a well designed policy, the first year guaranteed cash value can be in excess of the amount transferred. ($181,332 cash value on the $180,000 1035 transfer). This really comes home to roost if you look at a comparison with most typical policies.
A sidebar to this case is that the example policy is a continuous premium, which did not carry the policy as long as the new policy with only the 1035 funds. This difference would allow the client to save on an expense and he was free to fly around the country (or more seriously, invest in those policies no longer requiring premiums).