Financial Underwriting Tips For The Estate Market
The Tax Relief Act of 2010, which was signed into effect in December, brought significant changes to the estate, gift and generation skipping transfer taxes. Much has already been written about the window of opportunity that exists in 2011 and 2012 because of the act’s dramatic increase in the exemption to $5 million and the potential for it to drop to $1 million in 2013 if Congress allows the act to sunset.
Many brokers have already started to engage their wealthy clients about the life insurance opportunities. Consequently, now is the time to review the importance of packaging your estate case from a financial perspective to achieving approval from an underwriter. Following are tips that can help you position your estate planning cases.
Describe the “Big Picture.” The place to start in an estate case is with a big picture description. The estate plans of families with significant wealth are often complex, frequently involving distributions to multiple generations through numerous trusts and business entities. To provide clarity to the underwriter you need to paint the picture of this distribution.
Part of the description to an underwriter should include an explanation of the estate objectives. It’s also helpful for an underwriter to have an understanding of the family tree. When an estate’s objectives and insurance purpose/ownership requires an understanding of trusts/business entities established by the family, make sure you provide sufficient details about these entities so an underwriter can make sense of the structure.
Provide a Net-Worth Statement. Problems often occur because sufficient financial data is not provided. This is especially true for clients with significant wealth because of the wide variety of assets they frequently own. You should try to provide a complete net-worth statement, including any business interest, benefit plans (qualified and nonqualified), interests in trust, patents, royalties, mineral rights, etc.
You may find that some clients will want to provide only the minimum amount needed to justify the amount requested. While it’s possible to achieve financial justification based on a less than complete net-worth statement, you will want to make sure that the statement is large enough to justify both the existing coverage as well as the amount applied for. Be aware that carriers require that financial documentation comes from an independent third party when the insurance face amount is over a specific amount (which varies by carrier).
Be Consistent. The application, cover letter and supporting data should all tell the same story. Conflicting numbers and statements need to be explained. Build your strengths, but don’t hide the negatives—explain them.
Reveal Team. When working with a client’s attorney, CPA and other advisors you will want to reveal their involvement in the planning process. This will provide independent credibility.
Provide a Clear Statement of the Life Insurance Purpose and the Owner/Beneficiary Structure. In the estate market life insurance sales generally fall into one of the following categories: estate liquidity, income in respect of decedent (IRD), charitable legacy, and dynasty trust. Clearly identify the purpose(s) that the life insurance policy will serve. Remember, there can be more than one need for the insurance. Be careful that the ownership/beneficiary structure you propose is consistent with the estate objective. Be aware that while it’s possible to have a business as an ownership/beneficiary, in an estate case you will need to provide an explanation of how the arrangement will work, because this structure can be misunderstood as a business case.
Be Clear about How the Face Amount Was Determined. If the amount you are requesting is outside the normal guidelines, realize that you will have to include supporting facts about why the normal parameters should be stretched for your particular case.
Following are some general guidelines to determining the face amount for specific estate needs (carriers will vary on specifics):
• Estate Liquidity Coverage. The face amount of coverage is typically based on an estimate of federal and state death taxes and expenses that will be incurred.
• Reasonable growth in estate assets in the range of 4 to 6 percent for 10 years is usually acceptable, but will be adjusted down for older/impaired insureds. Higher growth rates are possible, but additional explanation and documentation is often required.
• Future inheritances may be included if you can demonstrate/document that an inheritance is likely in the near future.
• IRD Coverage. The face amount of coverage is based on the projected income tax expected to be incurred on assets that do not receive a “step-up” in basis at the death of the IRD owner.
• Assets that do not receive a step-up in basis include: IRAs, qualified retirement plans, nonqualified SERP/deferred compensation plans, annuities, stock options and other forms of earned income.
• Underwriters consider the age of the client and the expected accumulation time horizon when determining the amount of IRD coverage that makes sense. If the client is in the IRD payout period (i.e., minimum distribution period) only a portion of the current IRD will be covered.
• Charitable Legacy. There are several ways life insurance is used in charitable planning. Consequently, a description of the underlying charitable technique will be critical in the underwriter’s assessment of the face amount of coverage.
• Wealth replacement trust for charitable remainder trust (CRT). Often life insurance equal to the value of the assets transferred to the CRT can be acquired.
• Making a gift of a life insurance policy for a charitable legacy is an appealing planning strategy because the donor is able to make a gift without reducing his estate or depriving his surviving spouse or family of an inheritance.
Depending on state laws, the gift can be structured in one of the following ways: transfer of an existing policy, payment of premiums on a policy owned by a charity, and charity as the beneficiary of a personally owned policy. Carriers have guidelines, and some are very restrictive about the face amount of coverage they permit. Typically the face amount is limited to a multiple of prior average annual donations times the donor’s life expectancy. When the donor has significant wealth, larger face amounts are possible, but additional explanation will be required to demonstrate why this makes sense.
• Dynasty Trust/Generation Skipping Trust (GST). The face amount of coverage is usually based on the expected estate liquidity needs of the insured.
• The underlying reason for acquiring life insurance in a GST trust is to leverage the exemption amount. Consequently, the sales approach usually focuses on the potential leverage provided by the internal rate of return on death benefit. This kind of presentation will often meet with resistance from underwriting where the focus is on insuring loss. So while the sale may be closed on the basis of leverage, you will need to tie the face amount requested back to an insurable loss.
Before you send your estate case off for review by the carrier, ask yourself if the underwriter will be able to make sense of:
• The face amount requested.
• The ownership/beneficiary structure.
• The funding arrangement.
When the plan is a little bit unusual, take care to provide details as to why it makes sense.
This material is designed to provide general information in regard to the subject matter covered. It should be used with the understanding that we are not rendering legal, accounting or tax advice. Any information in this document cannot be used by any taxpayer for purposes of avoiding penalties under the Internal Revenue Code